Dawn writes: I need help! I am a homeowner who is doing a major remodel. I should say up front that I really like the GC we have picked… good reputation and references, been around forever. He has been very fair about working with us to change wording in our potential contract so that both of us feel like our interests are covered, etc. We have not signed a contract with them yet.
Here is where I am stuck, and maybe it’s just truly a lack of understanding on my part. The way the contract is worded now, it’s a fixed-price contract (at about $750K). There are two line items at the end (overhead and profit) that seem fair.
My biggest worry about signing this type of contract are the allowance items. Let me use two examples:
Example 1: I am working with a designer. She and I went to a plumbing place and got a bid on plumbing fixtures. I was able to eliminate some items that were wants, not needs (for example, a $1,000 pot filler). I was also able to find less expensive plumbing fixtures (still using this vendor) that are just as pretty, but cheaper. Just at first pass, I was easily able to eliminate 5K off the plumbing bid.
I thought that if I was able to come in under my allowance items, I would be saving money. But, the way I am reading this fixed bid contract, the GC gets the 750K regardless, giving me no incentive to spend less on allowance items.
Example 2: Flooring is an item that I have not looked at in detail with my designer yet. So, the GC put in what he thought was a fair number into the fixed bid contract, based on carpet in the basement (he didn’t ask me if I wanted carpet in the basement, he just assumed) and a medium grade hardwood throughout the first floor.
The fact is, with the flooring, I have really no idea what I want yet, because I haven’t looked at flooring options in detail. So, I’m struggling with the idea of this fixed bid, because I don’t see any incentive to go under the number he stated. There doesn’t seem to be that big of a risk if I go over the number he stated, because the contract states that then they do a change order for the additional amount. Are the change orders simply the additional money for the product (along with an percentage increase to his overhead and profit) or is there some type of additional monies he gets from me per change order).
So, can you help me better understand, before I signed a fixed price contract, what I am getting myself into. The GC is willing to discuss a cost-plus contract, but I don’t understand those either!
Steve Bliss responds: As a practical matter, it is often difficult to select all your finishes before getting a bid. So many fixed-price bids use allowances to price out materials that have not yet been chosen by the owner. If you select more expensive materials, then the contract price will be adjusted upward; if you select less expensive materials, the contract price should be adjusted downward. The change order are typically issued to document these changes as well as other changes made by the owner or designer during the course of the job.
Some contractors will include markup in these pricing adjustments, which is reasonable as more expensive materials often add additional risk and overhead costs. For example, if there is a problem installing a very high-end plumbing fixture or floor covering, the cost of repairing the problem will also probably be higher. In some cases, the allowance will include a labor adjustment since some materials cost more to install. For example fragile stone tiles may cost more to install than standard ceramic tiles.
Different contractors will handle this differently, but if costs can go up due to allowances, they should also go drop as well. Changes that reduce the cost of materials or labor are called “deductive” change orders and should result in a drop in the contract cost. For example, if you decide not to build a garage, the contract price should drop accordingly. Some contractors will charge an administrative fee for the change order. You should definitely ask your contractor what his policy is regarding changes and change orders.
Some not-so-reputable contractors will use unrealistically low allowances in order to present a low bid, knowing that the owner will likely pick more expensive materials. Or they will omit items from the contract to keep the bid low and make it up with change orders — for example, when you later discover that the bid did not include utility hookups or landscaping. So it’s important to do your homework to make sure that the bid covers all required work and that any allowances are reasonable. Also, if you are comparing bids from different contracts, check to see that you are comparing apples to apples in terms of the scope of work, specifications, and allowances. If one bid assumes vinyl window and another assumes aluminum-clad wood windows, the bids should reflect these differences.
You also asked about getting a fixed-price vs. a cost-plus contract (also called time-and-materials). All things being equal, I prefer a fixed-price contract in most cases with at least three bids to compare. Although there will inevitably be some adjustments to the bid price, if you’ve done your homework and the contractor is competent and reputable, the final cost should come in close to the bid price. This assumes that you don’t make a lot of changes after work has begun, and that the contractor has not intentionally or accidentally left important things out of the bid.
A cost-plus job, on the other hand, is pretty open ended. In some cases, where there are many unknowns, the contractor cannot submit a fixed bid, so cost-plus is a necessity. Also, some inexperienced contractors are not confident of their estimating skills, so prefer to work cost-plus to avoid underbidding. Some will tell you that you are better off with a cost-plus bid, since they will have to pad a fixed bid with a large enough cushion to cover their unknowns (or their inability to estimate accurately).
However, a cost-plus bid places all the risk of cost overruns on the owner who can be in for real price shock by the time the job is done. There are various compromises where the contractor works cost-plus only on portions of the job that contain a lot of unknowns — for example, blasting and drainage work for a foundation where there is a lot of ledge. Another option here is a unit-price quote, which fixes the price at X dollar per cubic foot of ledge removed.
If you do want to work cost-plus, make sure you still get an estimate of the job cost, even if it is non-binding. Some contractors are willing to provide a not-to-exceed price on cost-plus work. In some cases the owner and contractor agree to split the savings if the job comes in under the estimate, giving the contractor an incentive to holding down costs. In any case, on a cost-plus job, make sure that the contractor is going to provide you with a detailed, itemized bill showing where the money went.
My personal preference on a large job is to have a fixed bid, with more than one bid, since the risk of substantial cost overruns is great. On small remodeling jobs with a lot of unknowns and a trustworthy contractor, cost-plus can be a reasonable and economical approach. However, make sure you get an estimate, even if it is non-binding, on cost-plus work so that you and the contractor have a mutual expectation of both the scope of work and the approximate cost.
Best of luck with your project!