Cost-Plus Building Contracts

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.

What is a cost-plus building contract?

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.

How does a cost-plus building contract work?

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.

Cost-plus vs. fixed priced building contracts

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.

Advantages and disadvantages of cost-plus contract

The main advantages of cost-plus contracts are:

• The project costs are not capped as in fixed-price contracts.
• Enable projects to be more flexible and agile.
• Owners can closely monitor the project costs at each stage.
• Better control of costs from the owners’ perspective.

The main disadvantages of cost-plus contracts are:

• The contractor must meticulously document all costs received from suppliers.
• The owners’ interest is to keep the costs as low as possible, which is not always feasible.
• Contractors need to fund the supply of materials themselves before receiving funds from the owners.
• Sometimes it’s difficult to predict the total project cost in advance.

 Cost plus contract examples

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:

• Labour costs: $20,000
• Material costs: $50,000
• Other direct expenses: $5,000.

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.

What do builders charge for cost plus contracts?

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:

• Labour cost: cost for the amount of work performed in the project, calculated by multiplying the contractor’s hourly rate by the actual number of hours worked.
• Costs directly associated with the project, including essential materials, permits, and subcontractor fees.
• A predetermined profit margin, typically set at 10% or 20% of the total project cost.

Do cost-plus contracts differ for residential and commercial buildings?

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.

 How to negotiate a cost-plus building contract?

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:

• Clearly define the scope, timeline, and specifications of your project. This will help you manage the project efficiently from start to finish.
• Compare different builders and their offers: Gather information about reputable builders in your area and compare their expertise and pricing to make an informed decision.
• Discuss profit margins: Negotiate the builder’s profit margins during the initial stages of negotiation. Seek a reasonable profit margin that aligns with the builder’s experience and market standards.
• Request a detailed cost breakdown: Ask builders to provide a comprehensive cost breakdown, including labour costs, material costs, and profit margins. Compare this information from different builders to ensure transparency and make an informed decision.
• Review contract terms and conditions: Thoroughly review all contract terms before signing. Seek legal advice if necessary to ensure the contract is in your favour and protects your interests.

Common mistakes to avoid when signing a cost-plus building contract

Drawing from our professional experience, we have identified the following common mistakes in construction practice related to cost-plus contracts:

• Lack of clear cost breakdown: Ensure that the contract clearly outlines the labour costs, material costs, and any additional charges.
• Unclear profit margin agreement: Specify the level of profit margin for the contractors in the contract to avoid disputes later on.
• Poor cost control practices: Neglecting proper cost control measures can result in accumulating costs and unnecessary project expenses.
• Lack of open communication: Avoid the mistake of not seeking clarification for any ambiguous aspects of the contract.
• Neglecting legal advice before signing the contract: It is important to seek legal advice from a professional before finalizing the contract to avoid unfavourable terms or conditions.
• Neglecting contingency plans: Having contingency plans in place to address unforeseen situations and costs is crucial in effectively managing such issues.

 How are cost-plus contracts regulated in Australia?

Key regulating bodies in Australia that regulate construction contracts (and cost-plus contracts too) are:

• Consumer protection laws – The Australian Consumer Law (ACL) protects customers from unjust contract terms and ensure the contracts are fair and transparent
• Australian building codes – The National Construction Code (NCC) which sets the minimum mandatory standards for design and construction and performance of buildings in Australia
• Industry bodies and associations such as HIA provided guidance on best practices, ethical and professional standards and dispute resolution processes for parties involved in cost-plus contract.

How are cost-plus building contracts regulated in NSW?

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.

How can we help you with our expertise?

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.

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Angelo Antidormi

Managing Director at Property & Building Assessments Pty Ltd

Angelo Antidormi, Managing Director with over thirty years of experience in the building and construction industry, leads the team of experts at Property & Building Assessments Pty Ltd, providing professional construction advice and value-adding solutions to clients in areas of dispute, estimation, cost planning, and project management.

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