There are good reasons for real estate developers and project owners to prefer a “Fixed Fee” approach over a “Cost-Plus-Fee-up-to-Guaranteed-Maximum-Price (GMP)” approach to paying for construction work. But Cost-Plus GMP Contract Agreements have many virtues as well.
Which is best? There is no one correct answer.
Much depends on the project-specific goals. What does the developer or project owner most highly value? Speed of project delivery and firm pricing are, for example, often in conflict.
There are big differences between the Fixed Fee and Cost-Plus GMP approaches. Usually, when I get involved in a project, I will have a strong preference for one over the other.
I often ask my owner and developer clients to rank these project goals, in order of priority:
- high quality final product
- control over design decisions
- speed of project delivery
- not exceeding a price point
- contract administration ease
- dispute avoidance
- other factors
Often, my project owner and real estate developer clients might have picked ‘the wrong’ approach for the project before my involvement. That is, the project delivery method with potentially illusory upside, but with concrete and unavoidable risks.
Owners and developers who enlist advice from construction attorneys – at the very beginning of the project – regarding Project Delivery Methods and Contract Form Selection, before they are ‘at the altar’ with a contractor, increase the odds of achieving their project specific goals.
This post first discusses the differences between the Fixed Fee and Cost-Plus GMP approaches to contractor compensation. Next, the post addresses which goals tend to be served best by these very different approaches to buying construction services.
Spoiler Alert: while I like the Cost-Plus GMP approach for many projects, and I frequently negotiate Cost-Plus GMP Agreements, unless there is a good reason to prefer a “cost reimbursement” approach, I typically recommend using a Fixed Fee Contract.
When I was a young construction lawyer, the distinction between the Fixed Fee and Cost-Plus GMP compensation approaches confused me. Those terms sound so similar.
Fixed Fee sounds pretty definitive and certain. What could be bad? Likewise, the phrase “Guaranteed Maximum Price” also has a ring of certainty and safety to it.
It almost sounds like these are different phrases to describe the same thing.
Yet, nothing could be further from the truth. They are profoundly different.
Fixed Fee Contracts: The Basics
In a Fixed Fee arrangement, the project owner or real estate developer has a great deal of price certainty. That is one of the main virtues of Fixed Fee Contracts. Regardless of what the project actually costs the contractor to build, the price to the owner or developer is relatively set-in-stone (absent scope changes or extenuating circumstances).
This means the contractor typically bears the risk of price overruns. Such overruns could include increases in the price of steel from unexpected tariffs, or higher labor costs due to a pandemic or similar unexpected market changing events, for example.
The Fixed Fee approach also means that the contractor will reap the benefit of savings – if it can deliver the project for less than the Fixed Fee. The savings (extra profit) under a Fixed Fee will inure to the benefit of the contractor, not the owner, in a Fixed Fee compensation model.
On Fixed Fee projects, the contractor need not share very much financial information with its project owner or developer client. They often have little insight into the contractor’s actual profits, given its actual construction costs. That is the essential “business deal.”
While this is something of an oversimplification, the contractor bears the potential financial risks, and reaps the potential financial upside, on Fixed Fee projects.
Cost-Plus GMP Agreements: The Basics
Cost-Plus GMP Contract Agreements are “cost reimbursement” contracts. In a Cost-Plus price arrangement, there is no set or Fixed Fee. In other words, the contractor is paid for the Cost of the Work it incurs to complete the project, plus a Fee, not-to-exceed the GMP (absent scope changes or extenuating circumstances). Its compensation is unknown at the time of contract signing.
Just think about the full name behind the GMP or GMAX slang we throw around: “Cost-Plus-Fee-up-to-a-Guaranteed-Maximum-Price.” It is easier to understand the Cost-Plus GMP arrangements when you consider its full name. You must consider the words before “GMP,” i.e., “Cost-Plus-Fee.” It is not just a “GMP” or “GMAX” project. It is a “cost reimbursement” project. The contractor is reimbursed for the Cost of the Work, up to the GMP.
