The risk is on the consumer for a cost plus bid. The work costs whatever the work costs plus the contractor's fee. There is less incentive for cost controls to be first line thinking. This is the most transparent form of any contract. If a contractor thinks the project will cost 500K and will add his 23.75% on top of that 500K, then if he estimates wrong, and the sub's bids and materials cost 600K, you pay that plus his %.

The risk is on the contractor in a fixed bid. Especially in an old house. If he thinks that the project might cost him 500K to do, he might bid 600K to cover unknowns. Or he might bid 700K because he knows the red tape that will happen if anything untoward is discovered.

Or, he might have a bunch of ''unknown conditions'' written into the fixed bid, that would turn a lot of it into miniature cost plus portions inside the fixed bid. Which would up the end costs considerably. Which is basically what ''allowances'' are. They are guesses as to what that part of the project will cost. If you have a $10 allowance for engineered oak flooring to be stapled down but want site finished American walnut, the materials costs go up. But, the labor costs do too as they were based on the original type of material in the allowance.

Time and materials isn't ever used on a large contract. That's for the kid down the street who you pay $5 an hour to rake leaves plus the cost of the trash bags to bag them. A time and materials home build that you think would cost 500K would come in at 1.2M. Dragged out slow work would be profitable.

Sophie is correct. There are plus and minus to both scenarios. An honest contractor that has built trust with the client can make cost plus a safe dream for both parties. But, I now of contractors that salivate at cost plus, get a bid in under others, then push the next level products at every step of the build process to ramp up the overall job cost. On the other side, a good quality fixed bid needs good numbers in to get good numbers out. A low fixed bid not high enough to cover actual costs leads to delays, sub standard short cuts and sub par sub contractors, that is if the contractor can survive the low ball bid all the way through and not leave you hanging. I like a mix of the two best described as cost planning --designing and selecting finishes based upon the budget goal from the beginning with good solid numbers for each budget line item, & options to change / prioritize by the client as desired. I think it provides the best value, as it puts ownership of the numbers on both parties. Add in honest, open & timely communication throughout the build and away goes the typical 'horror stories' you read about here on a regular basis.

Time and Materials is not appropriate for a house project that will involve multiple subcontractors.

The advantage of Cost Plus a Fee is the drawings don't have to be complete when you start so it saves time but it requires more project management on both sides of the contract.

The advantage of a lump sum contract is better cost control for the owner but for the cost limit to be accurate and enforceable the drawings must be very complete which takes more time.

But those are the extremes; it is possible for a Cost of the Work Plus a Fee contract to have a Guaranteed Maximum Price or even a Shared Savings. Cost control is achieved by bidding the subs that have been approved by the owner. If the owner selects a bidder other than the low bidder, the GMP is increased by the difference in cost. A Shared Savings gives the GC the incentive to keep the cost down. That is how multi-family/commercial/institutional buildings are built but those contractors have gone to school to learn how to manage the time and cost of projects.

Since it is possible to competitively bid the Fee of a Cost of the Work project based on the initial interview, the Fee is often lower. I've seen as low as 7% and it was from the best of the bunch. With a competitive GC Fee bid, competitive sub bids and professional project management, Cost of the Work is usually the cheaper approach but if it is not managed properly it can be costly for the owner.

In a Lump Sum contract it is wise to exclude labor from Allowances and put it in the base bid since it should be possible to determine the scope of the labor in the contract documents even if it is only a unit price.

I work with contracts quite a bit ( but not for work on homes) and we follow some general guidelines.

Fixed price contracts work well when requirements are well defined and the scope is very clear. For example, fixed price is appropriate for building a brand new garage or other addition from a complete set of plans. For this contract the risk is on the contractor because he/she signs up to a fixed price.

Cost-plus fixed fee is more appropriate for areas where requirements are not fully defined until you get into the project. For example, you may not know what needs to be done for a renovation until you open up walls and get a complete assessment. In this case the overall cost/work risk is on the homeowner, so you must have very frequent reviews of cost items during the process, including a plan to manage cost as you go along, and a cap on total cost to avoid going over budget. If you don't manage the cost you have given the contractor an open checkbook to keep working until he/she is done. You can also include incentive fees if you want something done more quickly or have another well-defined goal you can use as a measurement. For example, you could add 2% to the fee if they finish by xx date. Just make sure they don't cut corners to make that date.

Time and materials works for small, well-defined projects, but would be very hard to use for a larger project.

Bruce

I'm confused as to how you have chosen a contractor if you don't even know the terms of the contract.

freeoscar -- ha ha! That's a very good question. It has something to do with it being a seller's market for contractors, and something to do with our architect having overbooked himself and not being able to give our project as much attention as he should. Sigh.

