If you were to buy a new, typical home to be built, you would purchase it at a certain, Fixed-Price. Let’s say your home will cost $100,000.
For that $100,000, you – now the “Owner” – get a defined home built to final plans and specifications. For example, your house will have wood-framed walls, a metal roof and tile floors.
Builders can offer you a Fixed-Price because they are building a defined product. They determine the cost to build it and add in a figure for their overhead and profit. Traditionally, that figure is about 18%.
So, the Builder expects your $100,000 Project to cost $82,000 to build and that they will make about $18,000, or 18%, overhead and profit. To keep it simple, let’s suppose that calculation looks like this:
$82,000 + $18,000 = $100,000
Cost 18% Profit Fixed-Price to Owner
Now, if it ends up costing more than $82,000, the Builder loses profit. If they manage to do it for less than $82,000, they make more profit. Whichever the case, the Builder is obligated to construct your home, as per the plans and
specifications, for that Fixed-Price of $100,000 – not a penny less or a penny more. This is the “risk/reward” system that drives Builders to do everything they can to control what are THEIR construction costs.
With Fixed-Price Contracts, the Builder, not the Owner, takes on the risk for all of the Project costs – no matter what they end up being.
If, however, you were to build a new, “high-end” custom home or remodeling project – like those common in SWFL – the work would almost certainly be done under a Cost-Plus Fee Contract.
“Custom” homes and remodeling projects are complex and (usually) large. The plans and specifications for them are always changing. They are never really “final”. Still, most Owners want to get their Projects done as soon as possible.
They have a budget in mind for the Project and believe that, ultimately, it will cover the total cost of the work.
So, at some point during the Pre-Construction phase, preliminary plans for the Project are issued to as many as (3) or more different Builders for pricing – even though the Builders lack the information that is needed to properly price the work at the time.
As they lack final plans and specifications, none of the Builders can be certain what the ultimate cost to build the home will be. Since they can’t determine a definite cost, none can offer to do it for a Fixed-Price. Instead, they will propose to do the work on a “Cost-Plus-Fee” basis.
Each will offer to build your home for a lower overhead and profit figure – or “Fee” – than the typical 18% they would expect to make on a Fixed-Price job. Say, 16%. 13%. Sometimes even less.
In exchange for the lower Fee, the Owner agrees to bear the risk for all of the costs of the Project. Sounds reasonable – right?
The issue isn’t the Fee, it’s with the Project costs. The problem? The Owner doesn’t know what they are! Builders may provide them with “preliminary” cost estimates, but none of them are accurate, because they can’t be. As the
information necessary to construct the Project is still incomplete, so are the estimates. In short, estimates from Builders for Cost-Plus jobs are invariably much too low because they CAN be. What good is a well-negotiated Fee if the estimate it’s based on doesn’t hold water?
The tables have been turned. Not only is the Owner now responsible for all of the Project costs, they can’t know, for sure, at this, or at any point over the entirety of the construction process what the true costs are or will be! Now, the
calculation looks like this:
$????? + $????? = $????????
Cost + 12% Profit = $???????
With Cost-Plus Fee Contracts, the Owner, not the Builder, takes on the risk for all of the Project costs – no matter what they end up being or how they come to pass.
Inevitably, Budget Creep (in tandem with “Scope Creep”) begins. Project cost increases seem to sneak – or “creep” – up as the work moves along, often as small increases, over time, over several cost line items. By the time the Owner
realizes their costs have spun out-of-control, it’s too late.
Owners with Cost-Plus Fee Contracts are exposed to a higher level of risk than they may think, especially in the “inverted” Construction market. They can’t know what their Project costs are, or will be, with any certainty, at any time. They can’t know from or control how hard their Builder is really working to manage their costs for them.
Naples Custom Home Cost Consulting CAN know all of these things and offers a full range of Construction Management Services to assist Clients. When hired as an Owner’s Representative, we work to prevent Owners with Cost-Plus Fee Contracts from unnecessarily overpaying for their Projects by mitigating their risk and “pushing back” on their behalf.