That means the Cost of the Work, which the contractor is paid, may never add up to the full dollar amount of the GMP. It may not be reached. It is a ceiling. It is a limit on what the owner might have to spend (absent scope changes or extenuating circumstances) to complete the project. The contractor typically bears the risk if the Cost of the Work exceeds the GMP.
Consider this, given change orders:
- On a Cost-Plus GMP project, when the owner grants a change order to increase the GMP, the contractor will not necessarily be paid the increased GMP. It is possible, of course. But only if the Cost of the Work, due to the change which led to the change order, actually increases the price of the contractor’s performance.
- Change orders are very different on Fixed Fee projects. If a project owner or real estate developer grants a change order on a Fixed Fee Contract, it can expect to pay every penny of the increased Contract Sum to the contractor. It will be paid the full value of the change order. That is the deal on Fixed Fee Contracts.
The hope on Cost-Plus GMP projects – at least for project owners and real estate developers – is that the Cost of the Work might not at up to the dollar amount of the GMP, and these lower actual project execution costs may result in construction cost “savings” under the GMP.
Beware the Cost-Plus GMP (or It’s Complicated)
For many project owners and real estate developers, the project delivery method analysis stops here. It stops with the almost irresistible urge to pursue GMP savings. Many instinctively prefer a Cost-Plus GMP arrangement over Fixed Fee compensation.
Many owners and developers think, in a “cost reimbursement” contract with a GMP, I might realize savings under the GMP. But in a Fixed Fee Contract, it is the contractor which will realize any savings (profit) if it can save money on construction costs.
Nominally, it is hard to argue with that logic.
This makes it an easy choice right? Nope.
Where project owners and real estate developers go wrong, often, is chasing illusory savings under the GMP. If the project is not right for a Cost-Plus GMP approach, or if they do not invest in a good Cost-Plus GMP Agreement, the “savings” they seek may never materialize.
Similarly, unless the owner or developer financially incentivizes the contractor to want to achieve savings, there is a ‘moral hazard’ the contractor might prefer to spend money rather than save money. Afterall, the “Fee” in “Cost-Plus Fee” is often percentage-based. Thus, the more money the contractor spends, the greater its Fee, in many cases.
Here is the blinding flash of the obvious: project owners and developers should incentivize contractors to save rather than spend, if GMP “savings” are to be realized.
Many owners and developers fail to ensure their project is right for a “cost reimbursement” compensation model. They fail to financially incentivize the contractor. They fail to negotiate and sign an appropriate Cost-Plus GMP Agreement.
Thus, they may have little chance of realizing any savings under the GMP.
Worse, these owners and developers incur the downside and risk inherent in Cost-Plus GMP arrangements. Risks which do not exist in Fixed Fee pricing.
Here are things smart project owners and real estate developers should consider…
Cost-Plus GMP Agreements are Difficult to Administer
Cost-Plus GMP Contract Agreements are much more difficult for the project owner or real estate developer to administer than Fixed Fee Contracts. And that is an understatement.
With Cost-Plus GMP Contract Agreements, the project owner is not simply dividing up the Fixed Fee by percent of work completed, and making percentage-based progress payments to the contractor each month. The monthly payment application process is now a lot more complex.
In a Cost-Plus GMP arrangement, where the contractor will be paid the “Cost of the Work,” the owner must concern itself with the actual construction costs. And, it must consider whether the contractor incurred them properly, under the often heavily-negotiated terms and conditions and limitations of the Cost-Plus GMP Agreement.
In a “cost reimbursement” model, the owner and developer must concern itself with cancelled checks written by the contractor, and bills of lading, purchase orders, receipts from Home Depot, etc., plus bankers boxes (or the electronic equivalent) of myriad categories of other backup documents, i.e., proof the contractor actually and properly incurred the Cost of the Work it claims to have spent in the proper execution of the project.
