You may have heard of this term “Cost Plus” but may not know what it is.
Here are a few questions we are going to quickly answer:
What is it?
What are the different construction agreements PROS and CONS?
How can I benefit?
When you hire a new custom home builder or general contractor, you sign a construction agreement for specific services that are defined in a written contract. This contract spells out the scope of work, materials, and components to be used or added as well as the way the contractor will be compensated for their services.
There are generally two types of construction agreements. The first type is a “Fixed Price” agreement and the second type is the “Cost + Plus” agreement.
Here at Diggs, we offer a new exclusive hybrid construction agreement called “Cost-Plus with Guaranteed Maximum Price”. This building system gives you all of the financial planning perks of a “Fixed-Price” agreement with all of the transparency benefits of a “Cost Plus” agreement.
Here is the breakdown of what each agreement, including our hybrid agreement, really means:
FIXED PRICE AGREEMENT
1 PROS: A fixed price agreement gives the homeowner a pseudo-peace of mind, knowing up front what the cost of the home is going to be. The house price appears to be very low and the builder will apparently guarantee that price.
Home builders especially like this agreement as they know they are guaranteed a fixed income on the home.
2 CONS: 2.1 OVERCHARGING ON SUPPLIES: Builders know that commodities fluctuate during the building process. Tariffs on imports come and go as well as suppliers going out of business resulting in builders having to switch suppliers or manufacturers commonly to a higher and more realistically priced material or component. In order to protect the builder from price increases, builders will cushion the material and supply costs by a large amount to absorb a “potential” price increase or loss of profits. If there ends up being no price increase, the money still stays in the builders pocket rather than going back to the customer.
2.2 OVERCHARGING ON LABOR: Labor shortages and the resulting time delays significantly add to the overall cost of building a home. As more and more people move into the Pacific Northwest, the demand for new houses increases and the skilled labor workforce is strained, commonly leaving homebuyers and builders with home building jobs that are sold but not started. To avoid this risk, builders mitigate the increased cost of skilled labor and differ that risk to the homeowner via the overall price. If they don’t increase the base house price, they make up the difference in overpriced upgrades or overpriced change order fees. And, if you use their referred subcontractors for dirt work, permitting, or other services, they can get monetary kickbacks and discounts, though the customer still pays full price.
2.3 QUALITY OF MATERIALS AND LABOR: Fixed priced builders buy low and sell high. If they lock you into a contract for a fixed price of, let’s say as an example, $169,950. You are committed to that price. If the builder gets a lower grade C, non-kiln dried lumber off of a ship from China for a steep discount, or sheetrock made from recycled material at a lower cost, you don’t get the price savings and your home can potentially suffer for the inferior products. You don’t get any benefit or say in the matter. The more the builder can cut out of the home, the more they make. Most fixed priced builders are typically more concerned about the bottom line than the quality. The less they pay for labor and materials, the more they make. Bottom line, there is more risk, you may not get what you thought you paid for.
2.4 HIDDEN PROFITS: Typically with home builders, every invoice is tucked away on their computer or in their filing cabinet. Everything is a secret. A builders profit is not shown in a transparent way and is often hidden in costs and charges not understood by the customer. In reality, profit is not bad, however, it is the abuse of profit that becomes the problem.
COST PLUS AGREEMENT
1 PROS: With a cost-plus agreement, there is transparency in pricing. Not only do you get to see every invoice, but you also get to have a say in the working budget as well as personally benefiting from any cost savings the builder discovers either in material changes or other means. You only pay direct wholesale builders cost, plus an agreed fixed profit margin. This makes it so the builder cannot make a secret profit. This is typically the lowest cost form of building a home. The builder is not overcharging on prices “In case” of a potential unforeseen price increase.
2 CONS: If the labor or materials price goes up, the house price also goes up. There is no maximum safety cap, so this could potentially be a huge increase above what you thought you were originally going to pay. This can cause many customers to break their planned budget.
COST PLUS WITH GUARANTEED MAXIMUM PRICE
(A Diggs exclusive)
1 PROS: With the exclusive agreement, you benefit by getting all of the financial planning perks of a “Fixed-Price” agreement with all of the transparency benefits of a “Cost Plus” agreement. You get the truth in home building with no hidden or secret profits. You see every nickel spent or saved and you only pay the actual, true cost of the home at direct builder cost plus you pay a fixed builder profit margin. Additionally, you also get a fixed price which we call the Guaranteed Maximum Price or GMP. We give a cost estimate plus a guaranteed maximum (not to exceed) price. We typically add a 5%-10% contingency on the price so your loan is locked.
Whether there are unexpected cost over-runs either in increased actual costs, or you change your mind during a build and want that higher-end luxury home component, we have you covered with the Guaranteed Maximum Price with a cost over-run contingency. The best part of this contingency is that if there is a cost over-run on a custom home, the money is there to cover it if you agree. If you have extra money at the end of the project, it lowers your principal loan amount. You have total control over the funds. We have created a hybrid building system that offers the absolute best of both building systems without the negative elements or risks of either of them separately. Nothing is perfect, but this is pretty close.
2 CONS None known.