The hard truth about soft costs is that they can either make or break a construction budget. In order to accurately plan a construction project, a contractor must account for both hard and soft costs. While soft costs often get glazed over during estimates, the truth is that they can represent a significant portion of a project’s total price tag. Here’s a quick guide to making sense of soft costs.
What Are Soft Costs in Construction?
Construction soft costs are “indirect costs” that aren’t directly tied to a project. The term soft cost is typically synonymous with being “intangible.” While some soft costs are set costs tied to simply operating a construction business, others vary from job to job.
Soft costs affect the price of completing a project from the pre-planning stage to the occupancy stage. It’s not uncommon for construction soft costs percentage to be as much as 25% of a project’s total budget.
Soft costs are important because they’re easy to overlook. When crafting quotes for clients, it’s easy to want to brush off soft costs in order to reduce estimates. However, soft costs don’t go away just because they’re often “invisible” costs.
Soft costs are also important because they help to determine your company’s profitability over time. For instance, underestimating the cost of paying for insurance over time can cause your company to lose money on every project if insurance isn’t being properly factored in as a soft cost.
Construction Soft Costs vs Hard Costs
Construction hard costs are easier to focus on because they’re the ones that create “sticker shock.” What’s more, the scheduling and ordering needed to ensure that materials and labor are available when it’s time to start a job keep them at the forefront of the mind. Hard costs are often called brick-and-mortar costs. By contrast, soft costs are more “passive” costs.
What are hard costs in construction? Hard costs represent the costs associated with procuring materials, labor, and equipment needed to complete a project. Hard costs are anything considered direct construction costs necessary for breaking ground on a project. Once the specifications of a project have been completed, it’s easy to accurately calculate anticipated hard costs for a project.
Common examples of hard costs in construction include lumber, steel, nails, roofing, siding, plumbing materials, electrical materials, and masonry materials. It’s not uncommon for hard costs to represent 50% to 70% of a project budget.
While hard costs allow contractors to break ground on a project by providing the labor and raw materials needed to build something, soft costs allow you to maintain the business status needed to have the legality and capital to actually obtain the materials that represent your hard costs.
Typical List of Soft Construction Costs
Soft costs are built into all of the nooks and crannies of operating a construction business. Here’s a construction soft costs list (examples):
- Inspection fees.
- Permits and surveys.
- Office equipment.
- Office software.
- Loan interest.
- Accounting expenses.
- Insurance fees.
- Taxes on projects based on local and state assessments.
- Architecture and design fees.
- Marketing costs for recruiting clients and workers.
- Legal fees.
- Bank transaction fees.
- Construction loan commitment fees.
- Professional liability insurance.
- Safety and security for workers and job locations.
- Geotechnical studies.
- Architectural fees.
- Land survey fees.
- Engineering fees.
- Traffic surveys.
- Environmental impact assessments.
- Security and safety staff.
While equipment rentals are considered hard costs by default, equipment rentals tied to your ability to do business are filed under soft costs. This can include something like a rental trailer that serves as a remote office during a long-term construction project.
In some cases, contractors take on post-completion project soft costs. These can include lingering legal fees, sales fees, leasing fees, repairs and maintenance, ongoing security, insurance, taxes, and building-management fees.
If you still need more clarification on soft costs vs hard costs, this video does a great job of breaking it all down in just a few minutes.
Emerging Soft Cost: LEED Certification
In recent years, construction firms and contractors have had to keep up with a new soft cost that is both costly and difficult to navigate. Construction laws are increasingly putting pressure on contractors to adhere to LEED (Leadership in Energy and Environmental Design) certifications for buildings.
As you can see from the fee schedule provided by the United States Green Building Council, registration and certification fees to local and state agencies for LEED Certification can add thousands of dollars per year to a contractor’s operating budget.
LEED registration is a flat fee that is paid fully at the time of registration. Next certification fees are priced based on your project’s rating system, gross floor area, and review timeline. LEED certification fees include both preliminary and final reviews.
