We run a small office that does mostly high-end residential work and some light commercial work (in a wealthy suburb outside NYC). I've been worrying about the possibility of a period of high inflation (which people far brighter than me seem to say is coming) and it's effect on our office. Thought it might be an new angle for a discussion.
In a small office such as ours, we really just do a handful of projects each year - a new house taking roughly a year to design and another year to build. And we are having to be much more flexible on our fees - meaning more fixed fees and hourly work (with a fixed cap). The duration of a particular project under a fixed/capped fee scenario in a period of high inflation is obviously not a positive thing. The only thing that I can think of going into such a period is to try to have all new clients work on a percentage of construction cost basis, so that as commodity prices rise, so would our fees along with it.
Typically in these situations... you can use what's known as an "escalation clause" in your fee contracts. You must use an index that both parties can agree upon that's appropriate to your specific market.
I'm assuming that your firm is in NYC?
In that case, you want to itemize your expenses because some expenses may not reflect the index that you choose.
For instance, an index that's appropriate to NYC would be the year-to-year increases in rents. However, commercial properties do not increase as rapid as residential rent due to the long-term nature of commercial leases.
Other expenses like the cost of paper, electricity, printing or computers will generally not be in any way linked or correlated to the increase of residential rents in the course of a year.
In this case, you'd want to use the "escalation clause" on the cost of labor (staff, yourself) as the labor portion is directly related to the cost of housing if you choose to use this index.
That being said... you'd need to reference the average cost of rent at the signing and closing of the cost of rent.
As for the construction portion, you'd probably want to use a different kind of index or estimate.
The problem with Capital-A Architecture is that the design and documentation timeline is much longer than what's standard in other aspects of the AEC industry.
If you could forecast the market to find out what pine boards would cost in a year... perhaps commodities trading would be more lucrative than architecture!
There's all sorts of ways to lock in prices but I'm afraid I don't know much about bulk buying and delayed orders.
What I'd do is estimate the cost of the materials, spelling it out very clearly and then include a schedule of what these materials might cost when it comes time. That may be anywhere from a 1% to a 15% to even a -4% increase or decrease.
But plainly spell out that you're giving an estimate than in all likelihood is more expensive than reality. That way if you estimate a 6% increase and it's only really a 2% increase... well technically you're actually coming in under budget.
In that case, there's many possible clauses and expectations in a contract.
When dealing construction cost in contracts, you ideally want to set a point at which the contract can't be negotiated-- between a 1% and 5% increase. After prices jump over a certain amount, the clause in the contract can invalidate the whole contract and you may at that point negotiate a new contract.
You also want to insert a contract clause specifying dissolution in the contract regarding unforeseen circumstances-- hurricanes, tornadoes, earthquakes, civil wars, floods, volcanoes et cetera.
If you want to pursue escalations and renegotiations clauses, you should speak with a lawyer about developing a cut and paste template for future contracts. It also might not hurt to seek the advice of a knowledge accountant or financial adviser about which specific or relevant indexes you can use for determining how you adjust costs.
tyvek - ignore all that drivel spewing out of gc - he's more concerned about pumping his word count and trying to sound smart than actually offering anything remotely useful.
You're not likely to convince many clients to add an inflation rider to your contract. From a fee standpoint, the best you can do is make your own best estimates about what inflation will do over the life of the project and try to build that into your fee. It won't be easy.
The bigger risk is what will happen to construction costs and whether you'll be obligated by contract to keep redesigning until the project is in budget - the last time we experienced significant inflation that factor was the single biggest burden to design firms of all size.
Start talking now to your clients about the potential for inflation and the possible impact that might have on their project. Make sure they know we can't control prices - only scope and quality. Do your best to have them build in a decent contingency - sufficient to cover their scope and quality aspirations - before committing to move forward.
Inflation tends to breed litigation - somehow clients seem to think our firms should be responsible for covering shortfalls when their contingency is not sufficient to cover both their aspirations for the project and an unpredictable cost environment.
