When homeowners compare custom home builders, one of the most important differences to understand is how the construction contract is structured.
Two common approaches are fixed-price and cost-plus construction.
Neither structure automatically determines whether a builder is good or bad, and both can be appropriate depending on the project. But they allocate cost risk differently and can create different financial incentives as a project progresses.
For a homeowner preparing to make a substantial investment in a custom home, understanding those differences is important.
What Fixed-Price Construction Means
Under a fixed-price agreement, the builder and homeowner establish the construction price after the plans, specifications, scope and allowances have been sufficiently developed.
The builder then assumes responsibility for completing that defined scope for the agreed price.
That means the builder has an incentive to estimate accurately, coordinate efficiently, avoid unnecessary waste and control construction costs.
At Artistic Contractors, this is generally the structure we prefer for new custom homes once the design, scope, specifications and allowances are sufficiently established.
A fixed price also gives the homeowner greater visibility into the expected construction cost before work begins.
What Can Still Change a Fixed Price?
Fixed price does not mean that the price can never change under any circumstances.
The most common changes occur when the homeowner changes the agreed scope, adds work, modifies selections or chooses an allowance item that exceeds the amount allocated in the contract.
For example, if the contract includes a $25,000 appliance allowance and the homeowner ultimately selects $35,000 worth of appliances, the additional amount would affect the project cost.
There can also be rare concealed or unforeseen site conditions that could not reasonably have been identified before construction.
Unexpected rock, unusual soil conditions or other concealed conditions are examples of circumstances that can sometimes require additional work and cost.
A well-written contract should explain how these situations are handled rather than relying on an unrealistic promise that a construction price can never change.
How Cost-Plus Works
In a cost-plus contract, the homeowner generally pays the actual cost of construction plus an agreed builder fee.
For a simplified example, assume a 15% builder fee.
If the construction cost is:
$1,000,000
the 15% fee is:
$150,000
and the combined amount is:
$1,150,000.
If construction costs rise to:
$1,200,000
the 15% fee becomes:
$180,000
and the combined amount becomes:
$1,380,000.
If construction costs reach:
$1,400,000
the 15% fee becomes:
$210,000
and the combined amount becomes:
$1,610,000.
This does not mean a builder operating under cost-plus wants costs to increase.
It does mean that when the builder’s compensation is calculated as a percentage of cost, the dollar amount of that fee increases as the underlying construction cost increases.
That is simply part of the mathematics of the contract structure.
A Builder Fee Is Not Necessarily Pure Profit
It is also important not to confuse a builder fee with pure profit.
A builder’s fee may help cover many business expenses, including project management, administration, supervision, office overhead, insurance, warranty obligations, operating expenses and profit.
Different builders account for these expenses differently.
Some include many of those costs inside the percentage fee.
Others charge certain expenses separately as general conditions.
General conditions can include items such as project supervision, temporary facilities, jobsite expenses, dumpsters, utilities, insurance, administration or other costs associated with operating the project.
That is why simply comparing one builder’s percentage to another builder’s percentage can be misleading.
A lower stated fee does not necessarily mean a lower final construction cost.
Questions to Ask When Comparing Cost-Plus Proposals
When evaluating a cost-plus proposal, homeowners should understand exactly what is included in the builder’s percentage and what is billed separately.
Useful questions include:
- What percentage or fee is charged?
- What costs is that percentage applied to?
- Are general conditions billed separately?
- Is project supervision included in the builder fee?
- Are administrative costs separate?
- Are insurance or jobsite expenses charged separately?
- Are materials marked up in addition to the builder fee?
- Are subcontractor invoices marked up?
- Are change orders subject to the same percentage?
- Are there any categories of cost excluded from the fee?
- Is there a guaranteed maximum price or other cost ceiling?
The goal is to compare the entire economic structure, not simply the headline percentage.
Who Carries the Risk of Increasing Costs?
One of the fundamental differences between fixed-price and traditional cost-plus construction is who carries more of the risk when costs change.
With a properly defined fixed-price agreement, the builder generally carries more of the risk that labor or material costs within the agreed scope will exceed the original estimate.
If the builder underestimated a defined portion of the work, the builder cannot simply increase the price because the estimate was wrong.
That creates a strong incentive to estimate carefully before construction begins.
Under a traditional cost-plus agreement, increases in actual construction cost are generally passed through to the homeowner according to the contract.
That can provide flexibility, particularly when a project has an uncertain scope, but it also means the final price may be less predictable.
Cost-Plus Fixed Fee Is Different
Not every cost-plus agreement uses a percentage.
Some builders use a fixed builder fee rather than a percentage of construction cost.
For example, a builder and homeowner might agree that the builder will receive a specific dollar amount for managing and completing the project regardless of whether actual construction costs move moderately up or down.
That changes the incentive structure because the builder’s fee does not automatically increase every time the underlying construction cost increases.
Again, neither method is automatically right or wrong.
The homeowner simply needs to understand which method is being proposed.
How Artistic Contractors Handles Allowances
Even under a fixed-price construction agreement, certain selections may remain as allowances because the homeowner has not made every final selection when the contract is executed.
Examples might include plumbing fixtures, decorative lighting, appliances, tile or other finish materials.
For allowance items purchased through Artistic Contractors, the client pays our actual contractor purchase cost plus a disclosed 15% markup.
For example, if our actual purchase cost for an allowance item is $10,000, the client cost would be $11,500.
If an allowance comes in under the amount carried in the contract, the remaining balance can generally be moved to another allowance or credited back through the project accounting.
If the homeowner selects items above the allowance, the difference is added.
This allows the homeowner to retain flexibility over selections while keeping the pricing method clear.
The Bottom Line
The most important issue is not whether a builder describes a contract as cost-plus or fixed-price.
It is understanding exactly how the contract works.
Homeowners should know which costs are included, what can change, who carries the risk of estimating errors, how allowances are handled, how the builder is compensated and whether additional general conditions or markups exist outside the headline price.
For new custom homes, Artistic Contractors generally prefers to establish a fixed construction price once the plans, specifications, scope and allowances are sufficiently developed.
We believe that structure gives both the homeowner and builder a clear target and creates a strong incentive to solve pricing and constructability issues before they become expensive problems in the field.
There will always be decisions during a custom-home project. Owners may change their minds, selections may exceed allowances and occasionally a concealed site condition may appear that could not reasonably have been identified beforehand.
Those situations should be addressed clearly in the contract.
But once the scope is established, we believe the builder should have a strong financial incentive to manage the project efficiently rather than benefit simply because construction costs increased.
And we think that is a better way to build a custom home.