Construction Contracts Explained: A Simple Guide
Understanding Your Options
So you're ready to pick a contractor and build your project. Great! But suddenly you're drowning in terms like "cost-plus," "GMP," and "lump sum."
Let's cut through the jargon and talk about the three most common contract types in simple terms.
The Big Picture
Construction contracts are basically different ways of answering two questions: how much will this cost, and who takes on the risk? Some contracts lock in a price upfront. Others are more "let's figure it out as we go." Some put all the risk on the contractor, others on the owner, and some split it down the middle. The good news? Each contract type serves different project needs really well. The key is understanding what matters most for your specific situation, then working with your architect and contractor to find the arrangement where everyone's comfortable.
Fixed Price (Lump Sum) Contract
The contractor reviews your plans, calculates everything they think it'll take to complete the project, and gives you one all-inclusive price. You pay that amount (usually in progress payments), and they're responsible for getting it done—even if they run into surprises.
The owner knows the exact cost upfront—no surprises, no budget creep. The contractor assumes the financial risk for material price fluctuations and unexpected conditions. The structure is straightforward: one price, one project. The timeline tends to be predictable since contractors have financial incentive to finish on schedule.
On the flip side, contractors must build in risk cushions. Since they're assuming all the uncertainty, they must include contingencies to protect themselves. The total contract price may include 15-20% above actual costs to account for this risk transfer. Changes require approval by all parties—any upgrades to finishes or materials mid-project require change orders to document the modifications.
Significant price variations between bids often reflect different interpretations of the scope or project complexity. If you're seeing a wide range, it's worth reviewing the plans with your architect to ensure all specifications are clearly detailed.
Cost-Plus Contract (Cost-Plus-Fee)
Instead of a fixed price, the owner pays the contractor for actual costs—labor, materials, subcontractors, permits, rentals, basically everything with a receipt—plus a fee. The fee is either a fixed amount (like $25K) or a percentage of costs (like 15-20%). The contractor essentially becomes the project manager, hired to run the job while the owner pays the bills as they come in.
This approach offers total transparency—the owner sees every invoice, every material receipt, every hour of labor. There's flexibility for changes—upgrades to finishes or materials can be added to the costs without formal change orders. Since the contractor isn't assuming risk, they're not building in contingencies. The owner pays actual costs only. This works particularly well for uncertain projects like renovations where conditions are unknown—cost-plus allows both parties to address issues as they're discovered.
The downside is no budget certainty. The final price remains unknown until the project's complete, which can be challenging for owners with strict budgets. With percentage-based fees, rising costs increase the contractor's fee as well. This arrangement requires trust and oversight since owners rely on the contractor's professionalism and efficiency—it works best with established, reputable contractors. The owner reviews invoices, receipts, and timesheets constantly, which requires significant time and attention to detail.
Since transparency is central to cost-plus agreements, make sure you're comfortable with the level of documentation and reporting your contractor provides.
Cost-Plus with Guaranteed Maximum Price (GMP)
This is a hybrid approach. The owner pays actual costs plus a fee (like cost-plus), but there's a ceiling—the Guaranteed Maximum Price. If the project goes over, the contractor absorbs the difference. If it comes in under, both parties often share the savings (like 50/50, depending on the contract).
This structure provides budget protection with flexibility. There's transparency and the ability to make changes, with protection from runaway costs. Both parties share the risk—the contractor has financial incentive to control costs and finish under the GMP. If the project comes in under budget, both parties benefit from the savings. Construction can start before 100% of details are finalized, with the GMP providing a cost ceiling.
The compromises? The upfront GMP can still be inflated since contractors must include contingencies for protection, so it may not always cost less than a fixed price. Defining what's "included" can get messy—contractors might have to set a GMP based on assumptions, then claim the owner's actual choices exceed it, leading to change order negotiations. Savings-split arrangements can create tension—owners pay all the bills but share savings equally with contractors who controlled the costs. These are complex contracts requiring clear terms about what costs count, what the GMP covers, and how savings get divided.
Savings-sharing arrangements vary by project and contractor. Discuss what makes sense for your situation. Clear definition of what's included in the GMP helps avoid confusion later. Work with your architect to ensure scope is well-documented.
Questions? Let's Talk
If you're working through contractor selection and contract negotiations for your project, we're here to help. While we're architects (not attorneys—definitely get a lawyer to review any contract before signing), we can help you understand what's typical, what's fair, and what to watch out for based on decades of experience.
Give us a call at 904-352-1203 or tell us about your project.