OP, your concerns are valid, but I'd be more concerned about commodity price rises killing off any kind of economic recovery state-side rather than the direct effect of higher inflation on your bottom line. Higher inflation, maybe even hyper inflation, has been in the cards since the Fed started effectively printing trillions of dollars to re-capitalize banks post-financial crisis, but since there was a multi-trillion dollar hole there to begin with, created by the collapse of the housing market and its derivitive bond market, all that money has effectively stayed with the banks - probably the biggest reason they've been doing so well the past two years. The increase in inflation we're currently seeing is a product of renewed consumer confidence and booming developing countries like China and is essentially a good sign that the recovery is taking hold.
All that said, things could still go to hell fast. So I'd follow won and done's advice and spend more time finding the work than how to bill for it, because frankly rising oil prices and an extremely unstable mid-east could doom us all back into collapse as early as this fall.
I'm deliriously tired (boo) because I'm unbelievably busy (yay!) though a lot of that busyness is networking for new work (meh). Point is, I may be way off with this comment.
We set our fee as a fixed fee that is a percentage of the Schematic/DD design. We also do high end residential, BTW, so our SD/DD are somewhat combined. So we fix our fee at 10% of an estimate made by a contractor on a given date. If his material price goes up or down, it doesn't affect our fee, but if his labor on a given piece changes - say we come up with a much more complex tile layout that the Owner approves even though it adds a bit of cost in labor - we adjust our fee up IF it also cost us significant additional time to design. If it doesn't cost us much more time, we just keep our fee at the percentage set at the DD cost estimate. If the Owner adds scope midway that cause us to design more, our fee goes up with the additional scope cost. Basically our projects are small enough and knowable enough that we rarely feel asking for more money is worth it, even if we end up doing a bit more work.
Because really, if the price of steel leaps up, that doesn't affect our design time at all. It does, however, effect the cost of groceries eventually, which is why I worry about inflation. We haven't raised our rates in a decade!
Inflation and the Small Office
We run a small office that does mostly high-end residential work and some light commercial work (in a wealthy suburb outside NYC). I've been worrying about the possibility of a period of high inflation (which people far brighter than me seem to say is coming) and it's effect on our office. Thought it might be an new angle for a discussion.
In a small office such as ours, we really just do a handful of projects each year - a new house taking roughly a year to design and another year to build. And we are having to be much more flexible on our fees - meaning more fixed fees and hourly work (with a fixed cap). The duration of a particular project under a fixed/capped fee scenario in a period of high inflation is obviously not a positive thing. The only thing that I can think of going into such a period is to try to have all new clients work on a percentage of construction cost basis, so that as commodity prices rise, so would our fees along with it.
Typically in these situations... you can use what's known as an "escalation clause" in your fee contracts. You must use an index that both parties can agree upon that's appropriate to your specific market.
I'm assuming that your firm is in NYC?
In that case, you want to itemize your expenses because some expenses may not reflect the index that you choose.
For instance, an index that's appropriate to NYC would be the year-to-year increases in rents. However, commercial properties do not increase as rapid as residential rent due to the long-term nature of commercial leases.
Other expenses like the cost of paper, electricity, printing or computers will generally not be in any way linked or correlated to the increase of residential rents in the course of a year.
In this case, you'd want to use the "escalation clause" on the cost of labor (staff, yourself) as the labor portion is directly related to the cost of housing if you choose to use this index.
That being said... you'd need to reference the average cost of rent at the signing and closing of the cost of rent.
be more concerned about finding your next client than trying to hedge against inflation, and i assure you, you'll be fine.
As for the construction portion, you'd probably want to use a different kind of index or estimate.
The problem with Capital-A Architecture is that the design and documentation timeline is much longer than what's standard in other aspects of the AEC industry.
If you could forecast the market to find out what pine boards would cost in a year... perhaps commodities trading would be more lucrative than architecture!
There's all sorts of ways to lock in prices but I'm afraid I don't know much about bulk buying and delayed orders.
What I'd do is estimate the cost of the materials, spelling it out very clearly and then include a schedule of what these materials might cost when it comes time. That may be anywhere from a 1% to a 15% to even a -4% increase or decrease.
But plainly spell out that you're giving an estimate than in all likelihood is more expensive than reality. That way if you estimate a 6% increase and it's only really a 2% increase... well technically you're actually coming in under budget.
In that case, there's many possible clauses and expectations in a contract.
