3 Steps to Master Cost Estimation for Tenant Improvement and Strategic Projects
Strategic Projects, cost estimates and financial decisions
A significant number of organizations authorize commercial construction and tenant improvement (TI) projects as a means of executing their business strategy. Whether in car dealerships, retail spaces, offices, or medical clinics, these projects aim to refresh branding, improve workspace aesthetics, or meet growing demands. Whether the space is leased or owned, TI, fit-out, or renovation projects are usually a necessity for businesses.
Some organizations may have in-house resources such as customer relationship managers (CRMs), interior designers, or architects who can collect initial requirements, develop a functional and technical program, and, most importantly, develop a scope of work, including sketches and layouts to be submitted for approval. The key milestone here is the decision to authorize the project or not. Every business decision has financial implications because it requires the allocation of business resources. Thanks professor Aswath Damodaran, a professor of finance and valuation, for continually emphasizing on this point.
For your potential commercial construction or tenant improvement project, how much budget is required? What is a cost estimate? What supporting documentation can be provided? The objective of a cost estimate report is to provide a client with data so they can make an informed decision about their project. The cost of the project and its output value need to be aligned with business strategy to allow a favorable financial decision. Once one configuration of the future space is acceptable, there is a need to develop its cost estimate. It is simple exercise but may seem complex to others. You need to understand the process and the first principle behind cost estimation.
Strategic approach to cost estimation: the main steps
Step 1: Define the Purpose of the Estimate
This is crucial and will help you focus on what is required to achieve the goal. Do you want to have an order of magnitude of the cost, or do you want a second opinion? These questions and more establish the goals, dictate the level of accuracy, and potentially impose the level of project definition and the methodology required. Keeping in mind that there are five classes of estimates, in practice at least in North America, including the US, Canada and Quebec. Order of magnitude or class 5 estimates are faster to develop than other classes of estimates in the following order: class D or class 4, class C or class 3, class B or class 2, and class A or class 1.
Step 2: Assess the Project Degree of Definition
Now that you know the purpose of the estimate, you need to assess the level of definition of the project, including drawings and specifications. If you require a class A estimate, architects and engineers must develop drawings up to 70% completion or more. If that is not the case or not feasible, go back to step 1 and revise the purpose. If you have more information than you need, just take what is needed and take note for the report.
Step 3: Determine the Methodology
Cost estimates can be developed using a top-down or a bottom-up approach or a combination of both. They may involve analogous, parametric, assembly, and detailed cost estimating techniques. The key parameter here is the level of effort required. Some are faster techniques, while others are not necessarily so. Five processes characterize the methodology:
Reviewing the Scope of Work: Collecting the requirements and understanding what needs to be done.
Developing the Work Breakdown Structure: Subdividing the project work into smaller and more manageable components and activities.
Estimating the Quantity of Resources: Determining the quantity of material, labor, and equipment required to complete each activity.
Pricing Each Activity: Using historical data and bids to find the monetary value of resources or costs to complete each activity.
Adjusting, Aggregating, and Reporting: Accounting for project specifics and special conditions, aggregating all costs, and most importantly, developing a cost estimating report.
Importance of the Cost Estimating Report
Developing a cost estimation report is critical. It serves as a cornerstone of successful project delivery, easing decision-making for project sponsors and helping them allocate resources efficiently. The report provides high-level information about the project, including key assumptions, limitations, exclusions, methodology, the basis of the estimate, reference documentation, high-level risk analysis, and the conclusion.
One of the first things executives usually look at is the conclusion, which offers a professional opinion on the probable costs in just a few lines. If the decision is made to move the project forward, the report becomes a cost measurement baseline. Because your cost estimate must be falsifiable, it needs to be documented and reported with the rigor of any scientific endeavor.
Here are some valuable pieces of advice:
"If you don’t know how it is built, you may not know how much it would cost."
"If you can't break it down into simpler elements, you may not be able to understand it."
"An estimate is usually false for two reasons: scope issues and pricing issues."
"An estimate is usually the cost measurement baseline, CMB, for project execution."
"Money always flows from the client to the contractor, with the client inclined to underestimate costs"
"The present is the past rolled up for action, and the past is the present unrolled for understanding" – Will Durant.
By following these guidelines, organizations can ensure they develop accurate and reliable cost estimates for their tenant improvement projects, facilitating informed decision-making and successful project execution.
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Reach out to Xenofan Consultants Constructions today and see how our expertise can turn your vision into reality. From planning to execution, your project delivery experience is our priority.