Your new home is designed and now it’s time to hire a builder. Before you do, the architect gives you some guidance and tells you that there are two types of contracts that govern construction. One type is called the Fixed Price Contract. The other, the Cost Plus contract.
Fixed Price Contract
The Fixed Price Contract is just what the name implies: the builder agrees to build the house for a fixed price. In order for a Fixed Price Contract to make sense, the builder and the owner must have an clear and similar vision of what the project entails. For example, the level of finishes must be understood as standards will be cost sensitive. The builder will base his price on a very detailed budget and other assumptions then will add a profit margin unknown to the owner. The danger of the Fixed Price Contract is that what the builder assumes may not match what the client is envisioning. This may not become apparent until well after construction has begun. For example, a builder might specify a certain type of shower fixtures throughout the house. When the contract is signed, the owner assumes the amount budgeted (or allowed) for fixtures will be adequate but later, when actually choosing the specific fixtures, determines that the allowed amount is not satisfactory. Many design elements are priced as allowances. In other words, the builder gives an allowance for a specific item knowing that the owner does not, at the time of the contract signing, know exactly which brand and style might be selected. As illustrated, many assumptions, allowances and expectations must mesh perfectly for both the builder and the client to be well satisfied. A Fixed Price Contract can work well if the project is sufficiently simple so that all involved have a clear picture of what the finished project will be. But in the case of higher-end custom homes, a clear idea of the finished project is quite difficult. The design aspects of the house can be exceedingly complicated. If a fixed price contract is governing this type of project, the owner, architect, and builder can come into conflict over expectations and ultimately, money. And the builder may use “change orders” to exceed the amount of the fixed price if the owner’s desires and expectations exceed the builder’s allowances and assumptions.
Cost Plus Contract
The Cost Plus Contract is a contract based on a estimated cost that is not fixed. The builder proposes an approximate budget, and agrees to take profit based on a percentage of the total cost of labor and materials. With the cost plus contract, the owner is given the actual cost of each expenditure and is aware at all times exactly what the builder has spent for labor and materials.During construction, the owner must approve all expenditures. As a result, the owner is very involved in the economics of the project and in fact, is called upon to supervise how and where money is spent. This type of contract allows for project flexibility. For example, if the amount budgeted for excavation is lower than expected, that amount can be, if the owner wishes, transferred to the amount budgeted for, as an example, plumbing fixtures. Though the Cost Plus project depends on an accurate estimate of costs just as does the Fixed Price project, the Cost Plus contract and process allows for greater transparency than the Fixed Price Contract. Of course, the Cost Plus Contract requires that the owner be willing to spend time participating in the supervision of the budget. Costs can escalate if the owner does not make efforts to control spending. The Cost Plus Contract is ideally suited to more complex projects where there is a great emphasis on design, standards, and finishes and quality is of utmost concern.
The Bottom Line
The home owner must make take very seriously the contract phase of the home building project. In the past, the Fixed Price Contract was often the instrument of choice. As custom homes become increasingly more complicated and thus difficult to budget with exact precision, the Cost Plus Contract provides flexibility and transparency that the Fixed Price Contract cannot. The Cost Plus Contract has become the contract of choice for complex custom home projects.
