Building_economics_presentation_1.ppt

ABA 2307: BUILDING
ECONOMICS
Dr A. Alkizim

ABA 2307 BUILDING ECONOMICS
• PURPOSE OF THE COURSE
• The course will expose students to theories used in
solving financial problems in building projects
• LEARNING OUTCOMES
The student should by the end of the course:
1. explain the importance of the the construction industry
to the economy
2. Describe the role of the quantity surveyor
3. Estimate the cost of building projects
4. Compile and interpret bills of quantities
5. Develop Life Cycle costing techniques

ABA 2307 BUILDING ECONOMICS: COURSE
DESCIPTION
• Introduction to Building Economics:
• Construction industry and the economy
• Construction output and its determination
• Demand for and supply of construction output
• Professional Services
• Housing
• Commercial buildings
• Industrial buildings
• Social buildings
• Market dynamics and price determination
• Role of the Quantity Surveyor in the Building Contract
• Estimates
• Principles
• Method of estimating
• Preliminaries and final estimates

ABA 2307 BUILDING ECONOMICS: COURSE
DESCIPTION continued
• Measurement of building works:
• Taking off
• Abstracting
• Billing
• Cost in use:
• Nature and sources of cost data
• Reliability difficulties
• Interpretation
• Application of measurement or cost in use techniques to a
studio project

TEACHING METHODOLOGY
• Lectures will be conducted using PowerPoint
presentations using a laptop computer and video
projector.
• Students will be required to do their own reading and
writing of notes. However, handouts will be provided to
supplement the student’s own efforts.
• Group discussions are encouraged and group assignments
will be issued

• INSTRUCTIONAL MATERIAL
• Multimedia presentations, handouts, slides, whiteboard
markers, whiteboards
• COURSE ASSESSMENT
• Examination and coursework will constitute 70% and 30%
of the overall mark for the subject respectively.

ABA 2307 : Building Economics
Introduction to Building Economics
- Building economics consist of the application of the
techniques and expertise of economics in the study of
construction firms, the construction processes and the
construction industry/built environment
- Economics is essentially about choice of the way in
which scarce resources are and ought to be allocated
between all their possible users.

Construction Industry and the Economy
Construction plays an important role in the economy in that it
produces and maintains the built environment.
The built environment consists of infrastructure, commercial and
industrial buildings and housing.
These buildings and infrastructure are needed for production to
take place and can be seen as an investment in the assets of a
country.
The size and capacity of the construction industry is therefore
important in meeting the needs of the rest of the society.

Construction Industry and the Economy Cont’d
• The main contribution of construction to the economy can be
discussed under the following:
• (a) Construction to National Income (GDP)
• The construction of any particular industry to an economy can be
measured by its contribution to national income. As all income is
earned for producing goods and services, the sum of the value of
all goods and services in a given year can be used as a measure of
the national income. This sum of the value of all goods and
services produced in a country in referred to technically as Gross
Domestic Product (GDP). If net foreign earnings of a country are
taken into account the sum of a country’s earnings is referred as
Gross National Product (GNP). The construction industry
contributes significantly to GDP and in 2003 was the 6th highest
among all sectors contributing 4.5%.

(b) Construction to Gross Fixed Capital Formation (GFCF)
•The construction industry produces and maintains the built
environment consisting of infrastructure and buildings needed
for production.
•An economy’s productive capacity is influenced by its stock of
fixed capital including buildings, plant and machinery. In terms
of the built environment, capital consumption means that the
building stock is in constant need of repair and maintenance
otherwise buildings become obsolete, dilapidated and unfit for
productive use.
• The stock of buildings can only increase if the rate of
additional new buildings and repair is greater than the rate of
demolition and disolescence.

(c) Construction to Employment
•The construction industry has a substantial constribution to
employment particularly in developing countries like Kenya where
mechanization of construction operations is low and dependence on
manual labour is high. Employment in construction ranges from the
highly advanced professionals like Project Managers, Architects,
Quantity Surveyors, Engineers, to technical level employees, artisans
to unskilled labour.
•The local nature of construction operations, particularly where
mechanizations is low guarantees many employment opportunities
for all cadres of labour. In 2003, construction contribution to
employment in Kenya was 4.43% and was the 7th highest for all
sectors.

Construction Industry and the
Economy Cont’d
(d) Construction as a tool of Government Economic Policy
•Government policies related to the construction industry
are concerned primarily with meeting societies’ needs on
one hand and the required level of employment on the
other.
•Partly because of the multiplier effect, the construction
industry has been considered by governments as a suitable
vehicle for economic policy.
•The government can give stimulus to the whole economy or
even to specific regions by varying the magnitude and
distribution of its expenditure on the construction industry.

