Understanding Home Construction Contracts

Construction Contracts

Due to the tight real estate market, your clients may be contemplating building a custom home or building a home through a tract home builder. In either scenario, it is important that you understand the differences between the two main types of home construction contracts. Your clients should also always be directed to consult with legal counsel before entering into a home construction contract.

Fixed-Price Contracts

A fixed price contract is just as it sounds.  It is a contract whereby the buyer agrees to pay a fixed amount for the build of a new home. These contracts are usually offered by tract home builders because they purchase finishes in high volumes to keep costs low. These builders retain as profit the difference between their costs for materials and labor and the purchase price. Oftentimes tract home builders only offer a limited number of floor plans. Changes to the structure or finishes in a fixed price contract are limited as well. In the event an upgrade in finishes is permitted, the buyer will have to pay the additional cost of the upgrade. Some builders will factor chosen finishes (including upgraded finishes) in the final fixed price the buyer agrees to pay. In addition to builders, home improvement contractors may offer services under a fixed price contract.

Another benefit of a fixed price contract is the certainty that comes with no unexpected costs. Most state laws provide penalties against a contractor that fails to provide an estimate of any excess costs associated with a fixed price contract.

Cost-Plus Contracts

This involves an agreement by the buyer to pay the contractor’s costs plus a pre-determined builder fee. For example, a buyer might enter into a cost-plus contract to build a home for $200,000 with a builder fee of 10%. Cost plus contracts do require contractors to act in good faith and follow other provisions in state law, but importantly do not contain any restriction on excess costs. Generally, if the contractor establishes that the costs are reasonable, the contractor is entitled to payment. These contracts are typically utilized by custom home builders, where the buyer seeks the flexibility to modify building plans and select finishes. Care should be given in these arrangements to assure the contractor is following a strict budget and informing the buyer of any overages.

Contractors who use cost-plus contracts enjoy many exemptions from state statutes regulating construction services. However, if it is proven the contractor intentionally misstates the construction cost or intentionally misrepresents any aspect of the transaction, the contractor can be subject to damages, a statutory fine and the buyer’s attorney’s fees.

As discussed above, with any contract involving the building of a new home, it is important that you recommend your clients consult with legal counsel. Legal counsel can draft either a fixed cost or a cost-plus contract that meets your client’s needs.