Understanding Construction Contracts.
Building a custom home is quite easily one of the largest investments you will ever make in your life. This process often involves navigating a complex world of contracts. Understanding the different types of construction contracts is essential for both owners and builders. The right contract not only sets the tone for the project but also ensures that all parties are clear about their responsibilities, expectations, and financial commitments. A good builder will be your partner in this and help you navigate this process in a transparent way. Weighing the pros and cons for both parties for each contract type. Often this culminates in a hybrid contract that works for everyone. Limiting as much risk as possible on both sides, but protecting individuals if something doesn’t go as planed.
Below is a break down of a few main contract types I use on my projects. I also give my preferred contract preferences at the end. When signing any contract it’s a good idea to have an attorney take a look before doing so.
So here we go:
1. Fixed-Price and GMP (Guaranteed Maximum Price)
Fixed-price, often referred to as a “lump-sum”, is a common type of contract used in residential construction. In this arrangement, the builder provides a single price for the entire project. This contract type is beneficial for homeowners who want to maintain a clear and exact budget.
Having a fixed-price contract obviously helps mitigate some risks associated with cost overruns. But, it requires thorough planning and clear specifications upfront allowing the contractor to bid the project accurately. Also the owner should be very comfortable and privy to the full design. Down to the smallest detail. As requested changes to the plan used to set the price can void the “fixed price” if the owner so chooses to change the design. A new contract would need to be put into place and both parties would need to agree if this happens. It is often just better to use a different contract type if your ducks are not perfectly in a row.
One important consideration with this type of contract is that the contractor has a strong incentive to complete the project quickly and within a specific price. While the speed of completion may seem appealing, it’s essential to be vigilant about potential corner-cutting, poor workmanship, and the hiring of subcontractors who may lack the skills and resources necessary to execute some higher-end designs and details. Additionally, there is often a tendency to compromise on the quality of materials in this scenario.
The "Guaranteed Maximum Price" (GMP) operates similarly, as the owner establishes or receives a maximum price they are willing to pay for the project. Typically, this amount is higher than the contractor's initial cost estimate. However, if unforeseen circumstances arise, the contractor has access to additional funds, provided that the total cost of the project does not exceed the specified maximum.
This contract is best suited for owners with a solid design set and home building experience themselves. They know what they want, and they want to know how much it will cost in total up front. For contractors this is best suited for winning contracts against less competent competitors. A contractor under this contract must be very organized, well versed in bidding and current market costs, and experienced enough to know how to execute on budget and on time.
2. Cost-Plus Contract
In a cost-plus contract, the homeowner agrees to pay the builder for the actual construction costs plus an additional fee (either a fixed amount or a percentage of those costs). This type of contract is often used for custom home building, especially when the scope of work may change or evolve.
For example, homeowners might want to modify design elements or incorporate sustainable building practices not detailed on the basic plan. Leading to costs that weren’t anticipated at the project’s inception. While this contract type offers flexibility, it can also lead to higher expenses if not managed carefully.
I commonly see this type of contract used in Bend for custom homes as it offers the owner the greatest flexibility in making changes during the construction process. One of the advantages of this contract is that it prioritizes quality and precision over speed and the contractors bottom line. A thorough and detailed budget can still accompany this type of contract so that a general idea of final cost is known. But at the end of the day, the cost of the home is the cost + the contractors fees. And the responsibility to pay rests solely with the owner.
This contract is best suited for owners with a design well below their means. That want the freedom to change and add along the building process. Owners that are concerned with absolute quality and perfection. Though it doesn’t have to mean an astronomical final price. Under this contract a custom home can still be built competitively.
For builders, this contract is best for super custom high end homes.
3. Time and Materials Contract
A time and materials contract bases the project's cost on the time the contractor spends on the work and the cost of materials used. This contract type is advantageous when the project scope isn't well defined. Owners embarking on unique build that might require custom features will find this contract type provides the needed flexibility. This is also a useful type of contract for smaller projects like additions and remodels. Especially when opening up old homes where a lot of unknowns may exist.
However, it’s important to establish an upper limit or budget cap to avoid exceeding financial expectations. This can be especially significant in allaying concerns about the rising costs of materials.
I see these contracts a lot in Bend. I personally only use them for rare and specific situations. If your contractor is good, they will know what they are doing, have a dialed team and can accurately cost your project based off the plans, specifications, and location.
4. Design-Build Contract
The design-build approach combines both design and construction provisions in a single contract. This option can streamline the building process since the same team manages both phases, helping to facilitate better communication and coordination. This type of contract can be a hybrid, where it includes a cost / pay structure of any of the first three contract options in addition to the design:build contract.
As a builder, this style of contract enables me to fully grasp the finer details and reduce ambiguity. Since I designed the project and personally created the plans, it helps minimize the number of Requests for Information (RFIs) during the project as well. But not all contractors offer in house design. This is both a contract style choice as well as a builder choice.
This is best for owners that want a one stop shop for their project.
What contracts do I use or like?
Let me begin by addressing why we are called contractors in the first place. As you might expect, it's directly related to our primary function: writing contracts. Each project is influenced by various factors such as owners, designs, circumstances, locations, and more, which makes every project unique. Contracts should be tailored to be as customized as the homes we build and the individuals we build for. Therefore, my approach typically involves a combination of several contract types, often incorporating special provisions that are relevant to the specific project at hand.
Another contract I didn't mention above is the "Subcontractor Agreement." I won't go into extensive detail here, but this is a contract between a subcontractor and the general contractor (GC) that relates to a specific project. It should operate similarly to the agreement between the owner and the GC. This contract ought to include insurance provisions for the subcontractor and detail the relevant construction documents, as well as a thorough description of their scope of work and expectations for their quoted price. This ensures that the GC is protected by establishing clear communication between both parties.
In conclusion, selecting the right type of construction contract is crucial for any custom home project. Each contract type offers distinct advantages and challenges that depend on the homeowner’s goals, budget, and the specific conditions. By ensuring clarity and mutual agreement from the outset, homeowners can enjoy a smoother construction process.
Best,