Q&A: Stadium Cost Overruns

August 17, 2010
By Barry LePatner, Construction Attorney, LePatner & Associates

In recent years, the New York Metro market has seen a remarkable spurt of major-league sports construction—five new facilities opening in the past few years, to be followed soon by a new arena for the NBA’s Nets. At a time when almost any development is welcome, these projects represent several billion dollars of investment. Yet some of these projects are also raising concerns about cost escalation. For example, would you outline the situation regarding the new football stadium for the Jets and Giants? What are the issues there?

BBL: The fact that a non-domed stadium built predominantly for NFL football teams can end up costing $1.4 – $1.7 billion is a precise example of why construction costs in this nation have risen to unacceptable levels. When initially agreed upon, the project was billed as a $998 million design\build concept, i.e. one that was awarded to a construction team made up of an architect/engineer and construction manager who bid to develop the completed project—for a fixed, specified price. Yet the project as completed added over a half a billion dollars in change order costs to complete.

To finance these cost overruns, the football team owners each embarked on a program to sell expensive seat licenses to season ticket holders, the cost of which was over and above the price of the annual tickets for each season. Purportedly, this license fee arrangement netted hundreds of millions of dollars for the NFL teams to pay for cost overruns not contemplated at the outset of the project. In addition, the costs of all other fan amenities—
from parking fees to the cost of food and drink, as well as t-shirts, jerseys and the like—will invoke premium prices that all make it more difficult than ever for families to take their children to a professional football game.

That new football stadium—like others of its kind around the country—is a huge, complex project. Why isn’t it reasonable to expect that any development of that scale will probably go over budget?

BBL: There is no reason for projects of this scale not to be built to the exact design specifications that were submitted, for a true complete price. Once construction begins, there is simply no reason for the construction team to submit change orders to the owner, adding new items not originally contemplated in the contract price.

However to do so, owners must eschew the commonplace demands of construction managers who frequently urge that these large projects be carried out as “fast track” projects—to begin construction before the project’s design is fully completed and coordinated. As a result of starting construction before the designs are complete, everyone in the construction world knows that excessive change orders—resulting from additional design drawings that are completed as the project proceeds—will drive the total project price up by 20 to 30 percent or more. Plus, the project undergoes substantial schedule delays.

As an industry, we must move to a system in which contractors must bid on jobs with complete design documents. Only then will they be required to do the work for a complete, set price—and to meet a defined schedule of completion. If the contractors were contractually obligated to hit their deadline targets—and stay within budget—in order to make a profit, each project, and the industry at large, would improve immensely.

Granted, the new Giants/Jets facility is a different kind of project from a master-planned mixed-use development or an office complex in a central business district. That said, are there any lessons learned that builders, lenders and other stakeholders can take away?

BBL: Today, private owners are finding it difficult to raise capital for every type of project. Moreover, lenders are making it increasingly harder to secure construction funding. The prospect of major cost overruns and project delays are issues that lenders and owners must address for new projects. With governments at all levels pulling back from funding projects, which raise the prospect of being subject to cost overruns (see the issues being raised as the City of Seattle struggles with anticipated cost overruns for its new downtown tunnel), the need for construction cost certainty has become the new imperative.

As I describe in my book, Broken Buildings, Busted Budgets: How to Fix America’s Trillion Dollar Construction Industry, when an owner signs a fast track project for a so-called “guaranteed maximum price,” it starts down the slippery slope of losing control over the all-critical role of the project’s final cost. Today, lenders are requiring owners and developers to provide 40—50 percent of the equity for the right to secure a construction loan. If there are cost overruns, not only are there no mezzanine lenders readily available to provide additional financing for the difference, but margins on these projects are smaller than in the boom years of the early twenty-first century.

These new financing constraints are going to force a change to the industry. Contractors typically win jobs by submitting the lowest bid. But owners can no longer assume the financial risks of accepting these low bids—often below market price—which typically come with numerous subsequent change orders from contractors once construction begins. Once the project is underway, owners have very few remedies against change orders. The best way to prevent them is to contractually agree that the project will begin—and funds will be made available—only for projects built from complete designs.

In your experience, why do real estate development projects most often go over budget? What are the most common errors that owners, designers, contractors and other stakeholders make these days?

BBL: The reality is that very few owners and their representatives have detailed knowledge about how construction in the U.S. is priced. This asymmetry of information puts the owner at a distinct disadvantage, since it prohibits the owner from engaging in a proper negotiation over the best construction pricing for the project. Only when the owner engages in a program that prices the design of the project as it proceeds—and has precise pricing for each trade and material supplier in hand before the project goes out to bid—can there be assurances that the construction bidders are providing valid and market-driven bids that reflect the actual cost of the work. Absent this critical step, no owner can merely rely on the bids received from the construction industry.

Are some project types—whether retail centers, office or anything else—more likely to exceed estimates than others?

BBL: All projects are equally subject to cost overruns. Owners of any project must proceed fully equipped with accurate information and with the knowledge that they will likely see their actual budgets explode if they agree to fund a project based on incomplete designs.

What are the consequences of excessive project costs to developers, lenders and equity partners?

BBL: When cost overruns occur on a project—whether public or private—everyone pays for it in increased costs. For a manufacturer, those additional costs are added on to the price of the products it produces. For the landlord, those costs get added to the rent a tenant is charged. For governmental projects, it is clear that the public pays directly for these cost overruns in the form of increased taxes, reduced services, or both, or the need to borrow funds that will tax future generations. There is no escape from the process. These excess costs are estimated to easily exceed $120 billion annually in impact on our national economy.

What would be an example or two of recent high-profile projects that went over budget, and what do those projects tell us about this issue?

BBL: The Cleveland Cavaliers’ Gund Arena incurred cost overruns of 50 percent when its initial price went from $152 to $228 million. The Seattle Mariners’ Safeco Field went from an initial $417 million to $517 million, and the recently completed Yankee Stadium and Mets’ Citi Field both reported cost overruns of $300 million. The recently completed Dallas Cowboy indoor stadium, initially budgeted at $650 million, ended up costing far in excess of $1 billion.

As development activity ramps up over the next few years, what are the main issues that stakeholders ought to bear in mind about cost control?

BBL: We are at a critical inflection point in the real estate and construction industries. The abuses of the “fast track” and so-called “guaranteed maximum price” cost structure have been shown to be illusory and counterproductive to owners and contractors alike. Today, fewer construction lenders and limited budgets will no longer allow for the cost overruns that have run rampant in past years. Standard form agreements permit these tactics to persist. They will not ensure against delays to projects and attendant claims that drive up the contract price.

If we are to break free of the grossly mismanaged system plaguing the construction industry and secure the final cost of a construction project then we will need to address these issues with true, complete pricing agreements and methodologies as set out in the LePatner C3 Method. The time to end these debilitating practices is now. The national economy will pay a dear price if new methods to control costs are not put in place.