Did you know there are actually some costs involved before construction even begins on a project? It’s true!
There will be some expenses that clients should be prepared for before the first brick is laid. These may include the cost of planning, purchasing materials, or pre-construction interest. Let’s take a look at pre-construction services and costs to help ensure there are no surprises when it comes time for your construction project.
Table of Contents
What are Pre-construction Costs?
Simply put, pre-construction costs are defined as those that the client must pay before a construction job even begins. While there aren’t many expenses associated with the pre-construction phase, there are a few that the client needs to be made aware of. The first of those is the cost of pre-construction itself.
Pre-construction Planning Costs
The pre-construction planning stage is the phase of a construction project that occurs before construction begins. This involves the initial planning of the scope of the project, scheduling, budgeting, and everything else that will help a construction job get done.
Careful pre-construction planning will be extremely important to ensuring a job runs smoothly and is finished at the agreed upon date, under the set project budget. This pre-construction stage can take anywhere from a couple weeks to a few months, depending on the scale and scope of the job.
Since this planning period is such a vital part of a construction job, it doesn’t come for free, especially since the company or contractor who conducts the pre-construction planning may not even end up winning the bid for the job. The cost of the pre-construction stage will vary widely based on the scope of the project, the location, and other factors, but will typically not be a major expense.
The pre-production cost will generally end up in the range of one to three percent of the project’s total cost, although it is a completely separate fee and not built in. This pre-construction fee will be paid before a bid for the actual construction is even awarded, but it could lead to major savings throughout the process.
A construction job that begins without thorough pre-construction planning will likely not be prepared when issues arise. However, jobs with careful pre-construction planning will have contingencies built into the budget to handle most situations, keeping the project in line and on or near its original budget. There are other reasons pre-planning can lead to savings as well.
How Pre-construction Planning Can Save You Money
Although pre-construction planning will not be free, it could end up saving you big on a construction job in the end. This is for a variety of reasons.
First, during the pre-construction period, your contractor will build contingencies into the budget that will be there should things go wrong. The contractor will use his or her expertise and experience to predict certain scenarios and what they would cost and prepares for those circumstances within the budget. This way there are no surprise expenses should something go wrong, and the project will not go way off its timeline and budget.
By thoroughly pre-planning the construction job, the contractor will also be able to look for cost-saving opportunities. These may include cheaper building materials or components that could save hundreds to thousands of dollars on the jobs overall cost. They will also look for ways to boost the overall value of the finished product, which will be beneficial down the road.
Things like using sustainable materials or more energy-efficient components could make the building more “green” which can drastically cut down on energy bills for years to come. In the immediate, this may have value to you or your company should this match your philosophy.
All of these factors, along with the peace of mind that comes along with knowing that your project has been properly planned from start to finish, will boost the value of your construction job and make the initial cost of pre-construction all the more worth it.
For homeowners, another expense to be on the lookout for is pre-construction interest. The pre-construction period begins when the homeowner takes a loan on a project and ends at either the point the homeowner fully pays off the loan or the March 31st directly construction is completed on the home.
The homeowner will be expected to pay the full interest on the loan before the job is complete. This interest is called the pre-construction home loan interest. Any interest that follows the March 31st cut off is considered post-construction interest. Check out our related blog about the post-construction phase and what to expect.
There are some tax considerations when it comes to this pre-construction interest.
Is the Pre-construction Interest EMI or Full EMI?
EMI are three letters that you will need to get intimately familiar with if you plan on taking out a home loan. EMI, or equated monthly installment, is a fixed amount that you will pay each month toward your loan. It isn't just interest, but also the principal repayment.
If you purchase a property that is under construction, the lending institution may choose to link the home loan disbursal to the remaining construction on the property. In these cases, you may be asked to pay pre-EMI or choose between pre-EMI and full EMI payments.
