The one thing I can guarantee about construction is that you will never have everything figured out before it starts. Try as you might, there are too many factors and parties involved to have zero surprises.
Given this fact, construction contracts and budgets need to allow for some flexibility. One way that this is achieved is with allowances. In this article, I’ll explain what an allowance in a construction contract is, how it works, and why it is important.
What is an Allowance?
An allowance is a pre-determined amount of money that’s set aside in the construction contract for specific items (or group of items) that have not been selected or specified at the time of contract signing. These items can include fixtures, appliances, materials, or any other item that is not yet finalized.
They are also used in the bidding phase of a project to carry a cost for portions of the work that isn’t well defined.
The allowance serves as an estimate of the cost of these items and is included in the contract as a separate line item.
How Does an Allowance Work?
The allowance amount is typically based on the estimated cost of the item, including any taxes or fees. This amount can be provided by the Owner or the GC but should be agreed upon as a reasonable and responsible amount.
Oftentimes in homebuilding, the contractor will give the client a list of items and options that fall under the allowance with the item’s associated costs. This serves as a sort-of shopping list for the client. The client then has the option to select the items they want from the list, or they can suggest their own items.
If the client chooses an item that costs more than the allowance, they are responsible for paying the difference as a change order. Conversely, if the selected item costs less than the allowance, the contractor is responsible for crediting the difference to the client.
What are some examples of allowances?
Allowances are most often used in homebuilding for finishes and equipment (like appliances). These are items that are installed relatively late in the project and often have to do with aesthetics. As long as the GC knows about its future installation, they can plan for it ahead of time.
Common allowances include:
- Flooring materials and patterns
- Light fixtures
- Plumbing fixtures
Some of these options require more planning ahead of time then others. For example, not all flooring are equal. Carpet is much cheaper as a material and to install, than tile. It’s much better to call for tile on the drawings and include an allowance for the type of tile and grout to be used. This way, the GC can plan for and price all of the additional needs of floor tile without the owner having to pick the exact tile ahead of time.
To get the most accurate estimate, everything would be specified ahead of time and included in the documents so the contractor knows exactly what they need to buy. The reality is that not everything is figured out at the contract signing.
Why are Allowances Important?
Allowances are important because they provide flexibility in the construction contract. They allow for changes to be made during the construction process without requiring a change order, which can be time-consuming and costly.
They also provide a way for the client to customize their project, selecting items that suit their preferences and budget. Additionally, allowances can help to prevent project delays, as they allow work to start or continue while the client makes their selections.
A warning about allowances
It’s important to consider the value of allowances when reviewing and comparing bids from contractors for two reasons:
- A contractor may use an allowance instead of pricing what is actually shown in the drawings if the drawings or specs are unclear. The preference is to have them price what is specified.
- To be able to compare apples-to-apples, allowances should be the same across all bids. If one contractor has a lower allowance amount than the other, they may be assuming a lesser quality or quantity of the items included in that allowance.
How to Manage Allowances
Managing allowances shouldn’t be an overly complex process but does require communication and coordination between the client, contractor, and other parties involved in the project. Here are some tips for effectively managing allowances in a construction contract:
1. Define the Allowances Clearly
It’s essential to clearly define the allowances in the contract, including the items that fall under the allowance, the items excluded from the allowance, and the estimated cost. Make sure it’s clear if the labor for installation is included in the base price or not so there are no surprises down the line.
2. Establish a Process for Selection
Establishing a process for the client to make their selections is important to prevent delays in the construction process. This can include the GC setting deadlines for making selections and providing a list of approved vendors.
3. Monitor the Allowances
Monitoring the allowances is important to ensure that the project stays within budget. Regular communication between the client and contractor is essential to prevent surprises or unexpected costs. This is generally the responsibility of the GC.
4. Keep Detailed Records
Keep a record of the costs of anything that have been applied to an allowance. Again, this should be the GC’s responsibility, but not a bad idea for the owner to track as well.
It is the contractor’s responsibility to keep detailed records of allowances and provide proper documentation to the owner when the project is complete. The work and materials should be agreed upon before the GC uses the allowance.
If you want to track allowances yourself, you can download this simple and free spreadsheet.
What’s the difference between an allowance and a contingency in construction?
The main difference between an allowance and a contingency is that an allowance is used for costs that are not yet defined or specified, while a contingency is used for unforeseen costs that may arise during construction. An allowance is an estimated amount that is based on the contractor’s knowledge and experience, while a contingency is a percentage of the total project cost that is set aside to cover unexpected costs.
To expand: an allowance is a placeholder for a cost that is not yet fully defined or specified at the time of bidding or proposal. It is an amount set aside in the contract to cover the cost of a particular item(s) or activity that is not fully designed or specified. For example, if the owner has not yet selected the type of lighting fixtures to be used in the project, the contractor may include an allowance for lighting fixtures in the bid. The allowance amount is an estimate of what the actual cost will be, based on the contractor’s experience or as agreed upon with the owner based on their preferences.
A contingency, on the other hand, is an amount of money set aside in the budget or contract to cover unforeseen events or circumstances that may occur during construction. It’s a cushion or buffer that allows for unexpected costs, such as changes in the design or scope of work, unforeseen site conditions, or other unexpected events that may arise during construction. Contingencies are typically calculated as a percentage of the total project cost and are intended to protect the project budget from unforeseen costs.
Let’s use bedrock at the building site as an example. If you know there’s a high likelihood of encountering bedrock during excavation, you may want to hold an allowance for removal. In this case, you’re pretty sure you’re going to come across it but the extent is unknow so you set some money aside for it. On the other hand, if you encounter bedrock during excavation that was completely unforeseen, you might use your contingency to deal with it since it was not planned for while creating the documents.
Allowances in AIA contracts
If you’re using AIA (American Institute of Architects) documents, the terms of allowances are explained in A201 General Conditions of the Contract for Construction. This document alone can’t be used as a construction contract. Rather, its part of a group, or family, of documents.
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