When dealing construction cost in contracts, you ideally want to set a point at which the contract can't be negotiated-- between a 1% and 5% increase. After prices jump over a certain amount, the clause in the contract can invalidate the whole contract and you may at that point negotiate a new contract.
You also want to insert a contract clause specifying dissolution in the contract regarding unforeseen circumstances-- hurricanes, tornadoes, earthquakes, civil wars, floods, volcanoes et cetera.
If you want to pursue escalations and renegotiations clauses, you should speak with a lawyer about developing a cut and paste template for future contracts. It also might not hurt to seek the advice of a knowledge accountant or financial adviser about which specific or relevant indexes you can use for determining how you adjust costs.
tyvek - ignore all that drivel spewing out of gc - he's more concerned about pumping his word count and trying to sound smart than actually offering anything remotely useful.
You're not likely to convince many clients to add an inflation rider to your contract. From a fee standpoint, the best you can do is make your own best estimates about what inflation will do over the life of the project and try to build that into your fee. It won't be easy.
The bigger risk is what will happen to construction costs and whether you'll be obligated by contract to keep redesigning until the project is in budget - the last time we experienced significant inflation that factor was the single biggest burden to design firms of all size.
Start talking now to your clients about the potential for inflation and the possible impact that might have on their project. Make sure they know we can't control prices - only scope and quality. Do your best to have them build in a decent contingency - sufficient to cover their scope and quality aspirations - before committing to move forward.
Inflation tends to breed litigation - somehow clients seem to think our firms should be responsible for covering shortfalls when their contingency is not sufficient to cover both their aspirations for the project and an unpredictable cost environment.
LOL.
Word count?
Escalation causes are very common.
He asked "how do I control prices in face of inflation?" That's how you control it.
You however just toed around the question and gave a bullshit answer that sounds like it was ripped out of "Introduction to Pro Practice."
Yawn...
We should probably be more concerned with deflation than inflation. Most of us still have a long ways to go before hitting bottom, yo!
Is this a genuine concern?
If so, make sure you get paid in gold, diamonds, canned food, bullets, and toilet paper, yo!
doesn't fox news have a course on all this?
OP, your concerns are valid, but I'd be more concerned about commodity price rises killing off any kind of economic recovery state-side rather than the direct effect of higher inflation on your bottom line. Higher inflation, maybe even hyper inflation, has been in the cards since the Fed started effectively printing trillions of dollars to re-capitalize banks post-financial crisis, but since there was a multi-trillion dollar hole there to begin with, created by the collapse of the housing market and its derivitive bond market, all that money has effectively stayed with the banks - probably the biggest reason they've been doing so well the past two years. The increase in inflation we're currently seeing is a product of renewed consumer confidence and booming developing countries like China and is essentially a good sign that the recovery is taking hold.
All that said, things could still go to hell fast. So I'd follow won and done's advice and spend more time finding the work than how to bill for it, because frankly rising oil prices and an extremely unstable mid-east could doom us all back into collapse as early as this fall.
I'm deliriously tired (boo) because I'm unbelievably busy (yay!) though a lot of that busyness is networking for new work (meh). Point is, I may be way off with this comment.
We set our fee as a fixed fee that is a percentage of the Schematic/DD design. We also do high end residential, BTW, so our SD/DD are somewhat combined. So we fix our fee at 10% of an estimate made by a contractor on a given date. If his material price goes up or down, it doesn't affect our fee, but if his labor on a given piece changes - say we come up with a much more complex tile layout that the Owner approves even though it adds a bit of cost in labor - we adjust our fee up IF it also cost us significant additional time to design. If it doesn't cost us much more time, we just keep our fee at the percentage set at the DD cost estimate. If the Owner adds scope midway that cause us to design more, our fee goes up with the additional scope cost. Basically our projects are small enough and knowable enough that we rarely feel asking for more money is worth it, even if we end up doing a bit more work.
Because really, if the price of steel leaps up, that doesn't affect our design time at all. It does, however, effect the cost of groceries eventually, which is why I worry about inflation. We haven't raised our rates in a decade!
donna, do you run hourly until the DD contractor's estimate comes in?
some day I really would love to sit down with you and talk shop.
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