Don’t Be Fooled: Cost Plus versus Fixed Price Construction Contracts

At Mike Blake Custom Homes we talk to lots of potential customers about “cost plus” vs “fixed price” contracts.  I believe this topic is one of the top 3 subjects that every customer must be familiar with.  The other two are discussions about the house specifications and budget allowances.

I’ve been told by several banks that we are one of the only builders that still does “fixed price” contracts.  Why?  Simply put it is the best option for the vast majority of customers. 

What Are They?

Typically, “cost plus” contracts are a series of budget allowances that encompasses the whole construction.  For an example, there will be a fixed amount budget allowance for plumbing, foundation, surveys, lumber, windows, cabinets, trim etc.  The allowances are typically vague regarding the specifics.  The reason is somewhat obvious.  Budget allowances with little detail regarding what’s included works to the builder’s advantage.  It gives the builder the power to determine what is and is not in the allowance. 

The Problem With Cost Plus Contracts

Almost all the horror stories you hear about building a custom home revolve around the budget allowances.  The common story is that the customer didn’t get what they believed was included in the price or had to pay more for what they thought was already in the bid.

A cost-plus contract also gives the builder cover for poor estimating.  Think about it.  What motivation does the builder have to be accurate with his price.  The builder can literally undercut the market by leaving out details, not adjust to seasonal prices changes and underbid labor costs.  The builder knows once the business is secured the consumer is on the hook to pay for cost overruns.  To add insult to injury, the consumer is also on the hook for the builder margin on top of the overruns. 

What Does The Industry Think About Cost Plus Contracts

What does the industry think of cost-plus contracts?  When presented with a cost-plus contract most well-informed banks will require the customer to get a loan in excess of 15% greater than the contracted amount.  Banks know that cost-plus contracts are notorious for being underpriced and significantly over budget.

What We Do

At Mike Blake Custom Homes we are advocates for our customers.  I research products and pricing to get the best possible value for our customers.  In addition, we are not a “chuck in a truck” organization.  We are large enough to get best possible pricing on cabinets, doors, trim, lumber, etc.  Those saving are passed on to you.  In fact, I have an open bid policy.  I will show any customer that is interested the bids I receive.

The Dirt Little Secret

That brings me back to another dirty little secret.  I have seen a builder that advertise cost-plus 10% construction.  On the surface that looks like a tremendous deal and you may wonder how they can do it.  Well they cannot do it and stay in business.  Most custom home builders’ gross margins range from 15%-18% depending on the complexity of the project.  After paying overhead most builders make a net profit of 5%-8% per home. 

So how can a builder offer cost-plus 10%?  Through the use of kickbacks (referral fees)!  This is how it works.  The builder asks the HVAC contractor for a bid.  The contractor knows they will be paying a referral fee (kickback) to the builder at the end of the project.  So, let’s say the builder receives a HVAC bid for $15,000.  The builder shows the customer the bid is $15,000.  Unbeknownst to the customer the builder will receive a 10% referral fee (kickback) at the completion of installation.  So, the builder is really making 20% instead of 10%.  That is done throughout the construction.  This unfortunately is a common practice.  The builder calls this a referral fee, I would call it fraud.  Another area that a builder will cheat his customers is in pricing.  For example, at Mike Blake Custom Homes we get a 25%-30% discount on plumbing fixtures.  Most cost-plus builders will not pass that saving to their customers.  Instead they will give the customer a 10% “Builder Discount” and keep the 15%-20% difference.  If the customer is also over budget the builder would tack on another 20% on the overage amount.  Making as much as a 40% margin on the upgrade!!

What Should You Do?

So, you might be asking yourself what you should do.   

I recommend all consumers whose construction costs do not exceed 1 million work toward only a fixed priced contract.  Fixed price requires more work on my part and on yours too but it’s the absolutely safest contract.  For our customers it takes much of the financial risk of cost overruns out of the equation. 

We do this by providing each customer a budget allowance guide that helps our customers preview options and establish an accurate budget allowance.  Then we write the most detailed specifications in the industry.  The more detail the better. 

With Mike Blake Custom Homes you know what to expect because it’s written in the specifications.

Our goal is no surprises and as a result we have very happy customers.



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