Now you’re ready to go to contract, but what type of construction contract is best for you? There are two main types of residential construction contracts: cost plus and fixed fee. They both have distinct advantages and potential disadvantages. Depending on which bank and contractor you’re working with, both options may not be available. While the choice may not be entirely yours, it’s important to understand the basic differences between these contracts so you can recognize which is the best fit for your project.
A cost plus contract is just as it sounds. It reimburses the contractor for the actual cost of construction plus a management fee, which is typically a percentage of the cost. It’s an open-book, transparent method that is generally used when a buyer is paying cash rather than utilizing bank funding. With this method, the buyer is able to capture the upside when costs come in lower than estimated.
They typically have a lower contractor margin because of their limited cost exposure, and the buyer has a better understanding of how each line item drives overall cost. But with this type of contract, there is no final price guarantee. The buyer also absorbs the cost overruns and price increases, and traditional lenders tend to shy away from contracts that don’t have a clearly defined final cost.
On the flipside, a fixed cost contract means your construction cost is fixed regardless of incurred construction expenses. Your contractor bears all the risk. You pay no more or less than the negotiated upfront contract cost, which gives most buyers and lenders a little less heartburn.
For either type of contract, your contractor should be very good at estimating current costs and projected inflation of pricing throughout your build. For a cost plus contract, they should be able to provide actual bids to back up their estimates. They can’t just shoot from the hip. In a fixed fee contract, bids must also be very tight, because extensive losses would quickly put a contractor out of business. However, they cannot overly project inflation that could significantly increase the contract cost, as they have to stay competitive in the current market.
I’ve found a pretty even mix of builders favoring one type over the other, and most are ardent about why they feel their contract choice is in both parties’ best interest. We offer both types of contracts because we feel there are times when one or the other is a better fit for the project. During initial meetings, we go through the various contract idiosyncrasies to determine which is the best fit for that project.
In either contract, the most important aspect is to clearly identify scope, specifications and their related cost in detail. Clear communication and pricing education is by far the most vital aspect of any project. Buyers need to know what their contract includes and how much the things they want in their home will cost so they can make informed purchases and have peace of mind that they are getting the home they envision for the price they have agreed to.
Mary Ludemann is the founder of New Old and has been designing and building homes for over 12 years. To discuss your next dream build or renovation project, contact New Old at 704-975-5196. For more information, visit www.newold.com or email them at building@newold.com.