Before you begin engaging a builder for your new home or other building project, it is important to reflect on what pricing strategy you want to proceed with.Fixed-price contracts, the norm in Australia, enable you and your builder to agree to a contract sum which is fixed and only subject to approved variations under the contract.

The alternative is cost-plus contracts which allow for payment for the actual cost of building in addition to a fee as agreed with your builder for their overhead, management and profit. This fee can either be a percentage of total costs or a flat fee.

So what are the advantages and disadvantages of these two pricing strategies?

Fixed-Price

Pros

You know how much you will be paying before signing the contract (subject to approved variations).
Lenders prefer this model as it provides more certainty.
There is less risk of cost blowouts for you as the owner; the builder takes the risk of any cost blowouts.

Cons

If you decide to make many changes during the building process, extra costs can add up quickly due to variation fees and mark-ups.
Builders will generally include extra padding in their costs to protect themselves against unforeseen events which may never occur, and so you end up paying more.
If a builder has underestimated the costs of building, they will tend to sacrifice the quality of the final product by taking short-cuts, using low cost, low skilled tradespersons, and using cheaper materials.

Cost-Plus

Pros

You only pay for the cost of building plus an agreed fee – you generally won’t pay for risk and contingency that a builder generally allows for under a fixed price contract.
You get full transparency to the costs as the builder submits invoices for all labour and material expenses incurred on the project.
Provides flexibility with choosing products and finishes during construction without having to pay excessive charges and fees for variations.
Is useful on large custom homes, when the scope has not been fully locked down and particularly when product and finish selections are likely to change or have not been chosen yet.

Cons

If the cost estimate provided by the builder is not realistic, you as the owner wear the risk of any cost blowouts.
There are certain provisions of the Home Building Contracts Act 1991 (for projects under $500,000) that do not apply to cost-plus contracts.
Depending on how detailed you are there can be some time spent reconciling invoices submitted by the builder at the end of each agreed milestone.
There is no incentive for the builder to keep costs down.
Some unscrupulous builders can include either fraudulent invoices or invoices from other jobs to increase the cost and hence their overall fee on your job – you must check the invoices submitted by your builder.

Note that under cost-plus contracts, the following costs will be passed on by the builder to you. These costs are no different to what the builder would allow for in a fixed-price contract; you just get full transparency to what these costs are through a cost-plus contract.

the costs of labour and services;
the net costs of all subcontracts;
fees payable to Statutory Authorities;
fees for professional services (e.g. surveyors, engineers, etc);
premiums payable for insurances;
net cost of building materials, temporary structures and cartage;
the cost to rectify any defects as a part of the Defects Liability Period, other than making good faulty materials or workmanship;
costs for plant, equipment and services (wholly for the Works);
costs to repair, replace and/or rebuild any damage or loss as a result of causes beyond the control of the Builder;
any excesses payable for insurance claims by the Builder; and
any GST payable on the supply of Works.

The bottom line is that both fixed-price and cost-plus contracts are successfully used in building new custom homes and other smaller building projects. Choosing a cost-plus contract can end up costing you less than a fixed-price contract if it is managed appropriately. If you trust your builder is competent and working on your behalf, and you are comfortable not knowing your exact final costs, then a cost-plus contract may be best for you. Your final cost will generally depend on your finish and product selections.

If you do pursue a cost-plus contract, make sure you agree milestone payments with your builder that are on a monthly basis or a similar timeframe. This will eliminate surprises in total costs at the end of the project. Also, make sure you obtain an estimate from your builder of the final expected costs and even do your own estimates and research into what it will cost to complete your building project.

Louis Gonzalez is a registered builder and certified project manager, and a director of Broadwater Builds, a Perth based building company specialising in custom homes, renovations and residential developments.

Broadwater Builds provides free and friendly advice on all aspects of the building process. Feel free to speak to us today about any building related queries you may have.