Some of this analysis can be deferred to the end of the project. There are ways to streamline the monthly pay application review process on Cost-Plus GMP projects. However, those shortcuts require a certain amount of trust – and risk to the owner. As the familiar maxim goes, “possession is 9/10th of the law,” as it is difficult to clawback dollars improperly paid. The project owner will, in almost every Cost-Plus GMP Agreement, eventually need to engage in a somewhat complete review of the Cost of the Work the contractor claims to have spent on the “cost reimbursement” project.
The issues I listed above are just the tip of the iceberg. There are many other considerations:
- Like whether the contractor will retain the benefit of bulk purchase rebates, and similar discounts? Or with fidelity pass them on to the owner (who may be unaware they exist)?
- Like whether the contractor is accidentally, or otherwise, “double-dipping” by charging the owner for duplicative “Cost of the Work” and “General Conditions costs?
- Like drawing the line between some expected (almost actuarial) amount of waste for which the contractor should be paid (every project will experience its share of discarded bent nails) and excessive waste due to improper performance?
- Like whether various percentage-based markups were appropriately applied, as lower tier sub-subcontractors and subcontractors and the contractor each layer on their respective markups.
The list can go on and on, covering many more nuances and issues…
And, the considerations above assume that the contractor is honest – and not seeking an intentional overpayment or windfall from an unassuming project owner or developer. If you encounter the occasional dishonest contractor, there are other risks.
For example, what if the drywall subcontractor is the contractor’s nephew, and he submits inflated invoices to the contractor? The contractor can look the owner in the eye and claim the inflated invoice is an actual cost which it incurred to complete the project. The owner, perhaps unwittingly, can significantly overpay for the drywall work – perhaps against the backdrop of a kickback arrangement between contractor and subcontractor?
I do not mean to imply this is a common practice. Most contractors are honest, and want only to be paid a fair wage for good work. But most good Cost-Plus GMP Contract Agreements will have terms to address “related party transactions” such the uncle / contractor and nephew / subcontractor situation, and the moral hazard of “non-arm’s length” transactions.
Due to these inherent complexities, most Cost-Plus GMP Agreements give the project owner a right to audit – with professional auditors – the contractor’s entire financial records for the project (including its “Job Cost Report”), both when the project is ongoing, and at its end.
Often, the audit is part of the final project closeout and the final payment application. On good projects, where the owner and contractor get along, the project is a success, and the owner has no concern about the contractor’s alleged Cost of the Work, the owner often waives the formal final audit. There is no need for one. Everyone is happy, so the audit is waived.
However, the mere fact that most Cost-Plus GMP Agreements contemplate that the project owner might actually hire auditors to descend on the contractor’s home office, force it to open up its accounting records, and enable the owner to audit the records of the contractor’s project-related accounting and expenditures, shows how different a Cost-Plus GMP approach is from a Fixed Fee payment model. Seldom is there any audit on Fixed Fee projects.
The greater length and heft of Cost-Plus GMP Agreements is also telling.
- The body of the AIA’s basic Cost-Plus GMP Agreement is 15 pages long.
- Compare that to the AIA’s basic Fixed Fee Agreement, which is just eight pages long.
There is a reason for those extra pages. Cost-Plus GMP is more complex than Fixed Fee. You need a lot more words in the construction contract to fairly document the “business deal.”
Here is an important takeaway: if you are a project owner or real estate developer who lacks the “in-house” capacity to engage in a month-by-month discussion with the contractor, and critically scrutinize the alleged Cost of the Work, properly incurred and documented, you should consider getting some help to review the contractor’s requests for payment.
Construction attorneys like me occasionally perform some of this review, but others can do it for less expense. Owner’s representatives and other construction cost experts can assist owners and developers who lack the capacity to properly administer the Cost-Plus Fee Agreement, both on a monthly basis, and at the end of the project.
Alternatively, project owners and developers can make their lives much simpler by selecting a Fixed Fee approach to buying construction services.