Construction Industry and the
Economy Cont’d
• Not only are people employed in the construction industry,
but those construction workers also create work for others
as they go out to purchase goods and services using the
income they now have.
• The construction work also creates demand for goods of
other economic sectors which produce raw materials for
construction e.g. mining and manufacturing.
• In addition, whenever factories, offices or shops are built,
industries which provide goods used in conjunction with
buildings, e.g. furniture, carpeting and machinery will also
be stimulated as demand for these goods complements the
same for buildings

GDP AND CONSTRUCTION
-Once an economy has developed, the demand for construction
products, in relative terms, declines and construction output as a
percentage of GDP tapers off. In an industrialized nation the building
stock is well developed, so the need to add to it is less.
-Much of the infrastructure and many of the buildings may be ageing,
but the requirement for new build work is generally smaller –
however, there is likely to be a far greater need for repair and
maintenance work. Generally, therefore, the higher the GDP per
capita, the higher the proportion of repair and maintenance work in
the construction sector.
-It is difficult to obtain accurate data on the output of the construction
sector for three reasons.

GDP AND CONSTRUCTION Cont’d
-First, the construction industry comprises a very large number of
small geographically dispersed firms that undertake mainly small
projects.
-This makes compiling comprehensive data sets difficult for
government agencies monitoring the industry.
-Second, much of the work in construction is subcontracted and,
consequently, there is a risk of double counting.
-Third, alongside the official activities ‘put through the books’ and
recorded in company accounts, there is a significant informal
economy – unofficial work carried out for cash in hand.
GDP = Consumption + Government Expenditures +
Investment + Exports - Imports

Importance of the Construction Industry to the
Economy
• Construction uses more raw materials than any other sector, and
the creation and operation of the built environment accounts for an
important consumption of natural resources.
• The construction industry has resulted to regeneration of many
urban areas of Kenya for example through the realization of major
infrastructure works.
• The construction sector contributes to direct employment. For
instance, increased activity in the construction of roads and
development of housing translated to an increase in employment
in the sector from 148.6 thousand jobs in 2015 to 163.0 thousand
jobs in 2016. These workers depend in one way or another on the
construction sector.

Importance of the Construction Industry to the
Economy
• The construction industry continues to be a key driver
of economic growth in Kenya, as it has been for the last
ten years. The Kenyan construction industry contributes
7% of GDP.

Demand and Supply of Construction Output
Clients and Contractors
In terms of construction economics, it is important to appreciate
that those making the demands are referred to as clients and
those who respond to their instructions by supplying the products
are referred to as contractors.
Clients
• At the core of any construction process are the clients.
• Some are well informed and know precisely what they want and
how it can be technically achieved, but the majority seem to
know little.
• independent advisers may be required to help clients. With a
similar role to financial advisers, they would assist
inexperienced clients to decide what is specified and how it can
be best achieved.
• Increasingly, these clients are based in the private sector.

Importance of the Construction Industry to the Economy
CASE STUDY
• Chinese model of development. The state of China has heavily
invested in huge infrastructure projects. These projects created
employment and spurred the economy once they were underway.
Also, since they were infrastructure projects, they literally paid for
themselves later.
• China now has one of the lowest manufacturing costs in the world.
This has been enabled by the large scale infrastructure. Electricity is
cheaper in China than anywhere else in the world. Also, Chinese
carriers can transport goods across continents cheaply. This has
made China the largest exporter and the second largest economy in
the world.

CASE STUDY
• In February 2009, President Obama signed into law the American
Recovery and Reinvestment Act of 2009 (ARRA).
• ARRA authorized $787 billion in tax cuts, expenses, benefits, and
other government spending to accomplish its three main goals:
(1) create and save jobs, (2) spur economic activity and invest in
long-term economic growth, and (3) heighten the levels of
accountability and transparency in government spending.
• The construction industry was intended to be a significant
beneficiary of the ARRA funds, as approximately $143 billion of
the total amount authorized was allocated for infrastructure and
public building investments. This helped tremendously to get the
US out of the recession

CASE STUDY – THIKA SUPERHIGHWAY AND
BYPASSES
• The Effects of the construction of Thika Road
• SOCIAL ECONOMIC EFFECTS OF BYPASSES AND SUPER HIGHWAYS
• Leads to creation of employment for the people working in the
project during the construction period, for the professionals as
well as the skilled and unskilled laborers.
• They facilitate greater accessibility to tourist destinations thus
leading to economic growth.
• They lead to displacement of residents so as to acquire more land
for construction especially the people living along the roads.
• Construction of bypasses and highways lead to displacement of
business and community services. An example is the demolition
of the Nakumatt Thika road during construction of Nairobi- Thika
super highway.

BYPASSES
• SOCIAL ECONOMIC EFFECTS OF BYPASSES AND SUPER HIGHWAYS
• Residents may be disrupted and inconvenienced e.g. by road closures,
heavy equipment and traffic on the existing road during construction.
• Neighboring structures may be destroyed due to vibration during the
construction process such as excavations of hard ground.
• On completion there is reduced travel time and fuel consumption due to
reduced traffic jam.
• There are reduced accidents and inconvenience to users on completion
since less time is consumed on the road.
• Leads to increased land values. For instance land values along Nairobi Thika
highway is on the increase.

