Cost Plus and Fixed Cost Hybrid Agreement  can be a Win-Win!

Cost Plus and Fixed Cost Hybrid Agreement 
can be a Win-Win!

January 8th, 2016
The final section of the
Construction Agreement discussion centers on a hybrid form of agreement where
portions of a Cost Plus agreement are combined with a Fixed Cost Agreement to
provide the best of both types of agreement. In this hybrid
agreement, the Homebuilder will provide a fixed number for the main structure,
permitting, roofing, site improvements, insurances, clean up, utilities
and other defined items. These are combined with allowances for
items which are unselected or not otherwise able to be defined. These
allowance amounts can be estimated or backed by proposals from vendors for a
certain finish level. When selections are finally made for these items the
difference between the final cost and the allowance is added or subtracted from
the original agreement price. This way the Homeowner always has a realistic
idea of what the final costs will be. Once all the allowance items are selected
the costs are then fixed and do not change (unless other agreed changes are
Like all agreements, this one works best when
the allowance items are based on finish levels the Homeowner wants. When no
selection is available or the Homeowner is uncertain of what they want, an
estimated allowance will be used. However, where possible it is best to have a
vendor price things based on the Homeowners current desires, knowing that the
final number will change based on final decisions. There are many items that
can be listed as allowances for this type of agreement. Some of the main ones
are: cabinets, flooring, countertops, appliances, pool packages, fireplaces,
hardware, landscaping, light fixtures, elevators, stairways and railings, and other
similar things.
The Homeowner and
Homebuilder will negotiate what happens when an allowance is exceeded. In a
cost plus agreement if the costs go up, the agreed percentage rate would apply
to this amount. 
In a true fixed contract
the Homeowner and Homebuilder should have agreed on a change order fee in the
agreement terms. The same applies with this type of agreement. We will often
bundle the allowances into a total allowance amount. Until the total is
exceeded, no funds are required and no additional costs are incurred.
The main advantage to the Homeowner in this form
of agreement is that there is a fixed number they can plan on. This fixed
number can still change if allowances are exceeded or other changes made,
however, it cannot change just because costs go up on the overall structure or
due to errors by the Homebuilder in the original estimate. Once the allowance
items are selected the Homeowner has a number they can rely on and plan around.
In an environment of increasing construction costs it provides the Homeowner
with an agreement which is less variable than other types of agreements.
This section will be on
Cost Plus Construction Agreements. Cost Plus Agreements are the favored type
agreements for remodeling, projects with unique site or other conditions, or
projects where timing maybe more important than final cost. Most remodeling has
too many uncertainties for a fixed price agreement to be realistically done.
Other projects where the scope of work is undefined or certain conditions
unknown lead themselves to the Cost Plus Agreement since there is no
contractual requirement to tie things to a final price. In new construction the
Cost Plus Agreement allows a Homeowner to enter into an Agreement quickly.
Since the final price is undetermined there is no need for a detailed bidding
process to take place. Most Cost Plus Agreements will have an estimate of what
the finalfee cost will be, however, this estimate is
specifically not a hard number. The Homeowner will select the contractor on
basis of reputation, prior work, availability, and compatible personality. The
advantage of this type of agreement for the Homebuilder is relatively obvious.
He is guaranteed a specific amount of profit and/or overhead on the project no
matter what occurs. If material costs go up during a rising market it is the
homeowner who pays the increase. The same applies to increased labor or
vagaries in the estimating process. The advantage to the Homeowner is when the
opposite occurs. If material and labor costs decrease or the Homebuilder over
estimates certain costs these savings are directly passed to the Homeowner. So,
from a construction cycle timing in a declining construction setting, a Cost
Plus Agreement has advantages to a Homeowner. This agreement also has advantages
when a Homeowner has not defined the home or its finishes and they are
concerned about the costs of “Change Orders”. (Some Fixed Contract Agreements
do not disclose the percentages used for Change Orders leading to uncertainty
in what the Homebuilder is earning). The Homeowner also has an expectation that
the Homebuilder will charge less profit and overhead since the risk of cost
over runs is being born by they Homeowner.
Cost Plus Construction Agreements also come in
two primary types. Cost plus a fixed fee and cost plus a certain percentage.
The Cost Plus a fixed fee may include an escalation based on final costs of the
project. If the project increases in costs or scope above a certain level the
Homebuilder is compensated for its increased management time and efforts.
Homebuilder overhead is either included in the percentage or listed as costs in
the overall home cost.
In most cases the Cost
Plus Construction Agreement should result in an open book reflecting the costs
of the project. The Homebuilder will review the individual invoices with
the Homeowner as they come in and then receive payments from the Homeowner at
specified intervals. After receipt of the payment, they will pay the
subcontractor and material suppliers for the work done on the project. The
determination of what is a reimbursable expense is where issues come up in this
type of a construction agreement. It is important to be very specific in this
definition so both parties go in knowing what to expect. Uncertainty may exist
in areas such as insurance deductibles in the event of theft or damage, repair
or replacement of work not accepted for a variety of reasons by the Homeowner,
overhead items of the Homebuilder associated with the project, clean up and
maintenance of the site not done by the subs, increases requested by the subs
to complete their work based on uncertainty in plans and/or specs, etc.
While the Homebuilder may believe these items
are expenses which the Homeowner should compensate the Homebuilder for, the
Homeowner may believe a properly managed project would not have incurred these
expenses, therefor he should not be billed for them. It is when these
uncertainties occur too often, or in too high of dollar amounts that major
conflicts can occur. This is why costs and scope of work, and responsibility
should be carefully defined. Another issue which can occur is when the initial
estimate varies dramatically from the final cost, resulting in project costs
greatly different than the Homeowners expectations. In times when construction
costs are rising, the frequency of increased costs occurs much more regularly.
Most of the time these issues do not occur,
however, when they do the issue is often resolved in arbitration or court.
The next Agreement type will deal with a hybrid
contract which contains parts of both the Fixed Agreement and the Cost Plus
Agreement. It combines parts of each agreement to provide many of the
advantages while avoiding some of the disadvantages each type offers.
Written By, 

Stephen Kauffman, CEO of DIVCO Custom Homes