Change Order

What is a Change Order?

In real estate development and construction, a change order is a written agreement that modifies the original construction contract between an owner (investor/developer) and a contractor. It formally adjusts the scope of work, the project's cost, or the project's schedule. Change orders are an inevitable part of most real estate projects, ranging from minor material substitutions to significant design revisions or unforeseen site conditions. They ensure that all parties agree to the modifications and their implications, maintaining legal clarity and financial accountability.

Why Change Orders Occur in Real Estate Projects

Change orders can stem from various sources, often impacting the project's budget and timeline. Understanding these common triggers helps investors anticipate and mitigate potential issues.

Common Causes of Change Orders

• Unforeseen Site Conditions: Discovering unexpected soil issues, hazardous materials, or hidden structural problems during excavation or demolition.
• Owner-Requested Changes: The investor or developer decides to alter the design, add features, or change materials after the contract is signed, perhaps due to market shifts or personal preferences.
• Design Errors or Omissions: Flaws in architectural or engineering plans that require correction during construction.
• Regulatory Changes: New building codes, zoning ordinances, or environmental regulations introduced after the contract signing that necessitate project adjustments.
• Material Availability or Cost Fluctuations: Shortages of specific materials or unexpected price increases that require substitutions or cost adjustments.

The Change Order Process

A structured process is essential for managing change orders effectively, ensuring transparency and minimizing disputes. Here's a typical step-by-step approach:

1. Identify the Need for Change: A contractor, owner, or architect identifies a necessary modification to the original scope of work, cost, or schedule.
2. Submit a Request for Information (RFI) or Proposal: The party initiating the change typically submits an RFI or a formal proposal detailing the proposed modification, its necessity, and potential impacts.
3. Evaluate the Proposal: The owner and their project team (architects, engineers) review the proposed change, assessing its technical feasibility, impact on the project's goals, and cost-benefit.
4. Negotiate Terms: If the change is deemed necessary or desirable, the parties negotiate the specific adjustments to the contract price, schedule, and scope of work. This often involves detailed cost breakdowns from the contractor.
5. Formalize the Change Order: Once agreed upon, a formal change order document is drafted. This document explicitly states the original contract details, the proposed changes, the revised cost, the adjusted schedule, and any other relevant terms. It must be signed by all authorized parties.
6. Execute the Work: Upon formal approval, the contractor proceeds with the modified work according to the terms of the change order.

Real-World Example: Residential Renovation

Consider an investor undertaking a fix-and-flip project for a single-family home. The original contract with the general contractor is for $150,000, with a projected completion in 90 days. During the renovation, two significant change orders arise:

Change Order 1: Unforeseen Structural Issue

During demolition, the contractor discovers significant dry rot and termite damage in a load-bearing wall, which was not visible during the initial inspection. This requires extensive structural repair and replacement.

• Original Contract Value: $150,000
• Proposed Additional Cost: $12,500 (for materials, labor, and structural engineer consultation)
• Proposed Schedule Extension: 7 days
• Investor's Decision: After reviewing the contractor's detailed proposal and consulting with an independent inspector, the investor approves the change order, recognizing it as a necessary structural repair.

Change Order 2: Owner-Requested Upgrade

Mid-project, the investor decides to upgrade the kitchen countertops from standard granite to a higher-end quartz, believing it will significantly increase the property's appeal and resale value.

• Original Countertop Allowance: $4,000
• New Countertop Cost: $7,500
• Proposed Additional Cost: $3,500 (difference in material and installation)
• Proposed Schedule Extension: 0 days (can be accommodated within existing timeline)
• Investor's Decision: The investor approves, calculating that the $3,500 investment will yield a higher return on investment upon sale.

Project Summary After Change Orders

• Original Contract: $150,000
• Total Change Order Costs: $12,500 + $3,500 = $16,000
• Revised Total Project Cost: $150,000 + $16,000 = $166,000
• Revised Project Schedule: 90 days + 7 days = 97 days

This example highlights how change orders directly impact the project's bottom line and timeline, underscoring the importance of careful budgeting and proactive management.

Mitigating Change Order Risks for Investors

While change orders are often unavoidable, real estate investors can implement strategies to minimize their frequency and financial impact.

• Thorough Due Diligence: Conduct comprehensive inspections, surveys, and soil tests before purchasing a property or signing a construction contract to uncover potential issues early.
• Detailed Contracts and Specifications: Ensure the initial construction contract includes highly detailed plans, specifications, and a clear scope of work to reduce ambiguities.
• Contingency Budget: Allocate a significant contingency fund (typically 10-20% of the project budget) specifically for unforeseen expenses, including change orders.
• Clear Communication: Establish open lines of communication with contractors, architects, and project managers to address potential issues promptly before they escalate into costly change orders.
• Review and Approval Process: Implement a strict review and approval process for all change order requests, requiring detailed justifications and cost breakdowns.