The point? Owners and real estate developers should not knee-jerk into a Cost-Plus GMP Agreement, in the pursuit of savings, without thoughtful consideration.
Cost-Plus GMP Agreements Can Breed Disputes
Cost reimbursement projects are also much more dispute prone than Fixed Fee pricing arrangements. Admittedly, I lack empirical data on the subject. However, “cost reimbursement” contracts are much more complicated and offer the parties a lot more issues to dispute.
There is lots of room to fight over whether the contractor properly incurred the Cost of the Work, whether its accounting is adequate and accurate, and whether any “savings” was created by its subcontractor buyouts and overall project management.
And that is on a typical ‘good’ project. Where the owner and contractor ‘know what they are doing.’ When both parties have successfully completed past GMP projects.
Often, owners and contractors can have different expectations, bred of different past project experiences, and can be like ‘ships passing in the night’ on key aspects of their deal. They read the GMP Agreement differently, and they ascribe different meanings to its key terms.
For example, many owners fail to closely scrutinize the all-important contract definition of the Cost of the Work. That phrase defines which costs are reimbursable, and which are not.
The owner might realize no savings under the GMP if, for example, the definition of the Cost of the Work includes excessive contractor home office overhead, bonus payments to employees, retirement benefits, and other costs not directly related to the project. Often, these costs can be ‘baked-in’ to hourly fees charged by the contractor for its supervisory and managerial staff.
Sounds outlandish right? Why would a project owner or real estate developer pay for any of those things? Well, they better read their contract closely, both before and after it is signed!
Unless owners and developers closely scrutinize which costs are “reimbursable” and “non-reimbursable” under the Cost-Plus GMP Agreement, they can get taken for a ride by the contractor, and destroy any real hope of achieving savings under the GMP.
Here is a pro tip: look closely at the definition of the “Cost of the Work” in the GMP Agreement, since that phrase is usually synonymous for a “reimbursable” cost payable to the contractor.
When owners and developers read the “Cost of Work” definition in Cost-Plus GMP Agreements, I encourage them to close their eyes, and imagine green dollar bills flying out of their pockets.
That is one of many commonly overlooked nuances in Cost-Plus GMP Agreements. The words in the contract matter. The words equate to dollars, much more than in Fixed Fee Contracts.
Project owners and real estate developers who think Cost-Plus GMP Agreement = savings for me = better than a Fixed Fee compensation model are taking an overly simplistic approach.
There is opportunity buried in this inherent complexity – but only for those owners and developers who dance with the nuance, from project conception to final completion.
Illusory GMP Savings (and Other Reasons to Fight)
There are many reasons for owners and contractors to fight over whether there are, in fact, construction cost “savings” under the GMP on any specific project.
- When are the “savings” measured? At the end of the project as part of a final accounting? Or after the subcontractor and trade buyouts at the project outset? What do the owner and contractor expect? Is it the same? What does the contract say?
- If subcontractor buyouts create an appearance of savings, is it illusory? Are the subcontract values low because of a bid bust? Because of missed scope? Is there really “savings” if subcontract change orders start pouring into the contractor? If it cannot pass them up to the owner, as there is no real scope change to the prime agreement?
- And if savings are created at the project outset after the subcontractor and trade buyouts, what happens to the money? Is it allocated to a contingency fund? If so, who can spend the contingency dollars, and under what circumstances? How to allowances play into this equation?
- What happens if savings are created through buyouts, and exist at project end, but a latent defect for which the contractor is responsible later arises? Does the contractor have to refund any share of savings to the project owner or developer?
- What if a force majeure event occurs? What of there is debate about whether the Cost-Plus GMP Agreement entitles the contractor to more money, or merely more time?
- What if the architect / engineer and contractor get into disputes about design and construction defects and quality? What does this mean for the GMP and savings?
I could go on and on, listing dozens more bullet points.
