There are different types of construction contracts for different types of projects. Having the wrong contract could result in overspending, unclear expectations, and project delays. Everyone should know which contract is best for their project.
The five (5) common construction contracts used for residential construction include:
- Lump Sum (Fixed Price)
- Unit Price
- Cost-Plus
- Time and Materials (T&M)
- Guaranteed Max Price
Lump sum Contracts
The client agrees to pay a fixed dollar amount to complete the job. If the contractor makes a mistake in the estimate for labor or materials, the contractor bears the loss.
Pros:
- Simplicity – The contract clearly indicates the scope of work and associated fees. It simplifies paperwork.
- Easier financing – Lenders know project costs as the entire scope is under one contract with a set value.
Cons:
- Higher risk (contractor) – The owner does not pay more if material prices increase.
- Usually more expensive – The contractor usually has a built-in “insurance” into the total price.
- Changes are costly – Scope deletions are done at a discount, scope additions are done at a premium.
- Projects can take longer – Changes require “change orders” which can be time-consuming and cause delays.
Common issues with lump sum contracts include transparency pertaining to material costs as well as additional costs vs. inclusions for “small” changes during construction.
Lump sum contracts are typically better when there is a clearly defined scope of work which is relatively straightforward to complete.
Unit Price Contracts
The client agrees to pay a set unit rate ($/square foot, $/cubic meter, etc) for each individual scope of work for the project. The “price per unit” typically includes all associated costs (material, labour, overhead, profit, taxes, etc).
Pros:
- Transparent – The approximate cost for a service can be easily calculated based on anticipated units of work.
Cons:
- Not a lump sum – The final price to complete tasks will change based on the final measured unit of work. An example would be additional excavation and hauling costs if someone over digs for a basement.
A common issue with a unit price contract is the costs can quickly exceed what the owner was expecting.
Unit price contracts are typically better for smaller projects with limited scope.
Cost-Plus Contracts
The client agrees to pay (reimburse) the contractor for the costs (labour, materials, office space, travel, etc) incurred during the project plus a set amount of money for profit (usually a percentage of the total price of the project).
Pros:
- Flexibility – Allows the clients to make changes during construction and the contractor knows extra time or materials will be paid.
Cons:
- Justification of costs – The client and contractor both must agree to the necessity of the cost.
A common issue with a cost-plus contract is most of the risk is placed on the client due to the requirement to reimburse the contractor for project costs.
Cost-plus contracts are typically best suited for clients who will be making changes and require flexibility during construction.
Time and Materials Contracts
The client agrees to pay (reimburse) the contractor for the material costs. Labour is paid using an established hourly or daily rate for the contractor’s time.
Pros:
- Flexibility – Allows the clients to make changes during construction and the contractor knows extra time or materials will be paid.
- Simplicity – The materials are being purchased by the client for cost and the contract has an hourly labour rate established.
Cons:
- Accountability – The contractor is required to submit time sheets and receipts for materials which need to be reviewed. In addition, the contractor does not feel the same time constraint to finish the project efficiently as they are being paid hourly for a task.
A common issue with a time and materials contract is most of the risk is on the client for unexpected costs or inflation in labour hours due to inefficiencies. Time and materials contracts are typically better for smaller projects where the scope is not well defined.
Guaranteed Max Price Contracts
The client and contractor agree to a cap on the contract price based on a fixed scope of work. Any material and/or labour costs above the cap to finish the project scope is at the expense of the contractor.
Pros:
- Better Communication – Having a project cap encourages the contractor to work with the homeowner on cost and time saving exercises to keep the project below their budget.
- Easier financing – Lenders know the maximum project cost as the entire scope is under one contract cap.
Cons:
- Tendering the job takes longer – The owner does not pay more if the construction is over the cap. As a result, the contractor may try to negotiate a higher cap or spend more time with the homeowner on cost and saving exercises before starting construction.
A common issue with guaranteed max price contracts is the amount of risk placed on the contractor and their estimates. With material pricing changes, it is up to the contractor to ensure they are paying close attention to the project budget.
Guaranteed max price contracts are typically better when added as a provision to a cost-plus or time and material contract to reduce the risk to the client and the contractor.
Cash “Deals”
A cash deal is when a contractor offers a low price in exchange for cash payment with no contract or receipts.
A cash deal puts both the contractor and the homeowner at risk since there is no payment commitment or work guarantee to each other. The homeowner is at risk with the contractor as they have less control over the project. The contractor is at risk with the government since they are likely not declaring the income or paying their taxes.
Always insist on a written contract covering the complete scope of work and detailing the contractor’s legal responsibilities. If you are ready to start your project and you need a permit, you should contact us at www.eternity.design.
Are you looking for one-on-one coaching, access to industry professionals, or a customized game plan to guide you through your project?
Turkstra Lumber offers a great program to assist with this. Build It Better – Build It Better (build-it-better.ca)
