Cost-Plus or Fixed Price?

rjaero19473March 4, 2010

We are getting bids for our new house and are getting both fixed price and cost-plus bids. Most of the builders in our area do the cost-plus thing, and so far I only found one contractor that we like who will only do fixed price. I have a good bit of references for all the contractors, so I can easily contact past clients, as well as current ones to see how the builder performed. At this point we are not sure what to do. The one guy who does fixed price is a really good contractor, but his price is about 75k more than the others. I'm not sure if that price is to cover his butt, or if he just has expensive subs. Also not sure if the other two are low-bidding. What are your thoughts?

Thank you for reporting this comment. Undo

I always say fixed price. How much "plus" is there in the cost-plus contracts? 5%? 10%? If someone bids $100 in a cost plus 10%, can you afford $110 -- because that's what you're going to be paying.

    Bookmark   March 4, 2010 at 9:00AM
Thank you for reporting this comment. Undo

The only thing you can "bid" with a "Cost of the Work with a Fixed Fee" contract is the Fixed Fee (usually a % of the cost) unless the contractors are including a Guaranteed Maximum Price (GMP). The full project cost is only an estimated budget which cannot be compared with other budgets or fixed prices.

To help you we need to know specifically what contract types the bidders are proposing and how they will be compensated. Frankly, I've never known a bid package to leave the contract type up to the bidders since there would be no way to compare the bid proposals.

As for the difference between a Cost of the Work and a Fixed Price contract it shouldn't cost more one way or the other in theory but in reality the success of a Fixed Price contract relies greatly on the completeness and quality of the contract documents in order to avoid expensive Change Orders during the construction phase and the success of a Cost of the Work contract relies greatly on the honesty and project administration capability of the builder.

Usually the choice of the contract type is determined by issues such as how motivated the contractors are, how soon you want to start, how complete and competently prepared the documents are, the level of control the owner wants to have in the sub-contractor selections, how much design work will occur during the construction phase, who is advising or assisting the owner during construction, and the experience, flexibility and management ability of the builder.

If any of this is not already clear to you then you need to review it with an experienced design or project management professional before proceeding.

Good luck with your project.

    Bookmark   March 4, 2010 at 9:39AM
Thank you for reporting this comment. Undo

In my area, higher end builds are usually done cost plus and more basic builds are done fixed price.

I think that actually makes sense. If you are flush with cash and you want significant upgrades, then you have no problem not knowing the exact final price. If you have $400k exactly to spend, then a fixed price is more guaranteed (as much as these things can be).

I think it also depends on your personality and how particular you are with things. There are always decisions to be made and the builder will always take the cheapest option if allowed (well not always but usually). So you say, specify everything in the contract - impossible I say. I had a neighbor who built with a fixed price. They leveled his yard and he loved it. The next day, they realized they needed some fill for the garage so they changed the level of his yard. Builder went with the cheapest option. With cost/plus (or my preferred fixed fee), the builder goes to you and says we are out of dirt. I can get some for $500 or I can mess up your back yard - your decision. Truthfully, it is your decision either way but you are more involved with a cost/plus.

Also - a fixed price has to include some wiggle room. Most builders have to pad things a bit for the unexpected. It is always a gamble and the builder has to make some extra money by taking on this risk. In capitalism, risking money always has to be met with rewards (otherwise you wouldn't do it). In cost plus - you are taking the risk and getting the rewards (not in every situation but in the majority...)

This is all my opinion but I would not want a fixed price. I had that option with my builder and I went back to him and said make it cost plus. He came back with fixed fee and his reasons why and I agreed. His reason why is that it matters very litle to him if I speced out a $1000 toilet or a $100 one, so why should he make more. Also, a cost plus does give a little incentive for him to go with more expensive options whereas a fixed fee does not.

At the time of my build, I knew that prices for some things would be less than expected - and they were. Some things were more expensive because of code changes but in the end, I saved a ton of money.

We upgraded things left and right and came out 3% over budget - and most of that was $10k extra on appliances and $10k extra for solar hot water and way upgraded HVAC. Throw those 2 items out and we were at budget with too many upgrades to list but I'll try - IPE deck, granite in extra bath, custom vanities in 2 baths, Grohe fixtures in 1/2 the house, 1 extra room hard wooded, Walnut floors (from wide oak), gutters to PVC underground (from flex tubing), an extra $5k in clearing/grading/drainage work, comfort height toilets, coffered ceiling in 1 room.

This was a function of cheap lumber and cheap labor but either way, a fixed price would have given that $$ to the builder.

    Bookmark   March 4, 2010 at 11:18AM
Thank you for reporting this comment. Undo

A clarification of contract terms may help. A Cost of the Work contact should always have a Fixed Fee but that Fee can be based on a fixed percentage of the billed Cost or it can be a fixed Lump Sum amount paid in installments. Both fees are considered "fixed" to distinguish them from the Cost of the Work or the Budget prepared by the builder.

