We all know that without risk there won’t be much reward. We also know that overstepping that risk/reward line can be detrimental to a business. The trick is to develop your construction company risk assessment plan to assess and minimize the downsides while maximizing the returns and protecting the business. For company owners and managers, construction risk management, like any other business or technical skill, can be mastered. This guide will help you do just that.

What is construction risk management?

While there are many risks in construction projects to consider and prepare for, there are three major negative risks in construction projects that stand out: financial, legal, and schedule risks. To effectively protect your construction business, this guide recommends implementing specific strategies for preventing unnecessary risk in the first place, as well as best practices for mitigating unexpected risks mid-project .

Positive vs. negative risk

When most construction pros think of risk, they think of negatives: financial risk, such as budget overruns; contract risk, such as disputes over terms; schedule risks, such as delays, and so on. But construction projects can include  positive “risks” too — better understood as unforeseen factors that have a beneficial impact, such as unexpectedly lower material costs. By taking the time to identify the potential positive and negative impact of certain risk factors, your resulting risk management plan will be more robust.

Responsible parties

There are usually several responsible parties in any construction project aside from the general contractor, including the property owner and any other stakeholders, as well as the architect, engineer, and subcontractors. Each party’s role should be outlined in the construction contract, and as our Houzz legal expert Jihan Spearman suggests: “Each party should be properly licensed and have the proper insurance to cover their respective areas.”

How risk management pays off

Risk management can help you avoid the negative consequences of unexpected issues, helping protect your profit margins, worker safety and client satisfaction.

Your blueprint to the risk management process 

Developing a risk management plan for a construction project takes an understanding of the concept, a system and relentless follow-through. 

Risk identification

The first step in managing risk is to know all the possible types and consider which ones apply to your project. Identifying, evaluating and ranking the likelihood and potential impact of each of the risks below should be completed prior to the start of the project. With this information, a prioritization list can be compiled as to the impact each individual risk could have on the project. By creating this list, you will develop a clear risk assessment framework and aid in the decision making for proper resource allocations.

Common construction project risks

Among the top liabilities in construction projects are what I call the Big 3: financial impact, delays and legal issues. Although each is independent, they all relate back to and ultimately have an impact on the financial success or failure of not just the individual project but the company as a whole.

Let’s go through the Big 3 one at a time.

1. Financial and Cash Flow Risk

This is far and away the most critical risk to a construction company. This risk can stem from many factors, including improperly estimating the true cost of a project, hiring the wrong people or subcontractors for the job and everything in between. Understanding this risk, knowing the dos and don’t of cash flow management, and developing systems to minimize the negative outcomes the company will experience are essential.

2. Schedule Risk

Project delays happen for a variety of reasons, but the primary reason is a lack of planning. They say in real estate the three primary drivers of value are location, location, location. I’m here to tell you that the three primary drivers in the success of a project — or a business, for that matter — are planning, planning and more planning. A carpenter would never start building anything without an accurate drawing. Yet we sometimes begin demolition before we have complete designs and specifications. This practice almost always leads to confusion and disagreements as the project unfolds, ultimately causing delays. Simply put, poor project planning, in order words “don’t start until all items are ordered.” 

Other common construction project delay risks are permitting and inspection delays, material delays, design changes, site conditions and client-caused delays. Additionally, weather, skilled labor availability and subcontractor scheduling can all have a hand in delaying a project. Although a few of these are out of our control, the vast majority are the result of poor planning. 

3. Contractual and Legal Risk

These pose a significant challenge to any construction company. As part of mastering construction risk management, there needs to be time spent assessing legal issues and how they can affect the company. Failing to recognize these risks or simply keeping your head buried in the sand can lead to disputes, emotional distress, financial losses and even regulatory penalties. Some key legal risks for consideration are contract or payment disputes, regulatory and safety violations and construction workmanship and defects.

A few best practices for legal risk management in a construction business are having clear and comprehensive contracts and specifications, ensuring compliance with local laws and regulations, and having a dispute resolution plan in place. Houzz legal expert Jihan Spearman also suggests: “have the homeowners contract directly with all of the people they hire, have the homeowner buy remodeling insurance, make sure they have proper home and renters insurance, security cameras during construction, to help you stay in control of your processes.”

It is relatively easy to see the interconnectivity of the Big 3 and how they can have a harmful financial impact on the business and affect the overall health of the company. As an example, delays generally lead to increased job costs and unhappy clients, causing a negative impact on the outcome. Delays can also lead to legal issues, further affecting the profitability of the project. Legal issues on their own have not only a financial impact on the business but cause emotional stress for the owner(s) of the company that can impact other areas of the company.

In addition to the Big 3, there are a number of other secondary risks that have to be taken into consideration. 

• Client or stakeholder risk. In a remodeling or construction project it is easy to have misaligned expectations between the parties around cost, quality or time. In most cases, the client gets to choose any two of the following three: low cost, high quality, shorter time frame. If misalignment happens, it can be detrimental to the project and those involved.

• Safety risks. Safety risks can occur operationally, such as with a nonstandard jobsite like a hillside or even as labor risk with an under trained workforce causing delays, rework, cost escalations or possibly worker injuries. At any rate, these all tie back to an insurance risk. For more tips on mitigating construction safety risk, check out our detailed guide on Everything You Need to Know About Site Specific Safety Plans in Construction and download our free Construction Safety Plan Template.