I'd recommended this book to help you understand the differences - it's a good reference to have:

http://www.amazon.com/What-Your-Contractor-Cant-Tell/dp/0979983800/ref=sr_1_1?s=books&ie=UTF8&qid=1461254210&sr=1-1&keywords=what+your+contractor+can%27t+tell+you

I'd also say that if your contractor wants cost-plus then that is likely your better option. If forced into a fixed bid he's (assuming its a man) going to bid very high to cover all possible contingencies. But regardless he should be giving you an estimate based on the specific plans your architect has drawn up, and should have firm sub-contractor bids in hand when you start. So you should know at the start what the cost should be to you. And then have a clear understanding of where he might see costs escalating. For instance, if the bid for framing is $60k, and it is done without changes and according to plan, he shouldn't be able to come back to you and say it cost $70k.

If the drawings won't be complete when the contract is signed and it is a sellers market for contractors, I doubt you have any choice but to use some form of a Cost of the Work Plus a Fee contract.

In such a situation, you can either wait for complete drawings or get started with cost control by asking the CGC what his Fee will be. It wouldn't hurt if he thought you were asking other builders too.

Then he should explain in detail how he intends to manage the project with emphasis on cost and time control and especially how the sub contracts will be bid.

Something far more important than the charges, contract, and the drawings is the reputation of the contractor. When you get the right one, everything else falls into place.

That all makes sense. I'm feeling pretty confident about the contractor. His references said he was very good about keeping costs down, so that was reassuring.

I recently had to make this decision. It was an interesting process ... and the work is just kicking off, so it remains to be seen how it will work out.

I entirely concur with Joe: the contractor is more important than the form of the contract. if the contractor isn't a good fit with you, the probability raises that you'll be unhappy, no matter what for the contract takes.

There's nothing fundamentally better about one form of contract than another. Any lawyer will tell you it really comes down to cost of risk. Risk has value: whatever risk your contractor accepts, he gets paid for it. The more a project can be de-risked, the less compensation but it never goes to zero. In a new build with complete plans, unknowns (= risk) goes down. In a remodel like mine, there's a fair amount we won't know until demo starts. I'll have some decisions to make: for example, do we level floors/to what degree. If the GC had to fixed price bid that now ... well, I don't know what I'd do. I prefer to treat this progressively: we'll have more information in a week and I can make a more informed decision now. The GC and I have talked about this extensively.

Anyway, risk apportionment is the fundamental premiss but in practice a lot of other things come into play. In particular, in a fixed price bid, a contractor is motivated to minimize costs to maximize profit. I'm not saying they do, but the cause-effect exists. In T&M, they can drag things out and bill more. Note, those are not symmetric: in my market, there's really not too much benefit to a contractor to drag out a T&M contract since there's more than enough work to go around. Since it's T&M, they (more or less) recognize the same income no matter what job they're working on. (I'm not including fraud here, where someone bills for time not worked. And I know job transitions aren't as profitable as continuing a single job.)

But this again highlights Joe's point: a bad contractor can take advantage of you in either case. With a good contractor, it's down to your personal level of accepting risk: pay a bit more for a fixed price or possibly pay more but possibly pay less for a T&M. This can come down to how much change you can accept in your estimate. In particular, if an overage could cause significant problems, you might be significantly better with fixed price.

I know in the commercial world, significant value is placed on predictability (don't necessarily mean construction here.) Many companies will pay a higher price for one that they can predict since this goes into long term budgets, etc. That's a major reason futures markets exist.

I found this article really interesting: Residential Construction Contracts: Cost Plus Fee. A few things stood out to me, knowing myself

• "the costs are completely transparent" This really appeals to me. I like knowing details. I like deciding on materials. I'm really into materials.
• "Most of the applications for payments on a Cost Plus contract could be used as ballast to anchor a battleship they’re so extensive" Good T&M execution requires a fair amount more bookkeeping on the part of the contractor since it's billed line-item.
• "the single most valuable aspect of the Cost Plus contract – teamwork" So far, this is what's been working well for me. I'm in very close contact with the GC.

I feel like there are style issues here. I find I work best with craftsman, individuals or small businesses. My GC is a small shop (though he's been bigger in the past.) He has a couple of other small projects but mine is his only big project (and it's not that big.. He'll be personally on site every day, do some of the finish work himself (previously a master finish carpenter.) I drop by every night, etc. We go over materials, designs, etc., in detail. I'd rather he educate me on tradeoffs and then decide together rather than him make a decision based on what he thinks I want/what he thinks is best.

He likes the process. He likes me being involved. And he likes that I'm trying to achieve something rather than just go for the cheapest approach. He says its a fun job to work on.

I talked to other and bigger GCs. I couldn't really see how I'd be able to be sure I was getting what I wanted rather than someone else's guess on what I want. They work on volume and fixed prices so can't really work with me to really fit my desires.