A Cost of the Work contract should have a well itemized Budget established by the contractor and the contractor should frequently update it as the work is bought-out, performed and paid for so you can know how you are doing (you can do this yourself but it's quite a bit harder since you have to get the information from the contractor in a timely fashion) Without that management service, a Cost of the Work contract can lead to serious cost overruns without sufficient warning for you to do something about it especially if the Budget was not accurate or the documents incomplete.

It is possible to receive competitive bids for the Fixed Fee or a Guaranteed Maximum Price along with proposals for management services and to then award the contract on that basis, but not on the basis of the proposed Budget since that price is not binding. Guaranteed Maximum Prices are rare in home building because there is no upside profit possibility if he keeps the cost down.

Cost of the Work contracts are not for inexperienced owners or builders unskilled in project management unless, of course, there is no project cost limit.

    Bookmark   March 4, 2010 at 12:20PM
Thank you for reporting this comment. Undo

Perhaps I don't understand the cost-plus concept, but it sounds like an invitation to financial disaster.

If the builder is finding the subs and supplies, but not paying for the subs and supplies out of his pocket, then he has no incentive to control costs. Further, unethical builders could accept kickbacks.

I can't imagine why an owner would accept this arrangement unless the owner was the one finding the subs and supplies directly. In that case, the GC would be just a project manager, and that function can be hired at a lower cost.

    Bookmark   March 4, 2010 at 3:54PM
Thank you for reporting this comment. Undo

A cost plus is not an invitation to financial disaster. It is just a matter of trust and watching. We had a budget, the builder called me if we were over budget (by a significant amount).

The builder has an incentive to control costs - it is called his reputation. I suppose on a fixed price, there is no incentive not to hire the cheapest (and worst quality) subs - but there is reputation at stake.

People always seem to complain about cost plus - no incentive to control cost arguments. But fixed price has no incentive for quality. So pick your poison and pick your builder on references and reputation....

    Bookmark   March 4, 2010 at 4:37PM
Thank you for reporting this comment. Undo

Sure, but if a contractor falsifies his costs (for instance by not passing a discount/kickback on to the owner) and bills the owner through the US Postal Service, he can be convicted of mail fraud. This is why I stressed honesty and sophistication as a prerequisite for the contractor.

As for not having an incentive to control costs, that is correct, so usually the owner is involved in the buy-out process and the Budget must be frequently up dated.

Large non-government commercial projects use the Cost of the Work contract type with a Guaranteed Maximum Price and a Shared Savings. If the contractor goes over the GMP he must finish the project with no additional payments. If the project cost does not reach the GMP, the contractor and the owner split the savings (usually 60 / 40, owner / contractor). This arrangement is intended to create the best relationship between owner and contractor and in my experience it works well. However, the parties must understand the process and be able to manage it properly.

The largest variable is the wide variation in the ability and sophistication of home builders. Unless I know that a builder is smart and experienced with Cost of the Work contracts, I would hesitate to use that contract type unless, of course, the owner was more concerned with quality than cost. Those are fun jobs.

    Bookmark   March 4, 2010 at 4:54PM
Thank you for reporting this comment. Undo

Well, a guaranteed max price protects the owner, and a shared savings clause provides incentive for the GC to cut costs. That is not an invitation to financial disaster.

Regarding an incentive for quality: Judging by the experiences of everyone I know, homebuilders typically make important mistakes on every job. (Shaving a foot or more off the specified length of the foundation, footings incorrectly placed, partition walls incorrectly placed, brick facade poorly done so that it bowed outward, etc.) Thus I expect to be on the job site frequently to confirm that everything is being done well and according to the plan.

    Bookmark   March 4, 2010 at 5:40PM
Thank you for reporting this comment. Undo
Lori B

We have a cost-plus contract and I am very happy that we have it, because I'm the type to want details for everything going into our home. There are so many things that come up after signing the contract. I like the flexibility of being able to see costs, evaluate our options, and control what products/upgrades go into our home. We have a guaranteed maximum. Every line item was budgeted prior to our construction financing. We have a 10% builder's reserve for things that they may have under/over estimated, and we also have an owner's reserve that was baked into the financing for wiggle room with upgrades. I agree with what others say in that the key is finding a reputable builder. We asked for samples of their progress bills up front and gained an understanding of how the accounting would work. They gave us actual copies of other projects (addresses omitted), and showed us Change Orders and everything. Even though, there's some minor frustrations at times, the Cost-Plus is reassuring that quality is not being cut.

Our GC also agreed to take out a few lines out of their workscope, but they helped us with a budget for the bank financing. We have the option as the project proceeds to cut different things -- like landscape, fencing, irrigation, etc.

They have also agreed for me to personally purchase a few things (thus eliminating their fee), like a mail slot, dog door, one special chandelier that was purchased prior to us signing the contract, etc. They are small things, but in that way, they were not so petty to say that they needed to collect their fee on every single item. These things were discussed up front and is all part of the "trust." And trust is a big, scary factor.

