Contractors and project owners shoulder different responsibilities during real estate development. When evaluating what type of contract to use, they likely have different priorities, too. There are many different types of contracts, but two of the most common are cost-plus and guaranteed maximum price. Keep reading to understand the difference between the two and evaluate which one is right for you.
Cost-Plus Contracts
A cost-plus contract is an agreement where the owner pays the contractor for all actual costs incurred (materials, labor, equipment) plus an agreed-upon fee or percentage for profit and overhead. This fee structure provides complete transparency as the contractor must document and justify all expenses. The profit margin is typically calculated either as a fixed fee or as a percentage of the total costs, usually ranging from 10% to 20% depending on project complexity and market conditions. Cost-plus contracts work best in several scenarios:
- Complex or unique projects where exact costs are difficult to estimate upfront, such as historic building renovations or projects with unknown site conditions
- Emergency projects where work needs to begin immediately without waiting for detailed planning, like disaster recovery construction
- Research facilities or specialized industrial projects where specifications may evolve during construction based on technological requirements
- Projects where quality is the primary concern over cost, such as high-end residential construction or premium commercial buildings
- Long-term projects where market conditions and material prices are likely to fluctuate significantly
These situations benefit from flexibility and transparency, allowing for real-time adjustments and ensuring the contractor can maintain quality standards without financial pressure to cut corners.
Pros of Cost-Plus Contracts:
- Flexibility to accommodate design changes and unforeseen conditions
- Transparency in actual costs
- Faster project start since detailed plans aren’t required upfront
- The contractor has less incentive to cut corners
- Better quality control as contractors can use premium materials without fear of losing profit
Cons of Cost-Plus Contracts:
- No cost certainty for the project owner
- Requires more owner oversight and documentation
- Risk of cost overruns falls entirely on the owner
- Less incentive for contractors to control costs
- Can lead to disputes over what constitutes legitimate costs
Many construction contractors prefer cost-plus contracts because they allow the project to start more quickly and ensure payment for all actual costs. Project owners tend to prefer guaranteed maximum price contracts to protect them from cost overruns.
Guaranteed Maximum Price (GMP) Contracts
A GMP contract sets a ceiling price for the entire project. The contractor agrees to complete the work for a price that will not exceed the established maximum, protecting the owner from cost overruns. This arrangement includes a detailed scope of work and typically features provisions for cost savings to be shared between the owner and contractor. The maximum price includes both direct costs and the contractor’s fee, which is usually determined during the pre-construction phase after thorough planning and estimating.
GMP contracts are particularly well-suited for:
- Projects with well-defined scope and complete design documentation, such as standard commercial buildings or typical institutional facilities
- Situations where owners require strict budget control and predictable financing
- Fast-track projects where construction can begin before design completion, provided clear parameters are established
- Projects where owners want to maintain some involvement in subcontractor selection and pricing decisions
- Developments where market conditions are relatively stable and material prices are predictable
Pros of GMP Contracts:
- Owner has cost certainty and budget protection
- Contractor assumes risk for cost overruns
- Incentivizes contractor efficiency and cost control
- Usually includes shared savings provisions
- Better predictability for project financing
Cons of GMP Contracts:
- Higher initial pricing to account for contractor risk
- Less flexibility for changes or improvements
- May lead to cost-cutting measures affecting quality
- Requires more detailed upfront planning and documentation
- Potential for disputes over change orders and scope
Evaluating cost-plus vs. GMP contracts requires a detailed understanding of the project before it begins. Real estate development software gives project owners a faster, more reliable way to calculate and track project costs. Head to our blog to keep learning about best practices in real estate development.
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