New construction: Cost-plus versus fixed-price

This article is the fifth in a series on new construction.  The contents of this series of articles apply to commercial as well as residential projects.

When building new, one of the main decisions the builder and the buyer need to address is whether the price will be fixed or vary with the price of materials, subcontracts, permits, etc.

This decision first should hinge off of whether a fixed set of plans for the project have been agreed upon in advance, and important price variables such as site work, soil conditions and governmental requirements have been fully explored.  If so, the project may be ripe for a fixed price contract.  If not, it is difficult for the builder to provide a fixed price, and the project is more suited to a cost-plus arrangement.

A fixed-price contract is as it sounds, for a fixed sum.  A cost plus contract says that the buyer pays all of the builder’s actual costs to third party contractors and material men, along with permitting costs, and then adds a margin for overhead and profit.  There are other options, such as cost-plus, subject to a guaranteed maximum price.

In each of these three contract scenarios, the issues of change orders, allowances and selections can still significantly impact the price.  Read about those here.

Fixed-price

In a fixed-price contract, since the builder is taking the risk for pricing variations and project “unknowns,” it typically wants a higher margin (i.e., profit and contingency) to account for that risk.

Cost-Plus

Sometimes a buyer wants to avoid paying that margin and is thus willing to accept the pricing risks accompanying a cost overrun.  Further, if the scope of the project is not tightly defined at the front-end (what is to be built and when it is to be built), then a cost-plus contract may be the only practical option.

“Headlights on” or “Headlights off”

Because a cost-plus contract can be an open-ended checkbook for the builder, we advise buyers to “turn the headlights on” during that process, and (i) start with a detailed line-item budget of anticipated construction costs and (ii) monitor performance throughout the construction process against that line-item budget.  As the project starts to run off the rails cost-wise, the buyer can rein in the project by scaling back the scope.  In any event, he is not hit with a surprise at the end of the project.

Building a new building is one of the more significant investments a business or individual will undertake, and the pricing of that product is one of the more important decisions in that undertaking.  Consider carefully how the product will be priced before the project starts.

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This article is one in a series on the Finney Law Firm blog on new construction.  Read more here:

New construction: The problem of “what” is to be built >>

New construction: The “when” >> 

New Construction: Change orders, allowances, and selections can significantly impact price >>

New Construction: On whose land are you building? >>

New construction: What form of contract?

New construction: Ohio residential buyers absolutely protected from liens in limited circumstances

 

Attorney | ‭513-943-6655 | chris@finneylawfirm.com | + posts

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