BYPASSES
• During construction, some businesses are likely to loose clients while
others may obtain additional clients, for instance hotels and kiosks along
the road under construction is likely to obtain more clients, while a
boutique is likely to loose clients especially if the road under construction
is not in use.
• They lead to improved accessibility to social infrastructure which in the
long run leads to increased opportunities to access education and health
facilities.
• They lead to improved marketability of perishable goods which provide a
direct incentive for more market oriented agriculture, thus additional
employment opportunities in the long run.
• They lead to industrial development.

BYPASSES
• ENVIRONMENTAL EFFECTS OF BYPASSES AND SUPER HIGHWAYS
• Construction of by-passes and superhighways could have a negative
impact on the flora and fauna, since the dust and other emissions are
likely to settle on the surface of the plants thus affecting their
growth.
• During construction of by-passes and super highways the
environment is adversely affected due to emission of gases such as
carbon dioxide and sulphurdioxide from use of petroleum products.
• Clearing of vegetation during road construction may lead to soil
erosion.
• Clearing of vegetation may consequently affect both local and global
climate.
• Road construction may lead to air and noise pollution thus affecting
the environment.

Clients and Contractors
Contractors
- Contractors enter into contracts with clients to supply the products in
the built environment. These could be roads, bridges, buildings etc
- Some contractors are well informed and know precisely what clients
want and how it can be technically achieved
- It has been suggested that independent advisers may be required to
help clients. With a similar role to financial advisers, they would assist
inexperienced clients to decide what is specified and how it can be best
achieved.

Theory of Demand
The quantity demanded of a product is inversely related to that product’s
price, other things being equal.
A standard market demand curve

Demand in the Construction Industry
- The determination of demand for goods and services produced by the
construction industry is a complicated process.
- This is partly due to the size, cost, longevity and investment nature of the
products and partly due to the broad range of what constitutes construction
activity.
- This will become clearer as we consider factors affecting demand for
various sectors of the industry.
A.Demand for Housing
- Each household requires some kind of shelter – a flat, bungalow, terraced
house, maisonette, semi-detached house, cardboard carton, or whatever.
- The related resources are allocated through the market mechanism and
the public sector, or through some mix of the two.

A. Demand for Housing Cont’d
Usually four sectors are distinguished;
a) The owner occupied sector – that is, accommodation owned outright
or being bought with a mortgage.
b) The private rented sector – property that is let at a market rent
deemed ‘fair’ to tenants and landlords.
c) The local authority rented sector – housing made available by the local
authority (council) at a subsidised rate from public funds
d) The registered social landlord sector – property managed by non-profit
making organisations that combine public and private funds to provide
housing for those in need. A large proportion of this sector is made up
of properties managed by housing associations.

Owner Occupied Housing
- This form of ownership is generally supported by government initiatives
that encourage demand by making the process of home buying as
fast, transparent and as consumer friendly as possible.
Factors affecting the demand for owner occupied housing
1. The current price of housing
2. The price of other forms of housing
3. Income and expectations of change
4. Cost of borrowing money and expectations of change
5. Government incentives such as tax benefits
6. Demographic factors such as the number of households
7. Price of associated goods and services, such as maintenance,
furniture, council tax, insurance, etc

Owner Occupied Housing
The logic is that if people own the property that they occupy, they will
maintain it better.
The feel-good factor derived from ownership makes the transaction costs
of choosing and funding worthwhile, especially as a house provides an
investment as well as a shelter.
Privately Rented Housing
In general, the market in private housing to rent varies greatly from country
to country for a number of cultural and economic reasons.
Factors affecting the demand for privately rented housing
1. Current rent levels and expectations of change
2. Income distribution – which determines affordability
3. The cost of borrowing and expectations of change

Factors affecting the demand for privately rented housing
Cont’d
4. The law on rents and security of tenure
5. Demographic factors, such as household formation
6.The price of owner occupation
Social Housing
- Housing provided by local authorities and registered social
landlords, such as housing associations, is generally
referred to as social housing.
- The origins of social housing lie in the idea that
governments should pay a subsidy towards housing to
make up for the shortage of accommodation available to
low-income families.

Factors affecting the demand for Social housing
1. The current price (rent) of social housing
2. The price level of other forms of tenure
3. Assessment of need
4. Availability of finance, such as income support and mortgages
5. Levels of government subsidy
Demand for Industrial and Commercial Buildings
- We now consider the demand for a whole range of buildings,
including offices, factories, warehouses, hotels, garages, shops
– in short, nearly all buildings except houses. Industrial and
commercial buildings are not required for their own sake, but for
the services they can provide.
- Consequently, demand for an industrial or commercial building is
based on factors related to the specific sector in which the
building will be used. Demand of this type is known as derived
demand.

