When embarking on a new building project, there are two types of building contracts available, each with its own advantages and disadvantages: cost-plus contracts and fixed-price contracts. In this blog post, we will delve into a detailed description of cost-plus contracts in the context of building projects.
A cost-plus building contract entails the project owner covering all construction expenses, including direct and indirect costs, and paying an additional profit margin to the contractor, usually determined by a predefined percentage, to account for overhead.
This type of contract offers significant convenience for contractors, as it allows them to account for both direct and indirect construction costs, while also providing them with a profit margin.
In this type of contract, the contractor is responsible for sourcing materials, staff, and necessary resources at every project stage, passing the actual costs to the owner, and calculating a predetermined profit margin.
In this contract, the cost comprises labour (calculated using the hourly rate and hours worked) and necessary expenses like materials; the contractor provides invoices if needed, and a fixed profit margin is claimed at specific intervals.
What are the main differences between cost-plus vs fixed priced building contracts?
In general, fixed price building contracts are simpler since the entire cost of the project is agreed upon at a predefined price. Once the contract is signed, there is no possibility to change the cost. Therefore, the contractor must manage all actual costs within the given budget, in contrast to a cost-plus contract.
In fixed-price contracts, if the actual building costs exceed the predefined construction budget, the contractor needs to use their own funds to finance the project, which is not the case in cost-plus contracts. Fixed-price contracts may also include provisions that allow for some additional costs to be covered. Usually, such provisions are specified in the contract itself.
The main advantages of cost-plus contracts are:
The main disadvantages of cost-plus contracts are:
Let’s start with a simple example: A contractor is hired to renovate a building for an owner. The contract specifies a cost-plus agreement with a 10% profit margin.
The direct costs in this example include:
In this calculation, total direct costs include $75,000 In this case, profit margin equals to total direct costs * profit margin percentage. Therefore, profit margin is $75,000 * 10% = $7,500. So, in total, the cost-plus contract amount equals to $82,500.
The charges for cost-plus contracts can vary significantly, depending on factors such as the project’s scope, the volume of work involved, the builder’s reputation, and the construction market in the region.
Generally, builders charge for three main categories of costs:
Yes, cost-plus contracts can differ based on the type of property they relate to.
Residential cost-plus contracts apply to building a new or remodelling an existing home or residential building. These contracts often take into account factors such as the size of the property, and the unique remodelling or building requirements of homeowners which can affect the types and the amount of costs.
Commercial cost-plus contracts apply to construction of new or remodelling of existing commercial properties such as offices, retails, hotels, or industrial buildings. These contracts may typically involve more complex project requirements, larger budgets, and other compliance issues specifically related to commercial properties, which also impacts costs.
While residential cost-plus contracts may have a predefined profit margin based on a percentage of the total project cost, in commercial cost-plus contracts, the profit margin may be calculated differently. It may consider factors such as the complexity, anticipated project risks, and similar factors.
Negotiating a cost-plus building contract requires effective communication skills and familiarity with construction contract terms and conditions. Here are some tips on how to successfully negotiate a cost-plus contract:
Drawing from our professional experience, we have identified the following common mistakes in construction practice related to cost-plus contracts:
Key regulating bodies in Australia that regulate construction contracts (and cost-plus contracts too) are:
In New South Wales (NSW), cost-plus contracts in residential building work are regulated by the Home Building Act 1989 and the Fair Trading Act 1987. Building regulations in NSW regulates technical standards for construction work, including safety and energy efficiency. The Master Builders Association of NSW offers resources, training, and support, with codes of practice and guidelines promoting best practices, ethical conduct, and dispute resolution for cost-plus contracts.
Property & Building Assessments specialise in providing comprehensive support to ensure the successful execution of your projects while maintaining strict control over costs. Our team of experienced professionals will work closely with you to develop accurate budgets, monitor expenses, and optimize resource allocation. Send us an enquiry today.