Just do your research on your GC, and make sure your contract is really ironed out!!

    Bookmark   March 4, 2010 at 11:19PM
Thank you for reporting this comment. Undo

I can't say enough to KNOW YOUR BUILDER!!!! 'david cary' is correct about reputation. We met our builder 2 or 3 years before we built our house. We heard of him by his 'reputation' as a very reliable builder not only by friends but the lumber yard and other contractors. After meeting him he took us to see homes he had built and he asked us questions about what we wanted. Then we sat down to discuss the contract that works best for him because he has had the same subs for years. During our build he met with us every week to show us prices, receipts, the budget, etc. He was totally honest and that was cost-plus. There will always be some 'unknowns' and they do have to make some profit!! Anyway, just be sure you KNOW your builder!!

    Bookmark   March 4, 2010 at 11:35PM
Thank you for reporting this comment. Undo

I'm confident that there are many fine builders; people who are honest, competent, and conscientious. I'm just not confident that I can identify them. I'm not a builder, and I don't work in the trades; I don't have an insider's perspective.

I know how to evaluate my peers, and I know who I would trust within my field, but a lay person isn't equipped to make those judgments. I might be wrong, but I think you overestimate your ability to select an excellent builder.

When I choose a mechanic I go through the usual steps to find a competent pro, and then I cross my fingers. With homebuilders, the stakes are fairly high, and the average performance(in my experience) is rather poor. That circumstance calls for close supervision, optimal incentives, and tight contractual controls.

A project may work out adequately with a cost-plus arrangement, but unless it contains the clauses macv describes, I think it increases risk without a proportional increase in reward.

    Bookmark   March 5, 2010 at 12:16AM
Thank you for reporting this comment. Undo

This discussion seems to have gone off on an oversimplified specious tangent. The primary risk in a Cost of the Work contract is not usually the cost of Subcontractors but the cost of the Contractor's own forces. That can usually be successfully addressed with unit prices (per hour labor for different tasks) and/or a "mini-maximum" cost limit for that labor and/or materials.

Contract type selection is never just a matter of one being superior to another; it is always a matter of the various specific conditions and requirements of the particular project and the experience, skill and motivation of the author of the contract. To describe all of the considerations would fill a book.

Where most Owners run into trouble is when the Contractor writes the contract. It would be unrealistic to expect a Contractor to write it from the Owner's point of view or to put the Owner's interests ahead of his. Hiring a lawyer often address some but not all of the important issues because few lawyers have much experience in modern project delivery methods other than Lump Sum.

The people who are the most familiar with these matters are architects if they were paying attention in school and have kept up with the issues as they have developed over the years but not all of them have done this and it is rare that an architect is put in a leadership role for a house project since the budget is so often "build it as cheap as possible" and the schedule is "build it as fast as possible". Neither approach is effective but that is a subject for another discussion.

rjaero19473, that's all I can tell you without knowing more about your project.

    Bookmark   March 6, 2010 at 12:08PM
Thank you for reporting this comment. Undo

macv, we have been working with an architect for the past 7 or 8 months to design the house. He's been very involved in helping us find a builder, and once we get our bids in next week we are all going to sit down and wade through the bids. Our architect seems like a very knowledgeable guy, so I will talk with him about his experience regarding contracts. One of the builders we are very interested in working with gave us a cost plus bid, but said he is so confident in his numbers that for an additional 2% fee he'd make it a fixed price. We're at around $400,000 for total cost, so for roughly $8k more we could lock in his bid.

    Bookmark   March 7, 2010 at 8:02PM
Thank you for reporting this comment. Undo

The customary procedure is for an architect to put together a bid package and that would include the drawings, the specifications and the contract you preferred to use in ordeer that every bidder would be bidding on the same terms and the results could b e compared. I really don't understand what you are doing or how you would know this bidder's price is reasonable for the local market so I'll bow out of the discussion.

    Bookmark   March 7, 2010 at 9:05PM
Thank you for reporting this comment. Undo

I think having an architect spell out everything first changes the dynamic - most people don't do that. They make decisions during the build (at least we did). That being said, you were given an exact $ amount premium for fixed price. While it may not be true, it shows how fixed price costs the customer more (on average). Again back to risk being rewarded in a market based economy.

    Bookmark   March 8, 2010 at 6:51AM
Sign Up to comment
More Discussions
Master Bedroom Floorplan Review
Hello, I am currently working on building a new house...
Open Cell Attic Insulation. No baffles/No vapor barrier?
We are in Chicago and are putting on an addition that...
building a simple modern farm house on a budget
I am planning to build a simple modern looking farmhouse...
Building a shed with living quarters
We are planning to have a shed built on our property...
House Plan: ALP-03CF, 51-338, DC-6690-32, W14453RK
Has anyone built this house?
People viewed this after searching for:
© 2015 Houzz Inc. Houzz® The new way to design your home™