Part 1 about Fixed Price Contracts
Last time, we reviewed some important elements of any construction contract. Don’t forget that a detailed Scope of Work is essential to setting the proper expectations with your contractor.
Now let’s go through the types of contracts that you may use. Contracts can be lumped into several different types: 1- Lump Sum, (or Fixed Price), 2- Cost Plus (with or without a Gross Max Price, or GMP), and then there are hybrids such as a design-build or design-assist that starts as a Cost Plus and then converts to a Fixed Price. So let’s start with the one most used and easiest to understand:
This is the contract used most often and one that we all intuitively know. You pick the house plans, select the options, and then the builder gives you the price. The builder’s price may be negotiable at this point but once agreed to and written into the contract it becomes the Fixed Price contract amount. If the house costs more to build than the agreed cost, and there aren’t any changes, then the builder must pay for the difference. Likewise, if a house is built for less than the agreed price, then the builder keeps the savings. As we reviewed previously, the scope of work is very important, and so is the time element. If you and your builder agreed on a 6-month construction schedule and the house is complete in 4-months, you and your contractor will most likely be very happy. You’re happy because you get to move into your new home sooner, and your builder is happy because by finishing 2-months early; he saved 2-months of costs and they become his savings. If the house takes longer than expected and there aren’t any changes, the builder should cover the construction costs for an extended time. If the home is going to be finished later than expected, I recommend that you and the builder sign a change order with the new completion date. It would be at this time you would discuss any costs that you are suffering because of the delay. For this to work, you must have a clause that states all changes must be approved in advance and in writing as we discussed in last week’s newsletter. If you don’t have this type of clause, the contractor may be contractually allowed to charge you for the costs associated with a delay. Although contractually allowed, this probably won’t feel fair. Hence, it’s important that at the time of contract negotiation that you address changes and delays in writing before signing the agreement.
The same concept goes for costs. If the builder is able to reduce the cost during construction, the savings go to the builder. Some ways this can happen is if the builder finds a new supplier or subcontractor that performs the same work, but cheaper, or maybe the builder develops a new and more efficient method for constructing that saves time and money. The builder is doing the work and taking the risk and by contract, and in general fairness, is entitled to these savings. Construction materials are always moving. The prices go up, the prices go down. Just like the cost of groceries in the store, even though it seems like material costs should decline, they never seem to as much as one would expect. So, your builder is taking a risk with a Fixed Price contract and assuming the cost of material and labor will remain constant throughout the build. A few…very few…builders are unscrupulous and will use the Fixed Price contract to actually cheapen the cost of your home. They will sell you on name brands and install generic, or they will use cheaper materials inside the walls and attic where you can’t see them. These contractors are dishonest and reflect a very small portion of the home builders. There are some great articles easily found with a Google search and with the National Association of Home Builders on how to select a contractor. My best advice is to choose a contractor that shares your personal values and then trust him- but verify by checking customer and subcontractor references.
If you don’t review the scope of work or project specifications (specs) and agree to them before the contract is agreed and signed, generally, the Owner is unable to make changes without additional cost. Sometimes, I hear Owners saying they things like they thought the roof was going to be a 25-year roof, but the contractor installed a 15-year roof. Nobody likes feeling that they have been taken advantage of. Please, make sure your contract scope of work contains all the options you want, and all the things that are important to you. The term “Fixed Price” does not mean that there can be no changes. If there is a change, whether it’s an addition or subtraction of money or time or options, the Fixed Price contract is modified via a Change Order as we discussed last week. Remember to make sure the scope of work for the Change Order is very detailed as well.
Next time, we’ll finish up with the Fixed Price contract with a brief discussion of allowances.