Demand for Industrial and Commercial Buildings Cont’d
• Derived demand implies that buildings are rented or purchased not because
they give satisfaction, but because they can be used to produce goods or
services that can be sold at a profit. This is different from the factors
affecting the demand to buy a house.
• Investments in industrial and commercial building, therefore, depend on the
expectation that the buyers or renters – that is, businesses – will make
profits in the future. If business confidence is low, investment will not take
place – even if there is current demand for an increase in production or
sales.
• The factors affecting demand for industrial and commercial buildings are
largely dependent on the state of the economy, and business expectations
concerning output and profit. In other words, because demand is derived, it
is dependent on many things other than prices.

Factors affecting Demand for Industrial and Commercial
Buildings
• Technological developments
• Changes in taste or fashion
• Expected levels of cost, including interest rates
• The state of the economy and government policy
• Business confidence
• The age and condition of the existing premises

Demand for Infrastructure and Other Public Sector
Construction (Social Housing)
Such as hospitals, roads, schools, tunnels, prisons, museums, bridges,
and police and fire stations.
The demand for these products is again largely derived. An excellent
example comes growth. In other words, China does not want
highways per se, but it demands the modern ways of transacting
economic activity rather than rickety, congested locfrom China where
recent highway construction has taken place alongside the
development of new cities, changing lifestyles and rapid economic al
roads.
The demand for community oriented facilities can be judged on much the
same basis as industrial and commercial buildings. However,
assessing the demand for these products is even more complex as it
also depends on the assessment of need and the funds available.

Factors affecting the Demand for Infrastructure and Other
Public Sector Construction (Social Housing)
1. Assessment of need – present and future
2. Availability of finance and levels of government subsidy
3. Government policy
4. The age and condition of the existing stock
A. GENERALISED DEMAND EQUATION
The recurring determinants of demand are the price of the good being
considered, the price of related goods, the level of income and
government policy. Therefore, we can quickly move towards stating a
generalised tool for analysis.

A GENERALISED DEMAND EQUATION
Qnd=f(Pn,Pn-1,Y,G,…..) – demand function
Qnd the quantity demanded of good ‘n’ is f a function of all the
things listed inside the bracket: Pn the price of the good itself ,
the Pn-1 price of other goods,Y income, G government policy
and….a host of other things
CHANGING MARKET CONDITIONS
Income
For most goods, an increased income will lead to an increase in demand
hence a rightward shift in the position of the demand curve

Income
- Goods for which the demand increases when income increases are
called normal goods. Most goods are ‘normal’ in this sense. There
are a small number of goods for which demand decreases as incomes
increase: these are called inferior goods.
- For example, the demand for private rented accommodation falls as more
people become able to buy their own homes. (It is important to
recognise that the terms normal and inferior in this context are part of
an economist’s formal language, and no value judgements should be
inferred when the terms are used.)

Price of other goods
Demand curves are always plotted on the assumption that the prices
of all other commodities are held constant. However the prices of
other goods that are assumed constant may affect the pattern of
demand for the specific good under analysis – substitute or
complimentary goods.
Let us consider plastic and lead guttering example a little more fully
(substitute goods). Assume that both plastic and lead guttering
cost 1000/- per metre. If the price of lead guttering remains at
1000/- per metre but the price of plastic guttering falls by 50 per
cent to 500/- per metre, builders will use more plastic and less
lead guttering. The demand curve for lead guttering, at each and
every price, will shift leftwards. If, on the other hand the price of
plastic guttering rises, the demand curve for lead guttering will
shift to the right, reflecting the fact that builders will buy more of
this product at its present price. Therefore, a price change in the
substitute good will cause an inverse change in the pattern of
demand for the other alternative.

Price of other goods Cont’d
For complementary goods however, the situation is reversed: a fall
in the price of one product may cause an increase in the
demand for both products, and a rise in the price of one
product may cause a fall in the demand for both.
Expectations
For example, potential house purchasers who believe that
mortgage rates are likely to rise may buy less property at
current prices. The demand curve for houses will shift to the left
reflecting the fact that the quantity of properties demanded for
purchase at each and every price has reduced due to
consumer expectations that mortgage rates will rise.

Government
For example (UK), changes in building regulations such as the Code
for Sustainable Homes, introduced in 2007, have placed a greater
focus on the standards expected for water and energy usage.
This, in turn, has influenced the design of, and demand for, the
standard fittings and appliances used in kitchen, bathrooms and
general heating. The demand for these products has increased,
regardless of their present price. Or to put it another way, the
demand curve for all code compliant products has shifted to the
right, reflecting the fact that greater quantities of these units are
being demanded at each and every price. (It will take some time
for suppliers to adjust to these new standards, so prices might at
first rise before technology catches up.) The government can also
influence the level of demand by changing taxes or creating a
subsidy.

