In this snack-size episode of Home: The Second Story, we dive into the world of construction contract structures—a topic many homeowners find confusing but absolutely essential to understand. We break down the two main contract types: fixed price (or stipulated sum) and cost-plus (often referred to as time and materials), exploring how each affects cost, transparency, and risk.
From Marilyn’s background as a contractor, we hear that contracts are essentially about who carries the risk. In a cost-plus setup, the owner takes on the risk—and reaps any potential savings if material prices drop. In contrast, a fixed-price contract shifts that risk to the contractor, who may build in a cushion to protect against unexpected costs.
We talk about markup structures and how they vary between contractors. A critical point we emphasize is that not all percentages are created equal—one contractor’s 12% markup might include overhead and profit, while another’s 18% could only reflect profit. This makes it essential to ask what’s included in the markup when comparing bids.
Another key topic is allowances in hybrid contracts. These are line items for unknowns—like what's behind a wall during renovation—and act as mini cost-plus agreements inside a fixed-price contract. Interestingly, while allowances often cover things like tile and appliances, Marilyn notes she always wished they’d be used for unknown site conditions instead—since tile choices can be made upfront.
We also highlight control estimates, which provide a baseline for cost-plus contracts. They’re not binding but offer owners a framework for budgeting. Marilyn reminds us these estimates are often required by consumer protection laws, not just construction best practices.
In terms of billing, fixed-price contracts result in streamlined invoices showing progress against the agreed amount. Cost-plus contracts, on the other hand, provide detailed receipts for every purchase and expense, which architects or owner’s reps typically review before payment.
We touch briefly on change orders, clarifying that in cost-plus contracts, they don’t exist—the contractor builds as directed. In fixed-price arrangements, change orders formalize any scope changes, whether due to material availability, homeowner decisions, or contractor requests. We suggest keeping a change order log to track who initiated each one.
Lastly, we stress that asking questions is not only allowed—it’s encouraged. Homeowners should feel empowered to understand where their money is going but should also respect the realities of construction work. The success of any contract, we agree, depends on clear communication, realistic expectations, and detailed upfront planning.
Voiceover (00:02):
Everyone says how horrible it'll be to renovate or build your house — we're here to say it doesn't have to be that way.
Join three seasoned architects as they interview homeowners who recently completed a large project, and ask them one simple question: what do you know now that you wish you knew before you started?
Welcome to Home: The Second Story Podcast.
Marylin Moedinger (00:26):
Hi everyone, and welcome to a snack-size episode of Home: The Second Story. I'm Marilyn from Runcible Studios.
Sheri Scott (00:34):
I'm Sheri, with Springhouse Architects.
Taylor Davis (00:37):
And I'm Taylor, from TPD Architect.
Marylin Moedinger (00:40):
And today, we are talking about something that everyone wants to know more about: contract structures.
Sheri Scott (00:47):
(Laughs) Boo, boo. Not fun.
Marylin Moedinger (00:49):
No, this will be cool, this will be cool. Don't change the dial, everybody. This is something that we hear from our (chuckles) clients all the time, it’s something that there's a lot of mystery around. What kind of contract do you set up? That kind of thing.
So, we're going to try something – so I used to be a contractor, a builder. I will present that side (from that perspective), and Sheri and Taylor are going to talk about more from the architect side. We're going to try that, see how it works.
Taylor Davis (01:18):
So, I think the terminology that gets used (at least in our neck of the woods, in Alabama) the most often, and I think it's the AIA (American Institute of Architects) terminology, is cost plus contract, or stipulated sum. Stipulated sum sounds terrible; it's a lot of syllables.
Sheri Scott (01:38):
We call it fixed.
Marylin Moedinger (01:39):
We call it fixed price, yeah.
Taylor Davis (01:40):
We call it stipulated sum. So, really, the difference is, are you getting a contract from your contractor that has a number, and that number is what it costs to build that project. A cost-plus contract essentially says the contractor is going to invoice you for the cost of the materials, plus their markup. And their markup might include different things.
