By Hasti Hejazi, Content Strategy Director, AIA Contract Documents
August 17, 2023
Table of contents:
Residential construction, while lucrative, can be a complex and risky endeavor because of many different variables. The type of contract you choose for your residential project is crucial for not only helping you to manage risk, but also manage your project through defining the project schedule, costs and scope. Understanding the types of contracts that are available to you and picking the right one can ensure that you have the flexibility, cost structure, and proper risk allocation to make for a more seamless residential project.
There are many types of contracts that home builders can choose from based on their preferences. Some of the most commonly used types are outlined below.
In this type of straight-forward construction contract, all construction-related activities will have a fixed price. This can be a good choice if the project has few uncertainties, the scope and schedule are well-defined and project parties agree to all the terms. These types of contracts are a good choice for more predictable projects that the contractor has experience in.
Lump sum contracts have many benefits for both the owner and home builder. Both parties have a realistic expectation of the parameters, costs and profits of the project. Payments go out on a progress schedule so residential contractors can forecast and manage cash flow more efficiently. Owners will sometimes build in incentives for early project completion as well.
These types of contracts leave very little room for flexibility and changes, however. If changes do occur, they can prove to be costly for the contractor. The owner must approve all change order requests and are not required to pay for costs above the agreed-upon price. Contractors can incur damages if unforeseen changes are necessary.
In cost-plus contracts, project expenses (materials and labor) are fully reimbursed by the owner, including fees for project management (usually calculated based on the building cost percentage).
In cost plus contracts, the contractor must understand their costs and desired profit margin. This type of contract reduces the risk that the contractor underpriced or overpriced their products and services.
Cost plus contracts offer more flexibility since construction can begin before the scope is defined and it is easier to make substitutions or changes throughout construction. All costs incurred by the contractor are covered, so there is little risk of going over budget.
A guaranteed maximum price (GMP) contract is a blend of lump sum and cost plus contracts. In this type of contract, there is a maximum price for a construction project, beyond which the contractor absorbs additional costs. The contractor agrees to complete the project within the agreed-upon budget, compensation is based on a fixed sum and the total project cost will not exceed the maximum price. One of the greatest benefits of using this type of contract is greater cost control.
Before entering negotiations, it is imperative to understand your project type, complexity and scope, as well as evaluate the benefits and disadvantages of the different types of construction contracts available.
Is your project scope defined and your project predictable? How much flexibility do you want regarding project costs and schedule? How much risk are you willing to assume? How do you want to handle and be compensated for unforeseen events and changes? What is your desired payment and cost structure?
Selecting the contract type that best fits your project is not an easy task. Arming yourself with knowledge regarding contract types is the first step to selecting and entering a contract that you are comfortable with.
AIA Contract Documents has published two new agreements for use by home builders: A111™–2021, Standard Form of Agreement Between Owner and Home Builder for Construction of a Single Family Home, and A112™–2021, Standard Form of Agreement Between Owner and Home Builder for Design and Construction of a Single Family Home. The documents provide the essential terms and conditions that define the roles of the home builder and the owner and can assist the home builder with educating the client and setting expectations about the course of the project. Learn more>
AIA Contract Documents has released A113-2022 Standard Form of Agreement Between Owner and Contractor for Remodel of a Single Family Home. This is the first document published by AIA Contract Documents that was specifically developed to address unique aspects of a home remodeling project. A must-have for residential remodelers, A113 is a streamlined document that provides the essential terms and conditions that define the responsibilities of the owner and the contractor on such projects and helps to mitigate the associated risks. Learn more>
Additional resources for home builders:
AIA Contract Documents has provided this article for general informational purposes only. The information provided is not legal opinion or legal advice and does not create an attorney-client relationship of any kind. This article is also not intended to provide guidance as to how project parties should interpret their specific contracts or resolve contract disputes, as those decisions will need to be made in consultation with legal counsel, insurance counsel, and other professionals, and based upon a multitude of factors.