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Negotiating Margin on Cost Plus

Posted by DoubleOhHoya (My Page) on
Mon, Jan 2, 12 at 23:19

We have a preliminary commitment with a builder. We are still in the planning phase, but are getting frustrated because our budget keeps going up. I realize builders need to make a buck, but at some point, I feel like I need to start negotiating on his margin. We're budgeting under a cost+20% context. Going to 17% would fit my bottom line. What are peoples' thoughts on this point? Can or should we negotiate here?


Follow-Up Postings:

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RE: Negotiating Margin on Cost Plus

Yes, definitely negotiate. We did cost plus 10%. When the economy was booming 15% was the norm, but when we built 2 years ago, it had gone down to 9-12%. 20% seems high but these thing vary by region.


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RE: Negotiating Margin on Cost Plus

This is just my opinion but building anything cost plus is VERY risky. Builders like cost plus because it tranfers all the financial risk from them to you. With cost plus the builder has almost no motivation to keep cost low because if he does he's reducing his profit. About the only positive I can see with cost plus is the builder might not be as likely to us inferior products and services to keep his cost low as he would on a fixed price contract. If you really have to go cost plus I would recommend reviewing every estimate before starting the build so you could do a sanity check on them and I would speak directly with the subs and vendors and try to get there assurance that the prices they are providing are the ones they plan on charging at the end of the job. No way would I pay a builder anywhere near 20%, pps7 paid a reasonable fee of 10% and that is what I would try for. I've been around the home building industry since 1997 and the only time I've seen cost plus pricing work is when the client is not 100% sure of what they will spend I.e. quality of fixtures, materials, one of items, etc. which usually happens on really high end home builds. I would interview a builder that works on a fixed price contract this might atleast give you a good comparison against what your about to sign up with.
Good luck!


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RE: Negotiating Margin on Cost Plus

My opinion is Cost Plus is the fairest way to build. Its only risky when you hire a shady or dishonest builder. Not only will fixed price go with cheaper materials whenever possible but cheaper labor too which could lead to some very serious problems down the road. A good, honest builder working cost plus is basing his reputation and future referrals on meeting the agreed upon estimate.

Fixed Price can make sense on straight forward sites with VERY detailed plans and specs. Be sure to get your change order policy in order with this method as well.


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RE: Negotiating Margin on Cost Plus

Why not go cost plus a fixed fee?


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RE: Negotiating Margin on Cost Plus

2nd on the fixed fee. I prefer it to the alternatives. I do think sometimes on a simple build fixed price makes sense.

20% does seem pretty high but every situation is different. We just built in a special area and the fee was almost 20% that I agreed to. But the finishes were simple and the difficulty of the build was high. And my builder did somethings himself (without extra charge) that were fairly time consuming.


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RE: Negotiating Margin on Cost Plus

The term "Cost Plus" is shorthand for "Cost of the Work Plus a Fee". The "Fee" can be based on a percentage of the Cost or it can be Fixed. Because every project is different, the type of fee should always be negotiated. The fee can also be bid competitively with multiple builders which usually takes the form of interviews where the builders make their pitch.

This type of contract can also have a "Guaranteed Maximum Price" to protect the Owner and since negotiated GMP's are usually high, there can also be a "Shared Savings" that splits the amount that the final Cost is below the GMP.

Use of all of these features provides the fairest contract for both sides and allows a faster project start up but it requires owners and builders capable of more sophisticated project contract administration.