Some people, we see sort of that general conditions broken out different ways. Their markup might include overhead and profit and maybe pure profit. There's all sorts of ways that different contractors do that markup. But it is essentially the cost of the materials and the labor, plus the markup associated with it. And so, that's where you get the cost-plus. And then the stipulated sum it is a fixed fee.
Marylin Moedinger (02:36):
Often times people will call (the cost-plus) it time and materials because you're paying for the time and you're paying for the materials. And side note, you should not be paying markup on the contractor's labor.
Sheri Scott (02:50):
The question we get from our clients, the homeowners, is which one's better? (laughs) And the reason there have been two around forever is that it depends. It depends on your project. Really, I try to explain it as it depends on your tolerance for unknowns.
Marylin Moedinger (03:12):
That's a great way to put it.
Sheri Scott (03:14):
A fixed price, theoretically, the builder will put more price in there to cover everything because they can't come back to you and say, “Oh, lumber went up,” or “Oh, I didn't bid this out correctly, and it costs more.”
So, they're on the hook to cover those things that are over. But then they also kind of get a windfall when it's under. And with good contractors that set good pricing, it all is kind of even. So cost-plus, when (the contractor) their percentage that they put on there is truly only their profit, it should be.
And then they have line items within the contract that actually pays for the work that they do, which some people don't know to look for, and to add all of those pieces up because that's one of the things that can swing between different contractors, that can swing the price.
Taylor Davis (04:22):
We'd see it a little bit differently that that markup (depending on the contractor) might include different things. They may have a markup that includes their profit and their overhead for the project. Some might have a pure profit markup.
And so, we encourage people when they're looking and they're comparing contractors, not just to look at that pure number, but to ask what's included in that number because the difference in percentage, it may not be an apples-to-apples comparison from somebody who's at 12% and somebody who's in 18%. There may be different things that are included in that. And so, it's not just like, “Oh, he's cheaper” that’s not the way necessarily that works.
Marylin Moedinger (05:06):
So, I was a construction estimator and a project manager at a general contractor, building custom homes. And that's what I did before I was an architect. And the way we understood it on the contracting side was, it's about who is taking the risk. So, if in the time and materials or cost-plus, the owner is taking the risk, so therefore, the owner gets the rewards.
If lumber prices go down, the owner reaps the rewards of that. They don't have to pay the higher lumber cost. If it goes up, that's the risk they're taking. In a fixed price, the builder is taking the risk, so the builder gets the reward. If it's higher, they get penalized. If it's lower, they get to keep the difference.
And so, which contract structure is right often comes down to risk tolerance of the owner, what their personality is, what feels right.
When I used to have these conversations with owners and they would say, “Which one do you do?” And I would say, “Well, there's different reasons why we choose different structures. But it has a lot to do with personality.”
The other thing that it has to do with is the type of project. So, in a renovation, especially complex renovation, you are not going to get a fixed price. There are too many unknowns. You can certainly fix the price for certain aspects, and this is where we get into kind of a hybrid contract where you would fix certain prices but then leave other things as allowances.
So, the allowance is the part that inside the contract, we fix the price for the things we know, and we've left allowances for the things we don't know. We actually don't know what the framing is going to cost yet because we don't know what it's going to be like when we open up the wall, so we're going to put a number here that we're going to hold, but it's an allowance. And that allowance acts like a mini time and materials inside a fixed-price contract.
Sheri Scott (07:05):
And a lot of times, those allowances are things that are in the homeowner's control. Like they choose their tile, they choose their appliances. A lot of times, I see that in our world, that's what the allowances are.
Marylin Moedinger (07:19):
As a builder, I wished it was the opposite. I wish they would pick out all their dang tile, because that is very easy to pick out.
Sheri Scott (07:27):
Good point.
Marylin Moedinger (07:27):
It is impossible for me to see in the walls. So, I always wished as a builder that it was the opposite. On a renovation, let me put allowances in for the things I don't know until I'm into it. You can fix all that other stuff; you just got to make the decisions.
