If you are considering building or renovating a home using a cost-plus contract, think again. From a homeowner’s perspective, there few advantages to cost-plus and many disadvantages. The risks of entering a cost-plus contract far outweigh any potential benefits.
I receive a steady stream of questions and complaints from owners who have run into serious problems on cost-plus jobs. In a number of cases, the final costs are more than double the original estimate.
In many cases, there is no written contract, which is always a bad idea and is illegal for home-improvement contractors in some states. Some homeowners are not even aware that they have entered into a cost-plus contract. They do not fully understand the difference between a fixed-bid and a non-binding estimate. The term “estimate” can be used in both ways, adding to the confusion.
Cost-plus contracts are very risky for homeowner. Even a contractor of the highest integrity is not immune to economic incentives. It’s just human nature. A disproportionate number of these jobs end up in dispute. Consider these risks before entering a cost-plus contract.
RISKS OF A COST-PLUS CONTRACT
- Cost controls lacking: The contractor has no economic incentive to control costs, always a difficult task on construction sites.
- Perverse incentives: The contractor has a perverse incentive to increase costs and job duration – especially on a cost plus-percentage job. The longer it takes, the higher his profit.
- Estimate is non-binding: The “estimate” you receive is just a non-binding “guesstimate”. The contractor has little incentive to put a lot of hours into a precise estimate. Without a guaranteed maximum price, the estimate could be way off. You may have spent 100% of your budget on a job that is 50% complete. It happens!
- Pass-through costs: The contractor has no incentive to negotiate and shop for best prices from suppliers and subs that pass through to you. Subs may also be working cost-plus, increasing the risk of cost overruns.
- Pay twice for mistakes: If the contractor makes a mistake, or there are problems with materials or their installation, you will pay extra to make things right. You may pay to have the work done twice.
- Permitting and code compliance: If there are problems with permitting, code compliance, zoning, or engineering, you will absorb all the additional costs.
- Double dipping: Some contractors charge hourly for supervision, office expenses, customer meetings, and other administrative costs that should be covered by the markup.
- Cost information lacking: Change orders are rarely used, so you may not learn about added costs or cost overruns until it is too late to make adjustments. You may get large surprise bills at the end of the job.
- Punch list costs: You will have no leverage at the end of the job to get substandard or incomplete work finished correctly or the job site cleaned up. Your punch list comes with a bill.. Either you pay more to have the loose ends tied up, or you will end up doing them yourself.
- Callbacks and warranty claims. If problems crop up after the final check has cleared, will the contractor charge you to come back and make things right? Not always clear on cost-plus jobs.
Get the picture? As unanticipated costs pile up, you pay and pay and pay – sometimes with no end in sight. By the time you realize that job costs are spiraling out of control, you are too far along to change course or back out.
In theory, the owner can save money, since the contractor does not have to pad his budget for “contingencies,” that is, things that do not go as planned, items missed on the estimate, or other unknowns that cause cost overruns.
I believe that Murphy of “Murphy’s Law” was a construction contractor. Murphy’s Law states that if anything can go wrong, it will. When things do not “go as planned,” they almost always cost more, not less – another of Murphy’s Laws.
A contractor with a fixed bid must work very hard to keep costs under control. He may need to push back on his subs or suppliers a little, order more carefully, buy or rent a more efficient tool, or find other ways to work efficiently – e.g., have materials delivered to the second floor by a boom truck.
It is true that a contractor working on a fixed bid may be tempted to cut corners that could affect the quality of the work. That places a greater burden on you to have complete plans and specs, find a reputable contractor, and keep a watchful eye on the project. This can be done by an architect, independent construction inspector, or yourself if you have the skill.
Of course, you should take these same steps on a cost-plus job also, although for a slightly different reason. You will still want clear plans and specs for efficiency and predictability. Making it up as you go is slow (expensive) and risky as details designed in the field may be less than optimal.
The fundamental problem is that the owner assumes all the risk for cost overruns, but has little ability to control those costs. Too often the end result is a big bill and a lot of tension toward the end of the job. Once you are over-budget, the relationship with the contractor often sours.
If you end things on a bad note, you can expect little cooperation for callbacks and warranty problems that show up after the work is completed and the final bill paid.
On any construction job, always:
- Written contract. Have a written contract that, at a minimum, defines the scope of work, price, and payment schedule.
- Plans and specifications. Start with detailed plans and specifications that accurately describe the work to be completed.
- Contractor choice. Find a competent and choosing a contractor. Often this is not the low bidder,
Read more about Cost-Plus Contracts.