Smart property owners and real estate developers, and contractors, might be unconcerned by this tome. They might routinely address these things in excellent Cost-Plus GMP Agreements.
Nevertheless, even with good contracts, risks may lurk in the shadows.
Assume, for example, that a Cost-Plus GMP Agreement has excellent terms to address all of these and other risks and contingencies. Assume the owner’s and contractor’s executives agree on the “business deal.” But what if the contractor’s estimating staff – months before the contract was negotiated – made different assumptions and ‘baked’ them into the GMP amount.
In other words, what if a “bid bust” is baked-into a Cost-Plus GMP Agreement which is, academically, a good contract? What if these issues remain unnoticed until after the Cost-Plus GMP Agreement is signed, and subcontractor change orders start to hit the contractor.
The temptation, often, is for the contractor’s project execution employees – out of concern for their job security and bonuses – to deny the existence of the “bid bust” and hit the owner with improper change orders, trying to cover their mistakes by increasing the GMP?
This is not hypothetical. It happens. And it is not pretty. It can lead to claims and disputes, some of which can drag on for years of litigation after project final completion.
Even if the GMP Agreement is good, in an academic sense, there is still lots of room for disputes. The more complex the deal, the more reasons to fight.
Fixed Fee Agreements are simpler. The owner pays what it agreed to pay, absent scope changes or extenuating circumstances.
Real estate developers and property owners should not have a “knee-jerk” preference for Cost-Plus GMP compensation. They should not assume there will be savings under the GMP.
Yes, risks can be mitigated and rewards can be maximized. But it is not automatic. It takes skill and attention in the early stages of the project, before contract execution, and after.
Misaligned Interests Create Risk
Project owners often fail to understand that if they do not “share” sufficient GMP savings with the contractor, it may have incentive to create savings under the GMP.
Consider a situation where the contractor’s overhead and profit (including its shadow profit margin) is 18 percent – meaning, for every dollar it spends, it gets $0.18.
If the owner wants to split savings under a GMP in a 90/10 ratio with the contractor, a financial incentive to minimize the Cost of the Work, and strive for GMP savings, is absent.
- For each dollar the contractor saves, it could theoretically earn only $0.10 in shared savings under the GMP, if any such savings exist at project completion.
- But each dollar it spends earns the contractor $0.18 in overhead, markup, etc.
Simple math. And misaligned incentives.
It gets little better when the owner wants to split savings in an 80/20 ratio, and perhaps slightly better when it wants to share savings with the contractor in a 70/30 ratio.
Depending on the specifics of the Cost-Plus GMP Agreement, and the eccentricities of the project, if the split is insufficiently generous, the contractor may prefer to spend any apparent mid-project savings (perhaps as contingency, contract permitting) rather than strive to achieve end-of-project savings, under the GMP, to be split with the owner in some ratio.
This stuff is complicated. There is lots of room for project owners and developers to get into disagreements with contractors over the existence of, and split of, savings under the GMP.
Let me be clear on one point. It is not always appropriate for a project owner to share savings under the GMP with contractors on a 50/50 basis. I am not advocating that approach. However, doing so is one way to align interests – and motivate contractors to save money.
Consider the following. If the owner shares savings 50/50, the contractor will want to ‘save a dollar’ because it will get to ‘pocket’ two quarters. Those savings are pure profit for the contractor. They go straight to its bottom line. They are rocket fuel for construction project profitability. Smart contractors understand this and strive for GMP savings.
It is obviously good for the project owner and real estate developer too.
Will the contactor be incentivized to ‘save a dollar’ if its share of the GMP savings is a dime or two, while the owner pockets 80-90% of the savings? Perhaps. But perhaps not?
The bottom line?
Real estate developers and property owners who love the idea of “savings” under the GMP and instinctively prefer it to Fixed Fee pricing – but spend little time negotiating good Cost-Plus GMP Agreements, and have no handle on how savvy contractors can creatively account for costs and allowances and contingency and savings and changes on GMP projects to serve their own interests, and who lack the ability to administer the contract and the more complex pricing approach – should not expect to realize savings under a GMP, save by accident or luck.
