What are cost plus construction contracts?
Cost plus contracts, which are also commonly referred to as open book or cost reimbursement contracts, are when a contractor is paid for all of their business-related expenses plus an additional predetermined profit. In residential construction this means that home builders or remodelers pass along the costs of their construction materials directly to their clients while still making a profit based on the agreed-upon fee or percentage. Residential construction projects that use these contracts offer clients a deeper level of budget and price transparency compared to fixed price or lump sum contracts.
The components of a cost plus contact
The main components of a cost plus contract are direct costs, overhead costs, and the fee or profit.
The direct costs of a construction project are the material and labor costs of the build. This includes lumber, appliances, carpet, cabinets, appliances, trade partner labor, and any other costs that can be directly tied to the production of a specific good. For these types of contracts, the exact costs of these goods are passed along to the client to pay for in their project.
Overhead costs in a construction project are the costs that go into a project that are not directly tied to a specific good. For instance, internal labor costs not specific to a certain trade such as HVAC or plumbing are the most common overhead construction costs. In cost plus contracts these overhead costs are calculated by the contractor and passed along to the client to pay as well at face value.
Fee or Profit
In these contracts a home builder or remodeler adds their own fee or profit amount to their direct and overhead costs to be paid by their client. This amount can either be a flat number or a percentage of the total cost of the project. On fixed price projects this amount is tabulated per line item and not seen by clients but on cost plus contracts the fee or profit amount is a specified line item for both parties to see.
Why are cost plus contracts important?
Cost plus contracts are important because they provide a very high level of customization and transparency to residential construction projects that fixed price contracts do not offer. Clients working with contractors to build custom multimillion dollar homes expect a certain level of customization that cost plus contracts meet by treating the entire project as an allowance. These contracts also help alleviate any misguided concerns about the costs of building by showing clients exactly what every step in the process costs and how much contractors are making.
Cost plus contracts also protect contractors from price instability in the market by passing direct costs onto clients. For example, when lumber prices started to skyrocket in 2020 contractors using this contract were able to compensate by having their clients pay the increased cost. Contractors using fixed price contracts, on the other hand, handle this fluctuation by renegotiating predetermined prices with their client or eating the additional cost.
Cost plus contract pros and cons
What are the advantages of using cost plus contracts?
Cost plus contracts allow contractors to reduce their risk to price fluctuations in building materials by passing costs along to their clients. These contracts also allow the entire building process to be treated as an allowance which can enable clients to totally customize their build to get their desired end result.
What are the disadvantages of using cost plus contracts?
Cost plus contracts directly show clients the profit that contractors are making on a project which many in the industry see as a negative. Open transparency about markups and margins opens the door for price negotiations and risks clients being unhappy with the total markup. On average projects using fixed price contracts have higher profit margins than projects using cost plus contracts, meaning that many contractors would take home more money if they used a different contract.
Should contractors use cost plus or fixed price contracts?
The short answer is that it depends on the project and client goals. If a client wants to have visibility to every aspect of the budget and building cost then contractors likely need to use a cost plus contract. Additionally in highly unstable market conditions, such as the lumber price fluctuations of the past 18 months, contractors who are more risk averse could benefit from using cost plus contracts for their material price advantages. However, if a contractor is working on a relatively straightforward project that contains few customizations if any, fixed price contracts may provide the right stability.
How do contractors use cost plus contracts?
Contractors can implement cost plus contracts in their residential construction business using manual methods, software methods, or fully integrated construction project management software.
Home builders and remodelers can use programs like Microsoft Excel or Google Sheets to manually add, update, and track their project costs. Unfortunately, manual methods such as these are very time consuming and can lead to costly mistakes.
There are a number of contract software packages available on the market today for contractors to use. However, the majority of these software solutions designed for rinse and repeat operations that do not have project to project variation. For contractors with project sizes and scope that change from job to job these solutions may not be ideal. While these solutions help automate some aspects of the contract process, they still are siloed from the rest of the construction project lifecycle.
Integrated construction project management software
Integrated construction project management software like CoConstruct not only provides support for cost plus contracts but also provides solutions for contractors throughout the entire build cycle. For instance, home builders and remodelers can use CoConstruct to build out their estimate which in turn helps create their proposal and contract which are sent to clients to electronically sign. Then clients can track a build’s progress step by step including the financials to stay in the loop without taking their contractor away from working on their project.