I sometimes think my GC worries more about my money than I do. Which I appreciate. That feels like teamwork.

I also did T&M with the designer. I really like the work product but I'm not so crazy about the process. She's far less transparent. And in fact, sometimes flat out wrong in terms of what she's committed to. And I get the feeling she doesn't think twice about conserving my money. For example, most T&M contracting says something like X$/hour billed in 15 minute increments. I have no problem with that but you kind of want the person to batch up a bunch of small stuff. So instead of doing 5 minutes three times (= 45 minutes) you do all 5 minutes in 15 minutes. She doesn't seem to do this. It's hard to tell if she's doing this intentionally or just poor at project management. It's a relatively small contract but still very stressful. If the GC worked that way, I'd be completely sunk.

In my experience, the form of the contract matters quite a bit and the choice is independent of the issue of finding a contractor you can trust. Its not as if you had to choose between these options; both are critical to a good project.

My contractor for my home addition/remodel has given me a contract with a pretty high fixed cost. I discussed it with him, he offered to do "time and materials" which I realize is not a good idea. I would like to suggest cost plus, but when I look at his cost breakdown, the areas that seem like high costs are all labor-related ($316K for a 550 sq ft addition in a nice custom home: $57K for framing labor, $14K for "finish labor", $17K for siding labor, etc). My contractor employs the laborers, so it seems like if I do a cost plus arrangement, I'm destined to get a bunch of invoices and time sheets that will use as many hours as they need to make up the fixed cost bid. How do I manage that, or protect myself from that?

I would like to use this contractor, as he is the original builder of my house (before I lived there), and I think he is generally honest and well-intentioned. However, I also just think he's really expensive, and I don't want to just pay through the nose just because he's a good guy.

Advice?

This is an old thread, but it's been resurrected, and it's timely in light of escalating prices for construction materials. I submit the only way to approach a fixed-price contract in the current environment is to negotiate one which includes allowances for materials subject to wide swings in price like lumber, metals, shingles, etc.

If labor is going to be charged by the hour, I suggest your agreement include a list of various unskilled and skilled labor and an hourly price for each classification. For example laborer, $15/hr. carpenter $25/hr., trim carpenter $28/hr. etc. You and/or your architect can then compare the labor rates with local averages. That leaves you to negotiate the contractors management fee as either a fixed number or a percent of the cost. You and your architect can then compare the proposed fee with local averages and more objectively assess whether the contractor is "expensive."

I'm aware that if you buy cheap, you get cheap work. That's not where I'm at.

I only considered good builders, so I willingly put myself in an upper price range. As I told my contractor, I'm not looking for a bargain, and I want the builder (and the workers) to make a good wage, but I also want costs to be fair. Just because I want quality, and am willing to pay for quality, does not mean the consumer should get fleeced. There is a middle ground between the wrong-cheap-guy and the guy-who-thinks-he's-building-Versailles, and the consumer should be able to find that middle ground.

Appreciate the sound comments by Charles Ross Homes on working with architect and builder to agree on hourly wages for a cost plus arrangement. I did not know I could reasonably negotiate to that level of detail. I'm still a bit concerned about the piling up of excess hours, but I guess at some level, I don't know if there is any alternative to just trusting that the builder's team is building at an appropriate pace.

I also wonder if subcontractors are charging high now due to the glut of building projects and the price variability of their materials. I don't think my builder solicited many competitive bids (only the plumbing was bid by 2 guys, otherwise all the sub bids were lone bids) but for my project the subs' bids seem to be about 30% more than the top of the range when I research online. And my project is not particularly complex. (And yes, I realize there is a lot of poor online info, but still.)

"I also wonder if subcontractors are charging high now due to the glut of building projects and the price variability of their materials."

Of course we are. This is capitalism; supply and demand. Remember 2008 when the proverbial shoe was on the other foot? We were dying and homeowners who could spend money got tremendous deals. Our sons and nephews watched that bloodbath, decided they wanted no part and went to chiropractor school. There are few replacements and we old farts are retiring quickly.

Your saviors are pouring through our southern border, so don't panic. Poorly paid and exploitable subs are on their way. Now our sons and nephews are positive they made the right call over a decade ago.

The marketplace, not contractors or homeowners, set prices.

Everyone's getting exactly what they have coming to them.

I am a bit confused by your intention.

You generally can't make an expensive contractor cheaper by switching the contract type. You are paying the same people to do the same job and no rearranging the contract terms is likely to make them work for less.

That's a good point, bry911.

My 2 thoughts: Perhaps the contractor in his fixed bid has built in too much protection from cost over-run or complications? Or, perhaps the contractor is pricing his building work high to intentionally obscure a chunk of the profit/overhead he will be making?

