Dino writes: What is the average percentage that builders charge when they build a new home on a cost-plus contract? Do you recommend that route for a custom home?
Steve Bliss, of BuildingAdvisor.com, responds: In pricing a new home, contractors typically mark up their hard costs by 18% to 25% for overhead and profit, although the actual number can vary considerably by region and market conditions. You’ll hear “10 and 10” sometimes mentioned for 10% overhead and 10% profit. These numbers are generally higher on remodeling jobs because of higher overhead costs.
In theory at least, you should pay a lower percentage on a cost-plus job since you, not the contractor, have assumed the risk of cost overruns — a very big risk to take on. So a 14% to 18% markup is more reasonable on a new home cost-plus contract.
As with all things concerning numbers, the devil is in the details. The markup percentage is added to the contractor’s direct costs, typically materials, labor, and subcontractor costs as well as consumable items like blades and drill bits. It might also include things like dumpster fees and special tool rentals required for the job. Labor costs typically include “labor burden,” which includes taxes, benefits, and Worker’s Comp insurance.
Direct costs billed to you should not include the costs of trucks, standard tools and equipment; office expenses, bookkeeping and accounting, advertising, training, legal, and other costs of being in business.
To complicate matters, there are a number of items that can go either way: permits, other insurances like Builder’s Risk, travel expenses such as gasoline, job-site security, scaffolding, and so on. The biggest item to watch is job supervision and management. In other words, is the company owner billing for his own time in the field (or a job superintendent’s time) as a labor charge or is that covered in overhead?
In small companies, where the owner might be on the job much of time and swinging a hammer at least some of the time, he generally bills his time on site as a direct job cost. Time he spends on evenings and weekends organizing and keeping track of the job should be paid for out of overhead. In a larger company where the owner is mainly in the office or out meeting with potential customers, his time is typically considered part of overhead. An exception might be time that he spends on the job-site supervising the work, which may be reimbursable.
A contractor who bills you for his management time on-site or off-site and then adds 18% markup on top may appear to be double dipping. A factor to consider here is what hourly rate you are paying for the owner’s time and what mark-up percentage.
In a cost-plus bid, it’s critical to know ahead of time what will be billed to you as a direct cost (and marked up) and what will be covered by overhead and profit. All direct costs should be made clear to you in detailed invoices that show the contractor’s actual costs for materials, labor, subcontractors, and anything else you are billed for. Of course, an element of trust is required here as contractors can easily pad expenses in many places. For example, is he showing a material’s retail cost or its discounted cost to him? Is he inflating other costs such as subcontractor rates? Contractor discounts are small on basic building materials but can be significant on things like windows and doors, kitchen cabinets, and plumbing and electrical fixtures.
There are many variations of cost-plus contracts and every contractor does the pricing a little differently. At the end of the day, however, you will be relying on the contractor’s honesty and integrity to give you a fair price, so make sure you choose someone trustworthy.
Personally, I would avoid a cost-plus contract on a new house or large remodeling job unless the contract has a guaranteed maximum price. The risk of out-of-control cost overruns is too great. Cost-plus contracts are a good choice for smaller remodeling projects where there are a lot of unknowns. In this case, fixed bids might be unrealistically high to cover the potential unknowns, so you may get a better price by working cost-plus.