The Builder Relationship - A Deep Dive into Contracts
Working with Bluerock Utah — Part Two
Who Should Build My Home?
Congratulations to you! You have decided to build your dream home or remodel your current home into something straight from your Pinterest board. It is about to be exciting! After landing on the idea of the build, the next step is to decide exactly who to work with. With all the options in northern Utah, this can be almost as difficult as deciding what things you want in the home itself.
If you recall from our previous post about creating a predictable experience, you want to make sure that you are leaning into our 4 ROCK pillars. The first pillar is all about the builder relationship and we are going to dive deeper into that today.
Review: The Deliverables
To recap, you need to understand what you are going to get when you choose a builder. This can help simplify the decision-making process. While the process itself has a lot of moving pieces, the process can be simplified by identifying three deliverables that every homeowner receives from their builder. These are:
The end product: Your dream home!
The services rendered: The quality of the laborers and subcontractors performing the work on your build
The experience: The experience your builder delivers from pre-construction, during construction, and after completion
Price: The Most Important Factor
When choosing your builder, one of the BIGGEST pieces that we found to factor into most people’s choices is the price, especially in this wild Utah market. It is a big deal to choose someone that fits your price range, someone who respects it, and someone who will work with you to keep the project in line with your budget.
“Choose someone that fits your price range, respects it, and will work with you to keep the project in line with your budget”
Contract Types
In the building industry, builders typically structure the contractual relationship with their clients in two ways—fixed price contract or cost plus contract. Both have major flaws which create tension in the client-builder relationship. We at Bluerock offer a different third option—cost plus fixed fee contract. This benefits our clients and protects our relationships. Let’s dive into these contract structures so you know what you’re getting into.
Fixed Price
Cost Plus
Cost Plus Fixed Fee
Fixed Price Contract
The first contracting method is a Fixed Price contract.
A fixed price contract is where the builder prepares a bid for the work on your project and agrees to do all the work for that fixed price. Let’s walk through the possible implications of this type of agreement.
Fixed price contracts work really well when both client and builder are 100% certain of the total scope of the project. This means that the blueprints are 100% complete and every material and finish selection has been specified in advance. With complete project documents in hand, all bidders can include the exact same scope of work in their price.
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—Works well for large scale production home builders where scope of work is clearly defined
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—When scope is not clearly defined, each bidder makes their own set of assumptions
—Often leads to conflict when costs exceed budgeted price
—Contractor makes more money by reducing costs or sending change orders
—No incentive for the builder to complete the project quickly
Pitfalls of Fixed Price Contracts
If the scope of the work is not completely defined, the bidding contractors will make assumptions about scope, products, and finishes. With each bidder making their own set of assumptions, it is extremely difficult to evaluate the bids. Is the lowest bidder the most competitive price, or did they leave something out? Is the highest bidder more expensive because they did a more complete estimate, do they use higher quality materials, or both? Do the assumptions the bidders make in their estimate align with your expectations for the quality of materials and workmanship? Do the bidders clearly define the assumptions they made regarding material quantities or actual products they plan to furnish?
When the project scope isn’t completely defined, it often leads to conflict when costs exceed the budgeted price. When the contractor sends a change order because the flooring material you chose was over the budget in their bid, how do you know what was in the original estimate if the flooring selection wasn’t specified in advance?
With a fixed price agreement, the contractor makes more money by reducing costs or sending change orders. Do you want to enter into a contractual agreement with a builder who has a financial incentive to cut costs by using the most inexpensive materials and labor they can find?
In addition, fixed price contracts contain no incentive for the builder to complete the project quickly nor to furnish the highest quality of materials and workmanship. The incentive is to hit the budget.
This kind of builder relationship works well for large scale production home builders. By building the same home design dozens of times they are able to clearly define the total scope of work, reduce inefficiencies, and lock in material and labor costs through bulk contracts with vendors and subcontractors.
Fixed price agreements do not work well for custom homes, additions, and remodels because of the difficulty to pre-determine the exact scope of the project in advance.
Cost Plus Contract
The second common way to structure a construction agreement is called Cost Plus. This is when the builder prepares an estimate for the labor and materials to build your project, and you as the client pay the actual cost of the work plus a builder fee percentage on top.
Cost Plus agreements are more commonly used for projects like custom homes, additions, and remodels because it allows for flexibility in defining the scope of the work as the project progresses. Moreover, it gives the client more time to choose materials and finishes.