The background to my situation is that the contractor gave me a written proposal 6 months ago based on our architect's design (not full plans) that said $260K and then showed up with his full 40 page contract 2 months ago that added up to $340K. And without a real explanation of why his initial estimate was so widely off.

Perhaps the contractor in his fixed bid has built in too much protection from cost over-run or complications? Or, perhaps the contractor is pricing his building work high to intentionally obscure a chunk of the profit/overhead he will be making?

It really doesn't matter if overages have become a profit center for him, it is whether or not he is willing to give up that profit center.

Suppose you get a monthly bonus 80% of the time, and your boss gives you the choice to forego your bonus for more regular pay. You are probably going to do the math to see which is better. You might be willing to take a little less because there is no risk, but you are unlikely to take a major pay cut just because there is no risk.

If he builds in 20% for overages but on average only spends 10% then you are unlikely to get him to discount it the full 20%. Why would he?

Well said, and well taken.

At an earlier point with this contractor, I noted his 10% fee and I commented that I thought it was low. I like the guy, and I want him to make a good and fair profit from my job. I asked if he had markups in other parts of the bid to supplement that, and he said he did not. He made a comment about his being OK with that level of profit, so we left it there..

Now that I've told him that his fixed price contract is too high for me, he has replied that he will consider a cost plus fixed fee arrangement and I am waiting for his new proposal. It will be interesting to see what number he comes up with as his fixed fee, because it will basically indicate to me how much he was expecting to make off the rest of his bid. I'm also getting additional bids on discrete portions of the job (ie. framing, etc) to compare the independent bids with what he is telling me it costs him to do it.

From a builder's perspective, a fixed management fee contract should also spell out what gets added to the "fixed" fee when substantive changes are made to the approved project scope or when the aggregate of changes exceeds a certain amount.

I wrote a lot a long time ago and have learned a lot since then.

We did three projects with two contractors. All were done to high standards.

The first contractor, the one I thought I could trust to do cost plus, ended up being a mess. He wasn't dishonest, just incompetent as a GC. His estimates were almost worthless. He didn't really care if his subs ended up spending more because it just got passed on to me. His scheduling was horrendous so there were too many periods of time where nothing was happening. He always had excuses for why things were late/over estimate. I really don't think he knew how much things were going to cost. In the end, he was no less expensive than the other high priced contractors we talked to, though he appeared to be at first. Hard to say if he was more expensive. And like I said, the quality of work was very high: he did have good subs, so quality didn't suffer. (And his custom cabinet maker walks on water: the nicest guy and such great work. We use him for lots of stuff.)

So we went with another contractor for the second project (an extensive cottage remodel) and a finished workshop. We did another extensive search. Both of these projects were fixed price and were fairly expensive. The cottage contract ended up having lots of change orders: but that was because the cottage was a mess. We expected a lot of issues and we got them. It really wasn't possible to know what we would find when we started and the contractor made that clear.

When we called references on him, one person, maybe a realtor?, said "I can't believe I'm actually recommending a contractor ..."

The second and third projects were fixed price but it wasn't just given as a lump sum: he gave us a breakdown for cost for every division (though that doesn't break out labor/materials). And he added profit and overhead at 25%.

The biggest thing about him was there was never an excuse. If something was wrong, it was always "we'll fix it." We mostly dealt with a super (which we also really like) but dealt with him directly on stickier issues.

So the big thing for us is finding someone we trust. We've been lucky to find that with a landscape contractor, too: same attitude: "we'll fix it." Sometimes there are issues of "has to be this way" but always trying to achieve what we can and always fixing anything that goes awry.

We do smaller cost plus jobs with them on an ongoing basis so we've done both fixed and cost plus.

Trusting is not just about the way the work gets done: it's also about pricing. We trust that he's charging market rates and not trying to take advantage of us. We ask about costs for projects now but it's more to see if we can afford it than it is to price shop. (With the cabinet maker, we don't even ask ahead any more ... we totally trust him and have no comparable sources anyway.)

We feel really fortunate to have found folks that we have such a good relationship with.

Really good point about estimates.

The low-bid contractor is often one who is poorly skilled at estimating. If you're the homeowner, you just hope the low bidder learns they're not making any money on your job until after the job is completed. If they learn it during construction of your project, well, that's when you get lots of material to post here on houzz.com....

So if I verbally committed to a GC on an initial proposal of $260K, but after the detailed specs & contract was worked out, the price jumped to $340, and I generally feel the GC is honest (but just majorly miscalculated the project) how much do I pay the GC for his time & specs if I decide not to do the project?

It was a lot of work on his part, and I would plan to use the specs if I try again in the future to do a modified version of the project. I want to value his time. At the same time, I also just went through an arduous and time consuming process with his under-estimation and still no project.