UNDERSTANDING CHANGES IN DEMAND
Change in a non-price determinant causing a shift in
demand

UNDERSTANDING CHANGES IN DEMAND
Change in price causing a movement along a given
demand curve

ELASTICITY OF DEMAND
Elasticity - A measurement of the degree of responsiveness of
demand to a change in an external variable.
A numerical value for the elasticity of demand may be calculated in
relation to price, income or a related good using the formula:
elasticity of demand = percentage change in demand
percentage change in the explanatory variable
For instance, we may wish to know the extent to which a change in
the price of petrol will cause the quantity of demand for petrol to
change, other things held constant. Let’s say that petrol prices
rise by 10 per cent and this leads to a reduction in demand by 1
per cent. The calculation would be as follows:

ELASTICITY OF DEMAND
price elasticity of demand = –1% = -0.1
+10%
This is a very small response and, in technical terms, whenever this
measure is less than one demand is referred to as inelastic.
The theory of demand states that quantity demanded is
inversely related to the relative price, consequently price
elasticity is always a negative number – if the price rises, which
is a positive percentage change, the quantity demanded falls,
which is a negative percentage change – but it is a convention
that economists ignore the negative sign when discussing the
price elasticity of demand

B. Supply for Housing
THE BASIC LAW OF SUPPLY
The quantity supplied of a product is positively (directly) related to
that product’s price, other things being equal.
The supply cur
ve for an individual firm

SUPPLY IN THE CONSTRUCTION INDUSTRY
SUPPLY AND THE PRICE DETERMINANT
The law of supply states that more goods are supplied at higher
prices, other things being held constant. This is because at higher
prices there is greater scope for firms to earn a profit. Firms already
in the market have an incentive to expand output, while higher
prices may also enable those firms on the fringes of the market to
enter the industry. At higher prices, therefore, the increased
quantity supplied is made up by existing firms expanding output
and a number of new firms entering the market.

SUPPLY AND NON-PRICE DETERMINANTS
Other things that are assumed constant other than price are the costs
of production, technology, government policy, weather, the price of
related goods, expectations, the goals of producers (do they wish, for
example, to maximise profits or sales), and so on.
Cost of Production
We have implied that producers are seeking to maximise their profits.
Therefore, any change in production costs will, ceteris paribus, affect
the quantity supplied. To illustrate this principle, If unit production costs
increase by £1, and this additional cost cannot be passed on by
suppliers, then they will supply less to the market at each price. These
changed conditions will cause the market to shrink so that, for
example, only 300 units per day would be supplied at a price of £6 per
unit.

Cost of Production Cont’d
The supply curve has shifted to the left: less is now supplied at each
and every price. The opposite would occur if one or more of the inputs
became cheaper. This might be the case if, say, technology improves,
but such opportunities seem slow to emerge in a construction industry
that is both labour intensive and culturally inclined to invest little in
research, development and training.
Government
In a similar way, taxes and subsidies also affect costs and thus supply.
For example, the landfill tax has increased construction costs and
reduced supply at each price. A subsidy would do the opposite, and
increase supply at each price, since every producer would be ‘paid’ a
proportion of the cost of each unit produced by the government. A
more complicated issue is the impact of general taxation, as much of
the construction industry’s demand is derived and depends on how
others forecast their requirements.

Government Cont’d
The most direct impact that the government has on construction
markets is through legislation. Obviously the industry is affected by
changes in statutory regulations that apply to building, planning, and
health and safety.
Supply Chain Management
It would be a very rare for a contracting firm to be able to complete any
construction activity entirely alone. The larger firms, especially the
huge conglomerates, ensure their clients are provided with prompt and
reliable services by diversifying into other businesses to extend their
range of operations; for example, a construction firm may choose to
merge with its material supplier to guarantee it meets completion
targets on time. Such a merger would also eliminate many of the
associated transaction costs.

Supply Chain Management Cont’d
Construction firms not only produce different products but they also
operate outside their immediate business and, to understand the
supply implications, we find ourselves considering changes in many
related markets as well as the conditions in the construction industry.
Expectations
A change in the expectations about future prices or prospects of the
economy can also affect a producer’s current willingness to supply.
For example, builders may withhold from the market part of their
recently built or refurbished stock if they anticipate higher prices in the
future. In this case, the current quantity supplied at each and every
price would decrease, the related supply curve would shift to the left.

UNDERSTANDING CHANGES IN SUPPLY
A shift of the supply curve

Elasticity
Price Elasticity of Supply = percentage change in quantity supplied
percentage change in price
COMBINING SUPPLY AND DEMAND
Changing market conditions across three markets

The three hypothetical markets and the changes described in Table
5.3 are plotted. In market A we assume an increase in demand
causing quantity and price to increase. In market B we assume an
increase in supply causing quantity to increase and price to
decrease. In market C we assume an increase in demand and a
long-run decrease in supply causing a higher equilibrium price but
no significant short-run change to quantity.