If you are compelled to use LEED certification, it’s important to make the fee schedule an important piece of data that is worked into your pricing roster. Due to the “membership nature” of LEED certification, all costs associated with the LEED certification process should be considered soft costs that must be factored in when calculating both business-related soft costs and project-specific soft costs.
Construction Soft Costs as Percentage of Overall Cost
Soft costs can account for up to 30% of a project’s budget. However, it is possible for contractors to whittle soft costs down by making operations as efficient as possible. Yes, it’s true that fees for permits, insurance, and taxes can’t be controlled. However, project management fees certainly can be controlled.
How to Reduce Soft Costs
Making cost-efficient decisions early on in the planning stage can set a contractor up for reducing soft costs across the board. Accurate budgeting and costing from the start allows the contractor to communicate expectations clearly with the client. This reduces the need to do, undo, and redo aspects of a project.
Get a Grasp on Scope and Complexity During an Initial Consultation
It’s important to discuss realistic parameters for project scope with a client from the start. Having clear, achievable expectations set in stone allows a contractor to move forward with permitting and site testing without the need to constantly go back to expand project parameters based on a client’s changing mind.
It’s important to know if you need to charge more for overly complex designs from the start instead of eating into your soft-cost budget as the project progresses.
Track Every Dollar in the Budget Using Software
Soft costs need to be assigned to each project in two ways. The first is by adding project-specific soft costs into your estimate. These are costs tied to permits, taxes, and consultants that are being incurred directly by the job you’re costing out.
The second is by adding cost-of-doing-business soft costs into your estimate. These are your global business costs.
Each job you take on needs to cover some portion of your total cost for operating your business. Ideally, your business plan should allow you to have a predetermined number that tacks on a certain percentage to each job to ensure that all of the business costs running in the background will be covered to keep you out of the red at the end of the fiscal year.
Use Crystal-Clear Communication
Poor communication can take a hard toll on your soft costs. Communicate regularly with workers, subcontractors, and the client to ensure that everyone is on the same page with both costs and operational decisions. When stakeholders aren’t communicating, miscommunication should be expected. This can eat into your soft costs in the form of wrong decisions, poor choices regarding which vendors to use, and inefficient scheduling.
Prevent Change Orders
Change orders eat into soft costs because alterations often require additional assessments, input from consultations, permit changes, and tax changes. When these changes haven’t been factored into the initial budget, you may find that your per-project soft costs quickly get out of control. This is before you even consider the increase in hard costs endured with every change order.
Keep Track of Who Is Doing Work for You
Managing workers and subcontractors effectively is an important part of maintaining accountability for project costs. The sheer task of managing timesheets and travel costs can feel like a second full-time project that you’re performing parallel to the actual project.
Clear scheduling that lets everyone know who is showing up, when they’re showing up, and the tasks on the roster for the day can ensure that estimates for soft costs stay accurate as a project progresses.
Estimating Construction Soft Costs
Soft costs must be factored into each project estimate alongside hard costs. The reality is that pinning down these costs is a difficult task. In order to properly price out soft costs for each project, contractors must use a combination of construction industry knowledge, past project costs, and pristine budgeting.
One problem that contractors often bump against is that clients don’t necessarily acknowledge soft costs. While a client can contextualize the cost of lumber by square foot on a spreadsheet, they may not understand why “extra” costs should fall on their shoulders. In fact, many clients assume that permits, taxes, and insurance are simply costs that should be absorbed by the contractor.
This is where factoring in soft costs from the beginning becomes important. It’s very easy for a client to feel like you are springing unexpected costs on them if soft costs aren’t itemized alongside hard costs in an initial estimate. To do this, you need to know how to properly quantify soft costs. Here are some strategies for quantifying and estimating soft costs.
