Budgeting a construction project can be intimidating. To cover the full scope requires knowledge of all the parts and the process. This article is an overview of the total picture, which for some reason, is rarely discussed online but is a large part of the workings behind the scenes.

There are many websites that pretend to explain how much can be built at some “target” cost. This is a sales trick to maximize what is purchased by advertising a false end point. My approach here is to back up and look at the larger picture to allot reasonable values for the entire project and to explain what a complete budget looks like. This is more relaxing than the industry model where the stated budget is just the beginning followed up with continuing additions, selections, changes, hidden costs, and fees. The whole point of working with an architect is to plan the entire project so that there are no surprises!

Above is a representative budget for a new home. The first four items (oranges, yellows, and greens) compose the greatest portion of the whole, the construction contract. This is the amount of money paid to the contractor in return for the materials and labor required to build the home as well as his overhead and profit.

The next four bluish slices represent another category of costs that I lump together as owner costs. These expenses can be paid directly out of the owner’s pocket to avoid any additional markup by the contractor. However, in many contracts, especially build-to-suit and starter homes, these costs are included in the contract so that they can be financed in the mortgage. Because they are often hidden, the price for convenience is usually additional markup and reduced options.

For example, take the 6% shown above for furnishings, fixtures, and equipment. Average home builders sometimes allow owners a few options for selecting plumbing and lighting fixtures and appliances. These choices might amount to only 1% of the total construction budget. Everything else is included without options. Any change to them results in an additional costs. Conversely, in working with an architect, every item and component is selected and stipulated in the contractual drawings and specifications prior to the contractor coming to the table. Since the information is precise, no allowance needs to be provided. This greatly reduces wiggle room, markup, and change orders.

Another benefit of detailed documents is that the owner can purchase selected components directly and avoid contractor markup. Most homes have a considerable number of item purchased by owners after the completion of construction. This is the reason home improvement stores in areas with new housing are such big business. Additional items the owner might buy directly include maintenance items like filters and light bulbs, appliances, pools, patios, decks, outdoor kitchens, security systems, home networking, audio and media, yard lighting, and irrigation. With the architectural process, any of these can be selected for inclusion within construction and financed. Or they can be purchased directly by the owner to avoid markup, installation notwithstanding.

A complete project budget also includes design, shown as pink and wine reds. This cost is hidden in merchant grade residential construction. But it is highlighted in architectural homes because it is the avenue those owners have to design exactly what they want. In fact, as discussed in a previous article, Architect versus Contractor, clear documents are the best means for reducing unknowns and getting market competitive bid pricing. It eliminates gratuitous overhead and unreasonable profit, budgeted above as the two greenish pie sections. Specialty consultants, either hired by the architect or owner, use used for structural, mechanical, electrical, plumbing, civil, and energy engineering as well as landscape architecture and interior design. They may compose as much as 70% of the total design costs.

One final but critical improvement to the budget includes contingency, shown above in grey and bright red. These are funds allocated for unknowns, and are split into two parts: design and construction. During early stages of design, less is understood. When I first sit down with a client, I allot as much as 20% of the budgeted construction costs to design contingency. This is about 12% of the entire project budget as shown on the chart above. After the first meeting to review schematic design, we already have a better idea of what the goals will be, so the contingency is reduced to 15%. After the design development phase, it is reduced to 10%, and then to just 5% at the construction documentation phase. By the time the house is ready to be bid by several contractors, we have spent so much effort resolving the design and details that the design contingency can be eliminated.

A construction contingency is allocated for unknowns discovered during construction. For new homes with thorough surveys and geotechnical investigations, we allow about 5% for unforeseen issues or optimizing adjustments during construction. For smaller homes or additions, we might reserve a bit more at 8-10%. For complex renovations, or unique sites or situations like historical structures, recommended construction contingencies may be as high as 10-15% to make sure undiscovered conditions do not undermine the entire project.

Throughout the project, contingency is either spent on changes or it represents a savings on the total cost. This is a much better system of budgeting than predicting 5-10% overruns, isn’t it?

There are two final categories of items not shown in these graphs: site costs and financial costs. Both vary widely depending on the situation. Site costs may be $50k or $5m depending on the size, location, configuration, availability of utilities, and regulatory requirements. Likewise, some owners pay cash and have advantageous personal relationships to reduce legal and real estate costs, while others may finance large portions at market rates.

I hope this article has explained the difference between the cost of a home and the initial budget recommended to complete it. By move in day, they are one and the same. But a precautious approach at the beginning is the best way to ensure that day has a feeling of accomplishment in financial responsibility.

Please leave comments below with your thoughts!

Edited 2014-08-26 for minor grammar and clarifications.