The Roles of the Quantity Surveyor
During the process of design development, the quantity surveyor is a
part of the cost management team playing the following roles;
• Prepare feasibility studies and determine the budget of the project
• Consider with client and design team alternative strategies and
prepare outline cost plan
• Carry out cost checks and finalize cost plan. Monitoring and control of
cost during the pre-contract stages
• To check and report the cost of design solutions as they are
established or refined by the engineers
• To prepare comparative estimates of various design solutions or
alternatives and advise the engineer accordingly
• As changes are introduced into the project, to estimate the cost effect
of the change and to report

• To prepare a pre-tender estimate based on a bill of quantities (BoQ) or
priced activities
• To prepare a financial appraisal for different sites, assessing the effects of
capital and revenue expenditure, life-cycle costs, grants and taxation
implications
• Advising clients on the project brief, preferred procurement routes, costs
and cash flow
• Preparing tender and contractual documentation, leading to tender
selection and appraisal
• Following the letting of the contract for the project, advising on payments
to contractors, and post-contract cost control (cashflow forecasting,
variations, fluctuations, claims), settlement of final account

• Negotiating with the contractor or subcontractors
• Reporting on programme and financial matters
• Risk and value management
• Giving contractual advice for either party in the case of dispute

Principles and Techniques of Cost Estimating
The primary function of cost estimation is to produce an accurate
and reliable cost forecast of a construction project.
However the costs to be forecasted depend on the requirements of
a client and also upon the information and data available to develop
the model.
For instance, a client or contractor may need to know the lowest
tender price at one stage and/ or the final project cost at completion
stage.
There are different techniques currently used for project cost
estimation at different stages of the project development process
and even within the same stage.

The attractiveness of each of these methods includes its:
• Ease of application
• Familiarity of the user
• Speed at which it can give results
• Its tolerable level of accuracy
• Its reliability

A.The following are the main models used by consultants in the
construction industry;
• Functional Unit- Also referred to as cost per place or unit method
• Cube Method
• Superficial Method- Also known as cost per metre of floor area
• Approximate Quantities Method
• Elemental Analysis Method
The data used in these models are usually derived from historical
records of already completed buildings

B. Contractors when preparing bids or tenders normally use
resource analysis method. This includes the analysis of major
resource constitutes or inputs such as;
• Materials
• Labour
• Plant
• Overheads
• Profits
The above units are normally considered so as to arrive at unit
rates

Cost Modelling Techniques of Cost Estimation
Methods
FUNCTIONAL UNIT
This method relies on the fact that there exist a relationship
between the cost of a building and the number of functional units
which it accommodates. These units are expressed in terms of
intended use of the building.
These may constitute for example;
• For hospital cost per bed
• For school cost per student space
• For cars cost per parking space
• For cinema halls cost per seat, etc.
By costing a single functional unit, rather than say floor area, the
designer gets area flexibilities which allow him choice of quality as
well as quantity of accommodation of the building during design.

Methods
This method is considered unreliable because every building is
unique on account of the following factors
• Site conditions
• Price levels set by market conditions at a given time
• Specifications levels variations
• Different access and circulation arrangement
• Client characteristics
• Consultant and design characteristic
• Contractor characteristics
• Project characteristics
• Contract procedure and procurement methods etc.
• Consequently these factors render the method unreliable.

Methods
THE CUBE METHOD
This method of estimation involves multiplying the plan area
measured over the external wall with the height measured from the
top of foundation to halfway the roof height if pitched. If the roof is
flat, an allowance of 0.6 m is made as extra over roof height.
Chimneys lifts, dormers, turrets, lantern lights are measured
separately and added as a lump-sum cost. Thus from historic
records i.e. costs of previous buildings, cost per cube is obtained
and this is used for obtaining costs of new projects.
This method is not reliable on account of the following factors
•All the factors disqualifying the unit methods
•The cost of a building is more related to its floor area than its cubic
capacity
•The allowance for pitched roofs or flat roofs are arbitrary abstract
and shed no light to the real cost items

Building_economics_presentation_1.ppt

Methods
THE CUBE METHOD (Cont’d)
This method is not reliable on account of the following factors
•The method would give the wrong view of costs if the foundations
were deep and extensive
Hence, its only virtue is uniformity.
SUPERFICIAL METHOD
This method bases its estimation on the fact that the building cost is
much more closely related to floor area. The method entails
measurement of total floor area within, the internal perimeter of walls
and is measured over all partitions, staircases, internal columns etc.
Where there are no external walls but instead columns exist,
measurement is done from the external perimeter of the columns. Lifts,
chimney stacks etc. are assessed separately and their cost added as a
lump sum.

Methods
SUPERFICIAL METHOD (Cont’d)
The advantage of this method is that it expresses costs in terms of
accommodation required. This is more meaningful to the client.
Sometimes when estimates are required at the initial stages of a
project the only available information is floor areas then it becomes
a very useful tool.
However, most of the factors causing unreliability cites under unit
method apply as well.