The instinct to prefer Cost-Plus GMP over Fixed Fee pricing, without project-specific analysis, is a problem for real estate developers and project owners. It is a bad habit. The decision to elect one model of contractor compensation over another should be thoughtfully considered.
If the owner or developer elects a ‘cost reimbursement’ model, it should be documented in a good Cost-Plus GMP Agreement, which is appropriate for the project, and reasonably aligns the financial interests of the owner and contractor, if savings under the GMP are to be achieved.
Pivoting to the Second Half of this Post
The remainder of this post describes the good reasons – and the bad reasons – why real estate developers and project owners might prefer Fixed Fee or GMP pricing arrangements.
Pursuing shared savings under the GMP can be one reason. But it is not the only one, and it should not unduly dominate over the other pros and cons listed below.
Choose Fixed Fee, Absent a Good Reason to Prefer Cost-Plus GMP
My general rule of thumb? I prefer a Fixed Fee Contract, between an owner and a contractor, unless there is a good reason to switch over to a Cost-Plus GMP formula
Do not get me wrong. I like Cost-Plus GMP Agreements. I negotiate them frequently.
Often, when I size up a project, I immediately prefer a “cost reimbursement” price arrangement. There are good reasons to prefer Cost-Plus GMP pricing. I discuss them below.
Ultimately, the decision depends upon the project specifics.
However, Fixed Fee Contracts are simpler. They’re simpler to administer. They are simpler at contract negotiation time. They are simpler at each payment application. And they are simpler at project closeout and final payment application time.
There are good reasons to prefer “cost reimbursement” pricing arrangements, and some are discussed below. Project owners and developers should consider those reasons carefully. And make an informed choice, rather than simply “knee-jerk” into a Cost-Plus GMP arrangement, in search of potentially illusory savings, and in exchange for much more certain risks.
Fixed Fee Pros/Cons: Slow Project Delivery, but Better Price Assurances
So what are the reasons to prefer a Fixed Fee approach?
One reason is if the owner or developer’s main concern is price. That is, not exceeding a set price point. The more developed the design, the greater the price certainty.
If a contractor is going to agree to build a project for a Fixed Fee, the design must be significantly developed. That is an implicit requirement.
Otherwise, the contractor cannot guarantee any price. It must know what it is expected to build with great particularity, in terms of program, scope, size, quality, etc.
A Small Digression (or Things That Make Me Crazy)
Nothing makes me crazier than when a project owner or developer has a fully developed set of Construction Documents – with complete architectural and engineering details – but nevertheless asks me to prepare a Cost-Plus GMP Contract Agreement.
In that case, the contractor clearly can guarantee a reasonably accurate Fixed Fee. There are typically no unknowns (or few unknowns) which could materially impact the construction cost. Any such unknowns could be treated as allowances under the GMP, which could increase or decrease as the allowance items are priced, to protect the contractor.
That is a product of a highly-developed design: more price certainty.
Yet, somehow the contractor convinced the owner that it is in the interest of both parties, rather than solely in the contractor’s interest, to use a “cost reimbursement” pricing model.
Invariably, when I question the project owner as to why it does not prefer a Fixed Fee Contract, he or she likes the idea of trying to achieve savings under the GMP.
But he or she seldom has a good answer for the next question.
Why would the final Cost of the Work, under a Cost-Plus GMP Agreement, be materially less than the Fixed Fee the contractor should be able to offer the owner right now?
Often, I suspect the contractor desires an artificially high GMP – one set so high it knows it can complete the project by spending substantially fewer dollars than the inflated GMP – to achieve eventual shared savings, all as a means to earn more money in building the project.
I usually hear a thin pretext as to why the contractor is unable to give the owner an accurate Fixed Fee right away, at contract negotiation. That is not always true, but it is usually the case. Certainly on commercial projects. Nobody can explain to me why any construction cost uncertainty the contractor faces cannot be handled through allowances, or similar.