• Insurance risk. The purpose of insurance is to transfer potential risk when possible. Insurance risk can increase when policies are not reviewed at least annually for proper coverage. You may find gaps in needed coverage, limits that could easily be exceeded, rising premiums or possibly even policy cancellations due to requirements you’re not meeting.

• Environmental risk. Toxic waste and hazardous materials can be uncovered during remodeling or construction projects. Many cities have strict requirements about site runoff and debris storage, it is imperative that you follow city codes. Some also have requirements for noise and dust control. Natural disasters like high winds, fires and floods are in the news more and more often and can affect projects.

• Political risk. Political risk comes in the form of governmental policy changes mid-project. Some examples of political risk to consider are building code changes, new or tightened environmental requirements and labor law changes. While these types of risks are slow-moving, it remains important to have them on your radar.

So, having said all that, what can we do to master construction risk management?

Solutions and tools to transform risk into results

Pre-Construction Planning

Some homeowners will spend more time planning a one-week vacation than they will planning a major remodel or construction project, which will almost always lead to unfavorable results for everyone involved. The time you and your clients spend planning a project before the work begins will pay you back in spades by helping you avoid common construction mistakes. It involves meticulously understanding the scope of work, estimating the cost honestly and accurately, allocating labor correctly, developing a schedule, and ordering materials. 

Understanding the scope of work starts with a complete set of drawings and specifications. It is imperative to spend the time learning what makes this project different from others like it and how to account for those differences. A thorough understanding at this point sets the stage for a positive outcome.

Once the project scope is understood, estimating can begin. While there are many ways and systems to estimate a project, the key is to use one you’re comfortable with and stick with it. Most important, it’s imperative to be complete and accurate. Yes, things do actually cost what they cost. Wishful-thinking estimating will only lead to trouble. If you do end up having to take out a loan to cover project costs, learn about the various loan options to choose the best one for you.

Next, you’ll need to evaluate your in-house labor capabilities and availability. You’ll also want to do that with your subcontractors. Do they have the necessary equipment, skills and knowledge for the project? Will they be available when you anticipate needing them, or are they committed to another project? You also want to have minimum hiring standards for subcontractors and employees.

Having this information allows you to develop the project schedule and set dates for material ordering. Again, it’s important to be realistic with how long things take to complete. Of course, you want to be aggressive with scheduling, but for the sake of a successful outcome it’s vitally important to be realistic. Developing the schedule early on will also help you identify when certain materials need to be ordered for their timely jobsite arrival. You’ll discover that some items have excessive lead times and those orders need to be placed earlier than normal in your schedule. 

A detailed, thought out pre-construction plan will help to minimize cost overruns, reduce the risk of delays, and help to prevent the risk of legal issues. Efficiency and company profitability will greatly increase when a well-thought-out plan is executed.

With a detailed plan in hand, what happens next?

Review progress and adjust as needed

Mastering construction risk management does not end with a pre-construction plan. That’s where the real value starts. Monitoring the plan will help ensure that problems or changes are detected early and corrective actions can be taken to ensure a positive outcome. 

Just because you have a very well-thought-out plan doesn’t mean that things can’t or won’t change. That’s why it’s necessary to accurately track job progress against the schedule and the estimate in real time. If something changes (a material was delivered damaged, a workforce illness or any other problem happens), the sooner you know about it, the faster you can make a course correction. If, for instance, one facet of the job was more complicated and took longer to accomplish than originally estimated, you can look for ways immediately to make up the difference. It might be by adding additional personnel to the workforce in an effort to speed things up or by finding ways to help subcontractors reduce their costs while maintaining their margins.

The important thing is that there should be no surprises at the end. Either the project went as planned, or there was a change that you knew about at the time it happened and you did everything humanly possible to adjust accordingly. 

In short, monitoring the pre-construction plan and making any necessary adjustments along the way will help to minimize any negative financial impact, delay or legal issue risk. 

Use technology

Transforming construction risk into successful projects involves the integration of technology. Technology integration can significantly improve speed, accuracy and data collection in just about every aspect of the business. As an example, through the use of a good project management program, all the drawings, contracts, specifications and communication for a project are only a few clicks away for anyone in the field or the office. There are also standardized estimating templates and systems as well as accurate budget tracking tools. 

Many of the top technology providers are happy to share their best practices to assist with implementation into your business. Some even provide onboarding and training services to get you started and your folks trained. Use them for their expertise as you develop your system. 

Access educational resources

There are many educational resources available, such as free templates for writing a construction contract and building a construction schedule. Other resources are available online for free or possibly a small investment. Another is your local builders’ association. They generally have a variety of educational products and networking opportunities that can be a great resource as well. NARI, NAHB and NKBA are the three big industry groups that provide their members with a wealth of information.

Use other tools, plans and checklists 

Like the educational resources, there are a wealth of available construction risk management tools, plans and checklists available online or through your local builder’s association. You also can try reaching out to someone respected in the industry. I have found that tapping into others that do what you do can be very valuable. You just must remember to always reciprocate when asked. 

Hire a risk manager

This position could be contracted out on a job-by-job basis or hired as an in-house employee dedicated to managing and lowering your risk across the board. They can be responsible for jobsite safety requirements and regulatory compliance as well as cost and schedule control.

Conclusion

Mastering construction risk management requires a complete understanding of key risks, methodical pre-construction planning combined with continuous project monitoring, and the integration of proven technologies and best practices. Implementing a construction risk management system not only safeguards projects but also increases efficiency and profitability, ensuring a healthy and successful business.