Methods
APPROXIMATE QUANTITIES METHOD
• Approximate quantities provide a more detailed approximate estimate
than any
• of the methods described above. They represent composite items which
are
• measured by combining or grouping together typical bill-measured
items. Whereas
• the methods described above estimate costs on the basis of
measurement and some
• cost relationship, this method relates cost to the actual work to be
carried out.

Methods
ELEMENTAL ESTIMATE METHOD
• This method analyses the cost of the project on an elemental
• basis, attempting to make use of the cost analyses from other similar projects.
• Cost planning, however, also seeks to do much more. It provides cost advice during
• the design process, offering the client better value for money. It keeps the designer
• fully informed of all the cost implications of the design in relation to an approved
• approximate estimate and likely accepted tender sum.

Cost In Use
Building costs in normal parlance refers to the capital costs of
providing a new building. However, once a building has been put up it
continues to incur costs such as:
• Maintenance
• Decorations
• Heating
• Cleaning
• Repairing
• from time to time, fairly expensive renovations
• Also, each year the interest in capital costs will have to be found
and a sinking fund paid into it.
• Consequently, the terms: Cost-in-use, life-cycle costing,
ultimate cost and total cost were coined to describe a form of
modeling technique to cope with this mixture of capital and
running costs. Hence cost in use can be defined to mean both
initial construction costs and all running costs, and include
maintenance costs.

Breakdown of Total Cost
The segments can be explained as follows:

Breakdown of Total Cost (Cont’d)
a) Initial costs: the capital or initial expenditure on an asset when
first provided
b) User costs: these are synonymous with future costs and
comprise both running costs and occupational charges.
c) Maintenance: this defined as work undertaken in order to keep or
restore every facility i.e. every part of a site, building and its
contents, to an acceptable standard.
d) Operating services: these embrace cleaning, caretaking,
operation of plant and equipment and other allied activities
e) Fuel and power: these represent the energy costs for heating,
lighting, air-conditioning and the like
f) Modifications and alterations: these are new works required to
improve or adopt an asset

Cost In Use Technique
Most cost budgets for construction projects only target initial capital
cost of land, construction and professional fees consequently,
materials and construction processes have been selected which are
low in initial costs but which require frequent expenditure on
maintenance and repair during the life of a building.
Ideally it is argued that if the architect were allowed to spend more
money initially on better materials, running costs and some
occupational charges would be lowered and in the long run pay for
themselves.
EXAMPLE
Advising a client on alternatives for windows;
a)Softwood windows1000/- per m2 initially but requiring painting at the
cost of 2500/- per m2 every 5 years
b)Toughened plastic costing 2000/- per m2 but requiring treatment
every 10 years at the cost of 2000/-
c)Aluminum costing 2500/- per m2 initially and requires no
maintenance throughout the life of the building.

Assumptions; The life of the building is 40 years. Assume 14% interest
rate.
1. Alternative A
COST PERIOD PVF AMOUNT (KShs.)
Initial cost - - 1,000.00
PV of painting 5th year 0.519
10th year 0.270
15th year 0.140
20th year 0.073
25th year 0.038
30th year 0.020
35th year 0.010
1.07 x 2,500 2,675.00
TOTAL COST IN USE KShs. 3,675.00

rate.
2. Alternative B
COST PERIOD PVF AMOUNT (KShs.)
Initial cost - - 2,000.00
PV of Treatment 10th year 0.270
20th year 0.073
30th year 0.020
0.363 x 2,000 726.00
TOTAL COST IN USE Kshs. 2,726.00

rate.
3. Alternative C to remain the same
Therefore,
A costs 3,675/-
B costs 2,726/-
C costs 2,500/-
Consequently, comparatively alternative C proves to be in the long run.
So it depends on what the developer will do with the product. If for
sale, option A may be the best option as the developer will dispose, if it
is for rent or owner occupier, then option C is the best option.

Difficulties of Assessing Cost in Use
There is reluctance by professionals in the construction industry to use
cost-in-use techniques to provide cost advice to clients because;
1. Lack of reliable historical data and the predicting useful life of
materials leads to inaccurate assessment of maintenance and
running costs of different materials, processes and systems.
2. There are three types of payments, initial, annual and periodic.
These must be brought to a common basis for comparison
purposes. This requires mastery of discounted cash techniques.
3. Income tax has a bearing on maintenance costs and needs
consideration as it can reduce the impact of maintenance costs.
Taxation rates and allowances are subject to considerable
variation over the life of the building
4. The selection of suitable interest rates for calculations involving
periods of up to 60 years is extremely difficult.
5. Inflationary tendencies may not affect all costs in a uniform
manner, thus distorting significantly the results of cost in use
calculations.

