The Three Loopholes In Guaranteed Construction Contracts

The Real Estate Espresso Podcast

The Three Loopholes In Guaranteed Construction Contracts

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The Three Loopholes In Guaranteed Construction Contracts

Welcome to the Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host Victor Menasce. On today’s show we’re comparing two types of construction contracts, the cost plus contract and the fixed price contract. We’ll describe the major differences between the two and outline the major gaping hole that exists in both, from which there’s almost no protection.

As the names imply, a fixed-priced contract, sometimes called a guaranteed maximum price, is supposed to guarantee the most that you would ever pay to get a project completed. A cost plus contract adds up the cost of the work performed by the sub-contractors and then adds a percentage on top of the total price to pay the general contractor or the construction manager. You might negotiate an attractive percentage for the general contractor. Generally speaking, the construction manager will build in a substantial contingency into the guaranteed maximum price contract in order to protect their profit margin in the event of a cost overrun.

The only time a change to the budget can occur in a guaranteed maximum-price contract is when the owner initiates a change. But there are three sources of possible changes that fall outside this nice orderly world of GMP contracts. They are, the Building Inspector’s differing interpretation of the building code, the architect or one of the engineers on the project making a mistake, and the uncertainty of the site work. If the general contractor is experiencing cost increases that threaten their profit margin, they’re likely to make substitutions, negotiate changes with the subs that reduce the quality of the built behind your back in order to protect their margin.

While the GMP contract is considered safer for the owner than the cost plus contract, there’s still numerous risks that can result in cost overruns. These are why it’s important for the owner to carry a construction contingency in addition to the general contractor’s contingency. Have an awesome rest of your day. Go make some great things happen. We’ll talk to you again tomorrow.