A Look Into Commercial Construction

The term "construction" often equates to how we build our cities and neighborhoods. However, the economic value chain for a large office tower is very different from that of remodeling a single-family home or building a new light rapid transit line. We are publishing this blog entry as a launching pad to explore the North American construction industry in more detail.

The U.S. Census Bureau splits construction into residential and non-residential. Residential includes all single-family homes, both newly built and remodeling, as well as multifamily dwellings. Non-residential is split into various sub-types of "vertical" work and "horizontal" work. We have found that multifamily residential is most similar to vertical non-residential work, creating the categories "commercial" and "civil" (horizontal) construction.

The Value Chain: Commercial Construction

In this post, we will explore the commercial construction value chain, the players in the commercial construction ecosystem (broken down into three groupings: Financial Partners, On-Site Construction, and Service Providers), discuss how commercial construction is contracted, and conclude with an example project cost breakdown. We often see startups targeting commercial construction because the technology buying decision is closely aligned to a return on investment or risk reduction to the project owner, general contractor, or another party.

Commercial construction — specifically, U.S. commercial construction owned by the private sector — is driven by the financial incentive of the Project Owner. In short, this means stakeholders are incentivized to deliver the project on-time and on-budget.

The Stakeholders

Construction projects are a web of participants with different economic interests and an aligned objective: finish the project on-time, on-budget. The stakeholders of a single project come together to accomplish that individual project, rarely to repeat exactly a second time.

Contracting and the Flow of Risk

Each stakeholder in commercial construction seeks to transfer a portion of project delivery risk through the contracting process. The scope of a project is often separated into five "risk" buckets: Enabling Work, Design, Construction Services, Lease-Up Services, and Property Management & Maintenance Services.

The key contract for construction services is the construction contract between the project owner and the CM/GC. For much of commercial construction, this is done through a Guaranteed Maximum Price (GMP) contract. A GMP is a fixed construction management fee plus a capped price for all in-scope construction work.

Typically, a project owner selects a CM/GC at the conceptual design phase based on a combination of qualifications, pricing, and relationship. The construction contract requires project completion by a fixed date — with some exceptions — including natural disaster, discovery of contaminated materials, unknown geotechnical condition, scope expansion, and third-party risks.

Project Cost Breakdown

Project cost by subcontracted trade varies widely by an individual project — mechanical components cost a lot more at hospitals and data centers vs. a suburban strip mall. We have illustrated two examples: an approximate budget breakdown for a typical apartment building, and an example of how the weight in these categories shifts when building a data center.

We anticipate publishing more perspectives on the construction industry over time. We believe understanding the nuance and differences within construction categories enables founders, investors, and others to navigate our sector more confidently and successfully.