Create a projected annual operating budget that covers all operating costs and expenses. This budget will be used for determining how much profit you need to make on each project to cover operational costs before profit is even considered.
Update your operating budget monthly based on cost increases tied to office rent, taxes, insurance, and other floating costs.
Create an itemized list of project-specific soft costs. This includes permits, security, time/cost spent recruiting workers, and consultancy fees. All of these costs together will represent a single “soft cost” that can be placed as an item alongside hard costs.
Cost Codes
It’s also important to talk about using cost codes for soft costs. Most contractors already know that it’s important to use cost codes for quantifying hard costs.
Construction cost codes are standard codes that allow construction companies to divide costs into specific categories that are assigned to specific divisions. Cost codes are dynamic. That means that they update based on data that is fed into the system in order to provide the most accurate, up-to-date pricing based on the date an estimate is submitted.
Cost codes allow contractors and construction firms to see exactly how much specific jobs or tasks will cost in relation to the entire budget.
Contractors have the ability to use customized soft-cost codes within their systems for construction codes to make the process of adding soft costs more dynamic.
Factoring Soft Costs Into Your Budgeting
The secret to not losing money on soft costs as a contractor is to know how to combine fixed soft costs with variable soft costs.
Soft cost can be managed by having a policy of keeping a predetermined percentage lump-sum amount aside for each project that will cover your “permanent” soft costs. Having this sum set aside will ensure that you are able to begin projects without the need to seek funding. However, the lump-sum amount that you set aside may not be the final figure that you need for the project.
Next, you must do accurate job costing that includes project-specific estimates for soft costs. Price out permits, design fees, inspection fees, project-management fees/ loan/financing fees, consultant fees, and study/testing fees for every project while developing a cost estimate for the client.
Your permanent soft costs related to your cost of doing business combined with project-specific soft costs is the true figure for soft costs that must be attached to a project estimate.
Contractors lose money when they ignore soft costs. When offering bids, there can be a temptation to ignore soft costs simply because they can be “brushed off” in a way that hard costs can’t be brushed off. Many contractors make the mistake of kicking the soft-cost can down the line when they first start off out of a desire to be able to beat their competition.
Of course, soft costs will eventually catch up with you unless they are properly addressed with every bid and estimate. This usually comes in the form of having operational costs that you can’t cover using profits generated from the bids that have been accepted.
How do you factor all of your soft costs into bids? The first step to factoring soft costs into bids is determining your profit objective. Minimum profit objective for any construction project should be at least 8%. If a project doesn’t allow you to hit that goal of 8% based on the bid you’re providing, taking on this project may not be worth the time and effort.
Ideally, the profit objective for any project should hit 10% to place you in the “average” range. However, striving for 15% is considered ideal for long-term viability as a contractor.
Having a minimum profit objective in mind when crafting a bid allows you to adjust your soft costs based on your desired return. You can work backwards using both your fixed (ongoing) and variable (project-specific) soft costs to see how much of your soft costs need to be transferred to the client in order for you to hit your profit target.
Seeing an example of how much soft costs can influence the already-tight line between profit and loss can help to drive home the importance of factoring it into a bid. Take a look at soft costs in action.
Based on the most basic contractor profit calculator, revenue minus your overhead equals your job costs and profit.
Let’s say you bring in $50,000 in revenue on a job. Your overhead for this particular project was $10,000. Subtracting $10,000 from $50,000 leaves you with $40,000 that represents jobs costs and profit.
Next, you need to subtract your job costs to arrive at your profit. If all of your job costs total $35,000, you’re subtracting $35,00 from $40,000 to be left with a profit of $5,000. This is a 10% profit margin.
As stated at the beginning of this article, construction soft costs percentage often reaches 25% of a project’s budget. What if the contractor in the scenario above hadn’t added soft costs into the original bid? They would need to then take 25% out of the $5,000 profit margin to cover those costs. This would create a $3,750 profit margin that is far below the 10% minimum that is recommended for business viability.