Difficulties of Assessing Cost in Use Cont’d
6. Where projects are to be sold as an investment on completion, the
building client may show little interest in securing savings in
maintenance and running costs
7. Where the initial funds available to the building client are severely
restricted, or his interest in the project is short-term, it is of little
consequence to him to be told that he can save large sums in the
future by spending more on the initial construction stage.

Life Cycle Costing (LCC) techniques
• Life Cycle Costing is a form of modelling technique which can embrace a
mixture of capital and running costs.
• It is an assessment of the whole life performance and cost of an asset
over its lifetime.
• It takes into consideration initial capital costs and future costs, including
operational costs, maintenance costs and replacement/disposal costs at
the end of its life.
• It is an economic assessment of the discounted net present value of life
cycle costs.
• The techniques discussed include; Discounted cash flow (DCF), net
present value (NPV), internal rate of return (IRR) methods

• NET PRESENT VALUE (NPV)
• In Table 1, the life of the project is 10 years and both receipts and
payments are not evenly spread over the years. The assumption is
that the project would be replaced after 10 years.
• It is not sufficient to judge the success of a project by the net cash
flow figure (25,000-11,000) giving the net cash flow of Kenya
Shillings 14,000. this argument ignores the cost of using the capital
say @15% per annum. To incorporate cost of capital into cash flow
analysis, the concept of discounting or getting the NPV of an
investment which is introduced in Table 2 under the Internal Rate
of Return (IRR).
• NPV is the capitalised difference between present values of all
future receipts from a project and its future outgoings.

• NET PRESENT VALUE (NPV)
• NPV gives the surplus the investor can expect after allowing for the
recovery of capital invested and for the current rate of interest and
it will indicate whether the project is worth undertaking or not.
• The investor will then decide upon the surplus whether it is large
enough to compensate for the risk and responsibility entailed.

• NET PRESENT VALUE (NPV) Cont’d (Table 1)

• NET PRESENT VALUE (NPV) Cont’d (Table 2)

NET PRESENT VALUE (NPV) Cont’d (Table 2)
•In Table 2 the NPVs at 15% and 20% are given. The project has a
positive NPV of 1,840.29 at 15% and a negative of (-288.28) at 20%.
•The decision rule is to accept a project with a positive NPV and
reject the one with a negative.
•The magnitude of NPV can be subjected to further analysis if it is
large enough to meet the requirements of the investor.

INTERNAL RATE OF RETURN (IRR) Cont’d
This is used to determine the rate of interest to adopt when
preparing budgets.
IRR is the rate of return adopted where discounted receipts equal
the discounted payments.
When this happens, the NPV=0. Because IRR shows the actual
point of equilibrium for costs and receipts it is said to be the internal
rate of return for the investment.
If money is invested in a project, one should allow the rate of return
that the investor expects on the project to be say x%. This enables
the investor to compare this rate of return directly with that of other
projects or investments and this method is used to calculate the
IRR.

The figures used in Table 2 are needed to illustrate how the IRR can
be calculated from the NPVs. From the table, the IRR is less than
21% because the NPV is negative and higher than 21% because
NPV is positive. Thus, IRR lies between 15 and 21% and possibly
closer to 21%

DISCOUNTED CASH FLOWS (DCF)
With IRR, one is looking for a discount rate that equates the NPV to
zero. That is that break even rate that equates expenditures to
receipts by the end of a project, which is in this case 10 years.
In DCF, the investor obtains NPVs per period as shown in Table 2,
but cumulatively adds them up to see at which period the NPV
starts to be positive, hence the break even point.
NPVs beyond that point will be a measure of the magnitude of the
profits.
The shorter the break even period and the greater the amount of
NPV, the more acceptable the project. The pattern and incidence of
cash flows is also a major consideration in DCF consideration.

DISCOUNTED CASH FLOWS (DCF)
For example, in table 2, the project only begins to break even in the
8th year when a cumulated NPV of 282/- is realized. The amounts
received in the 9th and 10th years are therefore profits.
Higher than 15% rates of discount or cost of capital will increase the
period at which break even takes place so that at 20.19%, this point
is reached in the 10th year.
Lower discount rates (less than 15%) or cheaper capital will bring
the break even point earlier than in the 8th year.

Benefits of life cycle costing;
•Encourages communication between the stakeholders and leads to
an improved project definition
•Clarifies the cost of ownership and occupation
•Optimizes the total cost of ownership/occupation
•Enables early assessment of risks
•Promotes realistic budgeting
•Encourages discussion and decisions about materials choices
•Enables best value to be attained
•Provides actual figures for future benchmarking.

• Rate build up from first principles
• Analysis of past tenders and adjustments as may be necessary
• IQSK maganize
• JBCC price index
• Some suppliers offer supply and fix prices and recommended retail
prices, from which data can be compiled
• In other countries we have price books
• Monthly cost information from subscribed data banks
Nature and Sources of Cost Data

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