Taylor Davis (07:41):
There's two other differences that I want to highlight. And one is that there's a difference in what you see as an owner in your invoice in a cost-plus versus a fixed fee. So, if you are getting a time and materials or a cost-plus invoice, it's not (at least with the contractors we work with) totally wild, wild west. There's generally a control estimate.
So, they've gone through the drawings and provided an estimate of what those things will cost with the understanding that it might not cost that. And so, they're sort of gauging progress based on that control estimate. It's not a guarantee, it's not a fixed sum, but it gives you a way to kind of gauge a budget.
So, it's a way to sort of begin to estimate things. An estimate is the most important word in that whole phrase.
Marylin Moedinger (08:30):
Can I add something about control estimates real quick? Control estimates, depending on your state, are required by law, by consumer protection law. Not construction stuff, not architecture stuff, by consumer protection.
So, I have seen contractors and architects and owners get burned by this in various ways. So, a control estimate is required often by state law, by consumer protection law for homes. So, that's just something to keep in mind.
Taylor Davis (08:55):
You are not just getting like an unknown if you take on a cost-plus project. You should have some sense of a general estimate of what the project is going to cost. When you get an invoice, you will get all of the receipts (or your architect or whomever is reviewing, your owner's rep, or whomever is reviewing) from all of the items that were billed in that invoice.
So, that means the Home Depot invoices, it means the lighting invoices, it means the receipts from the mason, and all of those things. If you are getting a fixed-fee contract, you are only getting that invoice, and you are getting a percentage of the fee that has been billed up to that point. So, it's like a control estimate, except those costs are hard.
So, you'll see our progress – if the fee is $10,000 for a lumber, we've billed $8,000 of that to date. So, you're going to see different things on your invoices as an owner. We, and I think all of us, offer services during construction where we review those pay applications, those invoices from the contractors and approve them prior to the owners paying those.
So, if you want your architect or your owner's rep to do that, there is a sort of tried-and-true process that goes along with reviewing those invoices, and maybe all of those receipts as well. So, what you want to sort of parse through as an owner when you are getting that invoice from your contractor and what is your tolerance for like a big envelope versus like two pages is something you should be thinking about too.
Sheri Scott (10:42):
Something you talked about, Marilyn, was the tolerance of risk on the homeowner’s side. Here in Ohio with the contractors we work with, it seems like we know which contractors do fixed-price and which contractors do cost-plus.
There's not a whole lot of room for the homeowner to choose that aside from choosing which contractor. So, that's something when homeowners have initial conversations with contractors, they should ask what structure they use, and if they're open to looking at a different structure if you don't like that structure.
We have a couple that are open to talking about what works best for the homeowner, but most of them just say, “We do cost-plus.” And in the projects that we do that are big custom home projects, those are always cost-plus. I don't know a contractor that picks that up as a fixed cost.
Taylor Davis (11:48):
I'm just going to utter two words and let y'all respond: change orders.
Marylin Moedinger (11:54):
Literally the words I was just going to say, Taylor. I was just going to say let’s talk change orders.
Sheri Scott (11:57)
I think that's a whole other topic. Oh, are we talking about that?
[Laughter]
Marylin Moedinger (12:00)
It is a whole other topic. So, we'll give the one-minute overview. So, in a cost-plus or time and materials contract, there are no change orders.
Taylor Davis (12:11):
Ding, ding, ding, ding, ding, ding, ding.
Marylin Moedinger (12:12):
The contractor is working as directed, there's no change orders. In a fixed price, there's a change order. And that means that somebody has ordered a change in the project. That could be driven by something that we have no control over.
Like the tile was not available, and we had to pick another one, and this one is 20% more expensive, so the contractor is owed 20% more on the tile. It could be something that's directed by the owner because they changed their mind. It could be something that the contractor is asking for.