Tax Benefits of a Home Loan
Luckily, you may not be completely on the hook for these interest payments. You may be eligible for tax deductions on the principal repayment and interest owed on a home loan. The conditions for these deductions include how long it takes to complete the project and the type of home. To collect a deduction on the home, the construction must be completed within three years from the end of the financial year in which you borrowed the home loan. Actually, a recent amendment has extended this time period for the financial year 2017-18 (actual year 2018-19). During this time period, you have five years to collect a deduction on home loans.
The type of house will also factor into your deductions. This is due to rules associated with the calculation of income tax or income from house property. These will vary depending on whether the home is a self-occupied property (used throughout the year only by the owner for their residential purposes), a rented property, or if the house is vacant. If the house is vacant, it is deemed to be “let out,” and is actually expected to generate income for you. Therefore, you will have to pay taxes on what you could have earned.
With regard to the pre-construction interest, the deduction will be available regardless of whether or not the property is self-occupied or rented. There will be no deduction on the principal amount repaid during construction, only the interest.
There are limits to how much interest will be earned for a self-occupied home, but a rented home will have no such limitations. The actual interest paid during and the pre-construction interest paid will each be eligible for a tax deduction.
How to Claim a Pre-construction Loan Deduction
The interest that you paid during the pre-construction period should be added and claimed as a deduction in five equal installments for five consecutive financial years. This will begin in the year construction is completed. Remember, the pre-construction period begins when you take out a home loan and ends when the construction is completed or you have paid off the loan. You cannot claim a deduction nor receive a repayment of the principal loan during the years that your home is under construction, only after it is completed.
How to Calculate Pre-construction Interest
There are some steps you can take to calculate your pre-construction interest on your own.
Step 1: Find the date your home loan started.
The date you took out the loan on your home is the date your pre-construction interest began.
Step 2: Find the date construction was completed or you paid off the loan and came into possession of the home.
Step 3: Work backward to find the last date of the financial year that immediately preceded the date of completion or acquisition. Again, this will be the March 31 that immediately preceded the completion of construction.
Step 4: Use the dates you came up with in Steps 1 and 3 to figure out your pre-construction period, also known as the “prior period.”
Step 5: Figure out the amount of total interest you paid during this pre-construction period.
Step 6: Next, you will calculate the allowable prior period interest. This will be the total interest paid that you just figured out in Step 5, divided by 5. This is divided by 5 because the deduction will be paid to you over a period of 5 years following the completion of construction on your home.
Step 7: Claim the number you came up with in Step 6.
The math involved may seem like a burden, but will certainly be worth it to get back some of the interest you paid on your home. Every little bit helps, especially during the expensive process of buying a home.
Thankfully, pre-construction also involves some measures to help with these costs. We touched on these earlier, but here we will go a little bit more in-depth on cost estimating and cost control.
Pre-construction Cost Estimating & Cost Control
During the pre-construction phase, contractors will come up with an initial budget for the project, with the goal of matching up against the number given to them by the client. They will form this total by looking into every aspect of the project to come. This may include costs of materials, workers, equipment, certain cost-saving options, troubleshooting risks and putting in contingencies, and reviewing all possibilities.
The contractor will come up with estimated costs for every aspect of the project, rather than just throwing an overall total on the project. The cost estimate will be formulated based on market conditions, prior experience on similar jobs, and other factors. This helps inform clients on the expense of every step in the building process, from pre-construction to breaking group and finishing the project.
Cost control will help to limit the overall cost by utilizing the contractor’s knowledge and expertise to find more cost-effective methods of construction. They may find these lower costs using cost control software, value engineering, or building information modeling software. These are just a few of the many tools at the construction company’s hands.
Both cost estimating and cost control are part of the pre-construction planning process. These pre-construction costs will often pay for themselves because of the value they provide by saving the client money later on, whether through material selection or construction methods.
Carefully planning the scope of the work, scheduling out every element and milestone in the production, and budgeting for every scenario will enable the client to get the most bang for their buck when it comes to their construction project. Contact us or schedule a demo for more information!