Clients like cost plus agreements because they know they will pay for the actual cost of the products and finishes they choose, and cost plus agreements are “open book”, meaning that the builder shares all project costs with the client.
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—Allows for flexibility in defining the scope of the work over time
—Clients will pay for actual cost of the products and finishes they choose
—Open book, meaning that the builder shares all project costs with the client
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—The builder with the lowest bid might leave things out of their bid in order to be awarded the contract, knowing percentage will be added on later
—No incentive to complete the project quickly or within budget – highest quality of materials and workmanship increases the builder fee
—Conflict of interest between the client and the builder – The more the project costs, the more fee the builder gets paid
Pitfalls of Cost Plus Contracts
With a cost plus format, there’s a strong disincentive for builders to prepare a thorough and complete cost estimate. Clients will feel pressure to choose the lowest bidder in order to save money. The builder with the lowest bid might leave things out of their bid in order to be awarded the contract, knowing they will get paid the fee percentage for anything left out of the bid when the client adds it into the project later.
Cost Plus agreements contain no incentive for the builder to complete the project quickly or within budget. The incentive is to provide the highest quality of materials and workmanship in order to increase the builder fee.
The major flaw with a cost plus agreement is the conflict of interest between the client and the builder. The more the project costs, the more fee the builder gets paid. Finding ways to save the project money actually costs the builder by reducing the builder fee. With the builder primarily in the driver’s seat managing the project, do you want to have a contract agreement which rewards the builder when costs increase and penalizes the builder for reducing costs?
Cost Plus Fixed Fee Contract
Both Fixed Price and Cost Plus agreements contain elements that put the interests of the builder and the interests of the client in direct opposition. We prize our relationships with our clients and want to earn and keep their trust from start to finish. That’s why at Bluerock we like to use a third contracting approach called Cost Plus Fixed Fee. In a cost plus fixed fee agreement, we as your builder prepare a competitive estimate for the labor and materials to complete your project. Then we add a fixed fee to that amount. The Cost Plus Fixed Fee Agreement we use is the best of both worlds.
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—Client has flexibility to choose material and finish options during the project rather than before — and you pay the actual price for the selections you make
—You know in advance what you are paying your builder to complete the project
—Builder is transparent about the costs of labor and materials and the different options you have
—Client doesn’t pay the builder fee on top of upgrade costs or price increases
—Builder fee isn’t reduced when items are under budget, which means the builder will be encouraged to find savings to the project
—Builder is incentivized to prepare a detailed cost estimate up front and not leave anything out
—No incentive for cutting corners and no incentive for allowing the budget to increase
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None
Benefits of Cost Plus Fixed Fee
Like the Cost Plus agreement, you as the client have the flexibility to choose your material and finish options during the project rather than before — and you pay the actual price for the selections you make
You know in advance what you are paying your builder to complete the project
Your builder is transparent about the costs of labor and materials and the different options you have
You as the client don’t pay the builder fee on top of upgrade costs or price increases which occur during the project
The builder fee isn’t reduced when items are under budget, which means the builder will be encouraged to find savings to the project
The builder is incentivized to prepare a detailed cost estimate up front and not leave anything out, while at the same time not over-inflating the estimate in order to win the job. This gives the client the advantage of not having to worry about costs going out of control after signing the contract.
With a fixed fee, the builder has an incentive to provide quality workmanship the first time in order to complete the project quickly. There’s no incentive for cutting corners and no incentive for allowing the budget to increase.
The Best Builder Relationship
The Cost Plus Fixed Fee Agreement creates a relationship between builder and client that best aligns the goals for both parties. When we align our priorities in the builder relationship, it’s easier to trust each other. You feel like you are playing on the same team. You should only undertake expenditures of this magnitude when you trust those who will make decisions on your behalf.
“The Cost Plus Fixed Fee Agreement creates a relationship that best aligns the goals for both parties”
In conclusion, whatever pricing structure you land on with your builder, make sure you educate yourself on where the risk and rewards fall, what you will be able to control as the client, and if there will be the potential for surprises down the road. All of this contributes to the relationship with your builder and how your experience will be.
Interested in learning more about building a home with Bluerock? Read more of our blog posts here. If you are ready to start your project with us, contact us here.