So, back when I used to do this and I would keep a change order log, and I suggest that as an architect you do it, as a homeowner you do it, and keep a change order log. Who asked for the change orders? Because 9 times out of 10, the memory of like, “Oh my gosh, this project cost so much, there were all these change orders, blah, blah, blah.” And you look back, and the owner instigated 90% of them (laughs) because they wanted to change their mind. By the way, that's totally fine.
Taylor Davis (13:14):
And change orders aren't necessarily bad. Everybody thinks change orders are like the kiss of death.
Marylin Moedinger (13:20):
Or the name of the contractor's boat.
Taylor Davis (13:22):
They're not, they're just not. And I would say, I think one of the questions to ask (and I don't know how contractors in y'all's necks of the woods do this), but if you are doing a fixed fee project, ask your contractor if there is an additional fee on a change order. That's a question to ask.
Some contractors will just put it at their regular markup and have that be the case. There may be some that add an extra fee to the change order. So, ask that question when you are talking to contractors.
Marylin Moedinger (13:54):
I've never heard of that. So, in all the places I've worked, that has not been a thing, so that's really good to ask.
Sheri Scott (13:59):
It's written in our contracts how they charge for change orders.
Taylor Davis (14:03):
Oh, that's cool. We could do a whole other episode on change orders.
Marylin Moedinger (14:07):
I also want to just point out from the contractor's perspective, that none of these things are bad or have any sort of value of like … as a homeowner, you are allowed to ask whatever questions you want. This is not an adversarial relationship. It is not bad to do a cost-plus or bad to do a fixed-price, or bad to have a change order.
It's just within the course of normal events of a project. And I would much rather (back when I was contracting and certainly now as an architect, which I've been a lot longer than I was a contractor) have a homeowner asking questions about the things they don't know.
We sometimes forget. Our heads are in this, we've been doing this for 20-plus years, we rattle off these words like change order or pay app or whatever, all these things. It is okay to ask. It is okay to not know. This is not your profession (as a homeowner), it is 1000%, and it is okay not to know. And it is your money, you are allowed to ask where it's going.
Now, I will ask that you should listen when the experts are telling you (laughs) where – if you come to the job site and you say, “Well, you charged me for this crew for eight hours, but I saw them taking a break for half an hour,” and I'm like, “It was 105 degrees today, you're lucky they were even on the job site.”
So, there is a give and take, you have to understand, especially if you haven't been around manual labor or used to understanding these processes. Understand that you don't know that, and that you're relying on competent professionals to help guide you.
So, yes, ask the questions about the dollars, but do not nickel and dime to the point where you become a pain in the ass, and then you get charged more later, and you don't even know it. So, that's my advice.
Taylor Davis (15:58):
Good advice.
Sheri Scott (15:59):
The advice (laughs), it's kind of counterintuitive. It's like if you have that personality and you want to nickel and dime and keep track of hours, you probably should do a fixed fee.
But then that person probably wants to be able to keep track of everything, and so they're going to naturally gravitate to a cost-plus. It's a difficult decision because there are pluses and minuses on both sides for every party.
Taylor Davis (16:25):
I will say that regardless of what kind of contract you select or what type of contractor your contractor wants to use or suggests you use, all of those things, the choice is certainly there. The most important thing you can do is give them the most information possible-
Marylin Moedinger (16:47):
Hear, hear.
Taylor Davis (16:48):
At the outset of a project. So, whether that is a detailed set of drawings, specifications, whatever that is, it doesn't matter whether it's a fixed fee or a cost-plus, that will do nothing but benefit the project, nothing.
A sketch on a napkin is never going to yield accurate pricing, and thus, will never yield a contract that gives you a fixed price. The more information (in whatever form) you can give that contractor will yield a better contract regardless of the structure of that contract.
Marylin Moedinger (17:25):
That's a mic drop.
[Laughter].
Taylor Davis (17:28):
Thank you.
Marylin Moedinger (17:31):
Thanks so much for joining us today on Home: The Second Story, for a quick snack. Questions for us or interested in being a guest on the podcast, reach out at admin@htsspodcast.com. We'll see you next time.
[Music playing]
Voiceover (17:45):
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