Whether it’s your first home project or your third, understanding how pricing works can make your head spin. Contractors don’t all use the same method and even when they do, they may not approach it in the same way. This is why, when you’re looking for bids, some contractors will present a much lower price than others. But why, if it’s the same project for all contractors? We’re here to explain the ins and outs of the two main methods used for pricing a custom home or remodel to help you know what to expect and get a grasp on home project pricing.
The two main types of contracts for a custom home or remodeling project are cost-plus and fixed price. In a fixed-price contract, the total cost is predetermined. However, with cost-plus, the expenses are estimated but the final price isn’t determined until the project is complete. Let’s further break down the details of what makes cost-plus and fixed-price contracts different and weigh the pros and cons of each.
Contractors use a cost-plus contract when they aren’t able to determine what the final cost will be. Whether this is out of inexperience, the complexity of the project, changing market values, or simply their preferred method, cost-plus means your budget can be exceeded outside of your control.
The contractor will provide the client with an estimate of expenses upfront and then documents all of the expenses to present a weekly, bi-weekly or monthly invoice of the expenses plus the markup. The ‘plus’ in cost-plus represents any costs that are not part of the initial estimate and the separate fee, which is the contractor’s predetermined markup. The markup is represented as a percentage of the total project price, which can increase in dollar amount as the price of the project increases.
Using a cost-plus approach to your contract is a method that may be used when the scope of a project is yet to be completely understood at the time of a bid or estimate. Perhaps a contractor doesn’t have a concrete price for a subcontractor’s services or certain material costs are rapidly changing and can’t be predicted.
Many pros of the cost-plus method are on the side of the contractor. When the price of the custom home construction project or remodel continues to rise because of unpredicted costs, so will the fee. It ensures the contractor won’t paint themselves in a corner, so to speak, by presenting a fixed price and reducing their fee if the job accrues unexpected expenses.
It might benefit the homeowner if the project comes in under budget. If the project does end up costing less than estimated in a cost-plus contract, you will pay that cost, possibly spending less than you anticipated.
As we’ve mentioned, you’d be responsible for covering costs that weren’t predicted in the original estimate, even if they go beyond your budget. When contractors use a cost-plus contract, they’re able to propose a lower bid, knowing that every expense beyond the bid will have to be covered by the homeowner regardless–while making their proposed bid very attractive to a homeowner.
The overall costs and accounting for the budget requires the homeowner to track.
One way to mitigate this is by agreeing on a negotiated fee, regardless of the final cost. This is a cost-plus a fixed-fee contract, however, it’s uncommon that a contractor will agree to this approach.
With a fixed-price contract, the homeowner knows the end cost from the beginning. It will include all materials, labor, fees, and other costs. The contractor’s overhead and profit (markup) making it a fixed-price contract.
Fixed price bids are typically higher than cost-plus because the contractor is taking on more risk, perhaps more experienced, has more industry knowledge about material and labor costs, or prefers the simple nature of this kind of contract. Homeowners know the price going into a project and will pay that price, regardless of costs that may arise due to errors on the side of the contractor or increased material costs.
In a fixed-price contract agreement, the contractor is taking on risk, is motivated to keep changes at a minimum, come up with cost-saving solutions if issues arise, and find cost-effective materials if substitutions are needed. Your cost is predetermined. No surprise fees or increases, unless they’re initiated by you, the homeowner, through change orders. This is why taking your time during the design phase is important: to note any needed changes, be it design or materials, before the construction phase.
The accounting and finance are simplified. Payments are typically predetermined on a payment schedule based on milestones of the project.
The bid with a fixed-price contract appears higher than a cost-plus contract. Of course, this is for the reasons we’ve explained, but also because a contingency is also built into a fixed price bid.
It is not open-book job cost accounting.
Although, in the end, it’s well-known that a lower cost-plus bid, as compared to a higher priced fixed price bid, will eventually be moot due to everything described in the cons portion of the cost-plus section.
Fixed price and cost plus will both have allowances for homeowners to choose their tile or countertops from. The fixed price contract may create a change order add if you go above your allowances or a change order credit if you are below your allowances. The cost-plus will simply be the cost plus the mark-up.
The fixed price contract puts more of the risk on the contractor and the cost-plus puts more of the risk on the homeowner.
At the end of the day, whether you go with fixed price or cost-plus, it is important to take your time, get a detailed plan and scope of work description from a reputable contractor, make as many selections as possible prior to the start of the project, build in at 10% contingency for yourself, check references and have positives vibes with your contractor.
If you’d like to learn more about the fixed price method to build your custom home or remodel your home, contact Hopedale Builders and we’d be happy to answer your questions.
Hopedale Builders has been delivering beautiful homes and remodels within budget and on time in Charlotte, North Carolina, for decades. Our portfolio of projects showcases our experience building spaces in any design, including both timeless and trending styles. Schedule a consultation with us to talk about your dream custom home or remodeling project today.