Fixed Price vs. Cost-Plus Contracts: Which One is Right for Your New Home Build?

When launching into the journey of building a new home and finding the best builder to team up with on your project, one of the critical questions to ask is what type of building contract the builder works with. The two common options are fixed-price contracts and cost-plus contracts. Each has its own advantages and disadvantages, and the best choice depends on your specific circumstances and preferences. The specific type of contract used significantly impacts the incentives, costs, and financial risk for both parties. In this blog post, we’ll explore the differences, pros, and cons of fixed-price and cost-plus contracts to help you make the right decision for your build.

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Fixed-Price Contracts

What is a fixed price contract?

A fixed-price contract, also known as a lump-sum contract, involves the builder providing a single, agreed-upon price for the entire project. This price is based on detailed plans and specifications and includes all materials, labour, and any other costs associated with the build. The price remains constant regardless of how much time or what resources the contractor requires to complete the defined scope of work.

The contractor assumes full responsibility if expenses exceed initial projections by locking in one firm price.

It should be noted that a fixed price contract may include Provisional Sum or Prime Cost items which may vary in cost. However, these should be limited to things you have not yet given the builder a specification/selection for or things such as excavation costs, where the extent of the work involved is unknown until the task is underway. You can read more about these PS and PC items Here.

Pros:

Budget Certainty: With a fixed-price contract, the total cost of the project is known upfront, which helps homeowners budget effectively and avoid unexpected expenses.

Risk Mitigation: The builder assumes the risk of cost overruns, as any unforeseen expenses are typically absorbed by the builder, not the homeowner.

Simplified Billing: Homeowners receive a straightforward payment schedule with clear milestones, making it easier to track payments and manage finances.

Cons:

Potential for Higher Initial Cost: Builders may include a contingency buffer in the fixed price to cover potential risks, which can result in a higher initial cost compared to a cost-plus contract.

Limited Flexibility: Changes to the project scope or specifications after the contract is signed can be costly and complicated, as they often require contract amendments and additional charges.

Quality Concerns: If you happen to sign with a “dodgy” builder, there may be an incentive for builders to cut corners to stay within the fixed price, potentially compromising on quality.

Cost Plus Contract

What is a cost-plus Contract?

A cost-plus contract is an agreement where the contractor bills the client for actual costs incurred, plus an additional pre-negotiated amount for profit. Unlike other contracts, the final price is determined only after project completion.

In this structure, the contractor tracks all direct costs, including labour, materials, equipment, and subcontractors. As work progresses, the contractor submits pay applications outlining these costs to the owner. On top of these expenses, the owner pays an agreed-upon profit margin, usually a percentage of the total costs (e.g 20%).

In cost-plus contracts, most financial risk sits with the owner, as the final cost is unknown until the project’s end. The contractor is guaranteed a profit regardless of whether the project stays within budget.

Pros

Flexibility: Easier for owners to modify project scopes and plans, even during the construction phase.

Quality Assurance: Contractors have less incentive to cut corners, as their profit is guaranteed.

Transparency: Owners can closely monitor spending with detailed expense reports.

Cons

Cost Overruns: Final costs often exceed initial budgets, especially with scope changes

Financial Risk: The homeowner takes on greater financial risk as all costs underestimated by the contractor or unbudgeted are passed on to the owner.

Administrative Burden: Owners must actively track expenses and make decisions to keep their budget on track as the build progress, this can result in a significant amount of time spent on administrative tasks by the owner.

Incentive Issues: Contractors may have less incentive to contain costs since their profit is guaranteed. The financial risk sits predominantly with the owner.

Key Considerations for Contract Selection

When deciding on a builder and considering their chosen contract type; a cost-plus contract or a fixed-price contract, consider the following:

Project Scope Clarity: Well-defined projects suit fixed-price contracts, while flexible scopes benefit from cost-plus contracts.

Financial Risk Tolerance: Owners willing to accept potential cost overruns may prefer cost-plus contracts, while those needing strict cost control should opt for fixed-price agreements.

Trust and Relationship: A positive working relationship is always important but is essential in making cost-plus contracts feasible.

Project Size and Complexity: Larger, multi-year or flexible scope projects often require the flexibility of cost-plus contracts, whereas, well-defined and documented residential projects can utilise fixed-price contracts.

So, what type of contract do we use at Lancaster Homes?

At Lancaster Homes, we primarily work with Fixed Price Contracts. Thanks to our detailed and comprehensive pre-construction process, we can sign contracts with clearly defined scopes of work, thoroughly documented designs and specifications, accurately priced selections, and precise subcontractor bids. This process allows us to present a fixed price quote and contract with minimal provisional sums or allowances.

This approach gives our homeowners peace of mind, knowing their budget won’t spiral out of control once the project begins. It also allows them to enjoy the excitement of watching their dream home take shape without the added stress of last-minute decisions and selections.