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RE: Negotiating Margin on Cost Plus

There are exceptions to any statement, I still hold to the fact that cost plus is risky financially not necessarily with quality. If you pick a shady contractor it won't matter if he's working on fixed fee,cost plus, cost plus not to exceed, firm fixed price with incentives, etc... you will still get burned in the end. When choosing a builder you should evaluate their integrity first and then negotiate a contract. If I were DoubleOhHoya I would interview other builders that operate on fixed prices to at least get a check on the cost plus price. I work with commercial contracts now instead of residential and about 98% of the contracts we bid/awarded are lump sum (fixed fee). These contracts force the contractor to "earn" their fee instead of having a garanteed fee at the end of the project regardless of how the build budget turns out.I'm not calling out cost plus builders I'm simply stating unless an individual is willing to accept a build with a budget that is a moving target I would avoid the situation. I just finished building my home without hiring a builder because I wanted to control every step of the build ensuring it was done to my satisfaction. Knowing my wife and I would make so many changes on the fly neither fixed fee or cost plus was going out work for me. I was able to negotiate not only material prices but also labor wages. Whatever direction you decide on just make sure you do your home work going the extra mile now may seem a bit excessive but will pay off during and after the build is complete.


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RE: Negotiating Margin on Cost Plus

ok, here's another question for the group. when people refer to percentages, are they breaking out overhead separately? i called a few builders to get a quote on margins. both said they don't really do cost plus, but one said he did one at 10% several years ago.


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RE: Negotiating Margin on Cost Plus

Overhead and Profit would be included in the Fee. The Cost of the Work is only what the GC spends for the project. That would not include the cost of his off-site office, office staff, or equipment/vehicles but it might include the rental of certain equipment just for your project. Sometimes the labor rates of the GC's on-site forces needs to be specified in the contract or some things might be given Lump Sum prices or Unit Prices.

A low fee (10%) might indicate a GC with very low overhead and/or one who plans to use a lot of his on forces at a marked-up labor rate and/or one who plans to keep his favorite sub-contractor's discounts/kickbacks (a violation of the terms of a properly written Cost of the Work contract).

Ask him if he owns his own truck. (old contractor joke)

The term "margin" would not occur in a Cost of the Work contract. What you are asking for is a "Fee" proposal as a Percent of the "Cost of the Work". The Fee would be the GC's only compensation. The fee can be negotiated and could be a percentage, a fixed amount, or a combination of the two. If you ask for the contractor's margin I suppose he might think you are asking for his profit markup.


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RE: Negotiating Margin on Cost Plus

Just remember the harder you squeeze the tighter the builder will stick to the contract wording.

Even the smallest change will be negotiated hard.


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RE: Negotiating Margin on Cost Plus

I talked to the head of the local home builders association. He told me that a 20% margin is common in my area for an in-demand builder, which he defined as anyone having more than 3-5 projects, which mine does. But he also encouraged me to go fixed cost instead, and said that I should be able to recoup any savings from not using the contingency or all of the allowances, so I think that's what I'll be doing.

I have planned to hire a lawyer to review the contract when the time comes. I assume that's money well spent?


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RE: Negotiating Margin on Cost Plus

Hey.... can I ask to see invoices??? Without insult.


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RE: Negotiating Margin on Cost Plus

We have a CPFF and we always ask for itemized invoices before we pay them.


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RE: Negotiating Margin on Cost Plus

In a Cost of the Work contract invoices are always required to be submitted to the owner; there is no other way to verify what was spent for the project.


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also

The term "margin" usually refers to the profit after expenses in a financial transaction so it is best avoided in a construction contract.

The appropriate term for a "Cost of the Work with a Fee" contract is the Contractor's "Fee" which is usually expressed as a percent of the Cost of the Work and includes the Contractor's overhead and profit. How much is for each of these categories would be interesting to know but is not important.

The Cost of the Work should only include money spent for the construction of the project and would not include the Contractor's overhead except possibly for the cost of a site office and staff working in that office if authorized by the Owner.

Any OH&P included in the cost of the Contractor's own forces on the site should be carefully reviewed and negotiated. So should the cost of rental equipment. Discounts and rebates from suppliers and subs should be stipulated to be subtracted from the Cost of the Work.

I have found the most common flaw in Cost of the Work contracts is the lack of management skills on the part of all parties involved. If the parties do not understand how to administer this type of contract, they might as well use a Lump Sum contract with Allowances.


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