By Pete Lee, Co-founder, President and CEO
In the many years I’ve built custom homes, the question eventually comes up regarding contract style.
Contracts take all forms, but the single most important thing you as an owner can do is ensure that the contract aligns your incentives with the builder’s. If you have picked a reputable builder to begin with, this will assist in mitigating conflict before it happens.
Often in high end custom residential construction, not all the details are worked out. Consequently, the budget may be subject to change. This is a critical time when owners and builders need to work together and when the style of your contract will help. THB uses three primary types of contracts:
- Cost-plus with a fixed fee (20% of the time);
- Cost-plus with a guaranteed maximum price (70% of the time); and,
- Lump Sum (10% of the time).
The first two styles dominate our arrangements because they do the best job of aligning our interests with the client’s despite the unfinished nature of the design. The client can rest assured that our incentive is not to run up the price, but preserve the value for the client.
Cost-plus with a fixed fee is a contract style that should help establish trust between the owner and the builder quickly even though the design is still in process. Cost-plus enables the owner to see copies of all costs incurred by the builder during the design and construction process. The owner will thus know that he is paying only costs affiliated with his/her project. There shouldn’t be any hidden mark-ups. The fixed fee above the costs is the fee the builder receives for providing the services. By fixing the fee, the builder only receives a portion of the fee as the percentage of the construction budget and he has no incentive to run up the cost because he does not stand to gain from the additional cost. However, the downside of this contract style is that the builder is not liable for cost overruns (and only stands to be embarrassed by missing his budget). Under this approach, you may find that that the builder doesn’t seem to spend a lot of time worrying about your budget …
On the other hand, Cost-Plus with a Guaranteed Maximum Price (GMP) eliminates the builder’s afore-mentioned potential lack of consideration for your wallet. That’s why THB makes such extensive use of such contracts. You see, all builders know what it costs to build in a given marketplace. Therefore, I believe they should be prepared to cap the financial exposure to the client for a given scope of work and a given budget. Having a a financial stake in accurately predicting and managing the budget is an important part of his job.
This is why Cost-Plus with GMP is so popular with THB clients. We recognize that many of our clients want to start building before all the design details are complete but they still want to know they are being treated fairly, hence cost-plus helps build that trust. Then we go one step further for our clients by ensuring that we have accurately created a budget. We create a Guaranteed Maximum Price (GMP) for our clients so they can rest assured that they will get the house of their dreams–without a nightmare in their final price No hidden costs. No surprises. No sweat.
These are the broad strokes THB’s two most popular contract styles. There are other subtle topics like GMP contingencies and shared savings that warrant further explanation. I’ll discuss them in future posts.