Fixed Price VS Cost Plus Contract – Which one should you consider?

Congrats your development approval is in the right place and your construction project is about to begin, then what is the next move? Probably you need to tender a few quotes from the bunches of listed builders.   

During the tendering process, literally you have encountered two different types of contracts, ie, Cost Plus Contract VS Fixed Price Contract. Fixed Priced Contract was used to be very common, especially for low-end building project. However as the materials cost keep creeping up and labour force is still in shortage nowadays, more and more builders intend to promote the Cost Plus Contract, especially when the building cost is expected to be over $1M value. 

What Is a Cost-Plus Contract?

A cost plus contract is a contract where a builder obtains material and services throughout the stages of the building process and costs are passed to the owners, with an agreed margin to cover overheads and profits. for example, a builder estimates a project will cost approximately $1,000,000, the project owner may a lot a maximum of another $100,000. If the contract also stipulates a fixed $200,000 profit, the most money that can change hands is $1,300,000.

Advantages:

A cost-plus contract has advantages for both the builder and project owner. Flexibility is one, allowing work to begin before the project’s full scope can be determined. Another important advantage: Because project expenses are reimbursed, the builder can better focus on quality of work, using the best materials, rather than worrying about the cost of materials. This also eliminates the contractor’s responsibility for cost overruns (providing they don’t exceed a cap set forth in the contract). And with profit being its own line item, so to speak, how much the contractor makes on the job is protected against unexpected expenses along the way.

Disadvantages:

Of course, a cost-plus contract has some drawbacks to consider as well. Significant among them, a builder must be meticulous about managing and tracking all expenses it lays out in order to be reimbursed. This can create potential cash-flow issues if not handled well, which is why many turn to software for the heavy lifting.

Secondly as majority of project owners do need to borrow the construction loan from the lender, who will set a numerous restriction to regulate the loan. Most of the lenders do not have appetite to accept the Cost-Plus Contract nowadays as there would be full of uncertainty ahead in managing the drawdown process. 

Also Not knowing how much the project will cost in the end may make some project owners feel uneasy. If profit is to be paid as a percentage of costs, a builder has little reason to keep costs down, right? A cost-plus contract that includes a cap on expenses can go far in avoiding disputes down the line. 

What Is a Fixed-Price Contract?

A fixed-price contract is typically used for simple projects with predictable costs. Under this agreement, the builder and project owner agree to the scope of work required and set a price to complete a project. The contractor’s profit is built into the fee. Any changes along the way — for example, if additional material is needed — would require an approved change order. This type of contract initially will be valid for 6 months, however with things uncertain to be expected, the builder tends to shorten the valid period. 

Advantages:

With a fixed-price contract, the cost is clear right from the project’s outset. Perhaps that advantage is the most obvious. Prices for time and materials are understood in advance. The builder and project owner know what is to be done and exactly how much money will change hands in the process. The builder knows how much profit they will make, too.

The lender has also more favourable appetite for this type, which will make the mortgage application less hassle. 

Disadvantages:

On the flip side, a fixed-price contract may increase risk for any builder who underestimates the project’s total price. In that case, the contractor is responsible for paying for the added expenses, which eat into the profit margin. As you probably have heard the rumors sweeping in the construction market that more and more builders are struggling with the cashflow issues. 

Along those lines, another disadvantage lies in the difficulty in making changes to a fixed-price contract once it has been signed. It’s not out of the realm of possibility that something may change during the course of a project — perhaps a change in direction or scope. A good contract will stipulate a process for making changes, but it’s important to realize such a process can slow down the project’s progress.

Finally, added attention to maintaining costs under a fixed-price contract may sometimes come at the cost of work quality and creativity. 

Choosing the Right Contract

To choose a right contract might need your careful analysis and intensive negotiations, which is a laborious work. If you do need to borrow the loan from a lender, fixed price contract is mostly the only option.