In reality, I suspect the contractor has discussed a Cost-Plus GMP approach with the project owner or developer for many months, and they may feel it is too late to change course. They feel like it is better to proceed with the “cost reimbursement” approach, despite good reasons to prefer switching to Fixed Fee pricing.
This always strikes me as odd. Real estate developers are among the shrewdest businesspeople I encounter. Rarely do they unnecessarily give up a penny, much less a dime (and I mean that as a complement). But, not in this instance! For reasons I struggle to understand, many project owners and developers choose to stick with the “cost reimbursement” approach.
I dislike artificially high GMP numbers, figures the contractor knows are very high. They can be a way for the contractor, via shared savings, to drive its profit percentage up from a 5-10% markup to something much higher. To a markup percentage no owner would, overtly, grant.
It is kind of like the contractor doing a beautiful reverse 360 degree slam dunk with a basketball hoop that is only 6 feet off the ground. Not that impressive. No style points awarded.
Likewise, I dislike shared savings if the GMP is set so high the contractor knows, from day one, it can be substantially beat. That is the real issue. Is the GMP a legitimate attempt to price the anticipated Cost of the Work? Or is it inflated to create the later illusion of savings?
If the GMP is legitimate, a true estimate of likely costs, why not make that GMP a Fixed Fee? The odds of achieving any substantial shared savings under the GMP are slim. So why take on all the complexities of a “cost reimbursement” contract? Why not make it a simple Fixed Fee?
If a project owner or real estate developer cannot get a contractor to provide a reasonable Fixed Fee on a nearly complete set of Construction Documents, something is often amiss.
Again, this assumes the lead design professional has issued a set of Construction Documents which are materially complete, in both architecture and engineering.
But I digress…
GMP Pros/Cons: Possibly Faster Project Delivery, but Less Price Assurances
What are the drawbacks of having a significantly developed design?
One drawback is the design phase and the construction phase are more likely to be sequential. They do not overlap. This extends the length of construction.
First, the design must be developed to a great extent. Next, the contractor must put its price on the design. Then, and only then, can construction begin.
This is a slow approach.
If the owner or developer is concerned about the speed of the project – if they need to complete it quickly to move in a tenant, or take the project to market – reimbursing the contractor’s costs, up to a GMP, may be preferable to a Fixed Fee approach.
When the owner is promising by contract to reimburse the contractor for construction costs incurred – rather than a Fixed Fee for the entire project – construction can start early.
In fact, under a Cost-Plus GMP approach, construction can begin before the architectural and engineering design is completed, or is even significantly advanced. The civil and sitework can begin, subject to an initial GMP or not-to-exceed agreed price, while the lead architect or engineer completes the design of the remainder of the project.
Sometimes this is called a “fast tracked” project or a “fast track” approach. The design and construction effort overlaps, so construction can begin as quickly as possible.
As the design effort advances, the project owner or developer can negotiate amended GMP figures. The GMP can be amended several times, until the design is complete.
This is common. I recently amended a Cost-Plus GMP Agreement three times, with the Final GMP Amendment setting the GMP which covered the complete final design, the entire project. This allowed construction to begin nine months before the final GMP was agreed.
Fast tracking the project, using a “cost reimbursement” approach, can shorten the time to project completion. Design and construction can be simultaneous, not sequential.
However, this typically deprives the project owner or developer of the cost certainty that comes with a completed design, and a Fixed Fee, before starting construction.
Fixed Fees Can Lead to a Higher Quality Final Product
If concern for the quality of the completed project is very important, the real estate developer or project owner might prefer a Fixed Fee approach.
Of course, this is because the design must be highly-developed before construction, in order for the contractor to guarantee a Fixed Fee. The highly-developed design, of course, enables the contractor to better understand the architect or engineer’s design intent.
By contrast, on projects where construction begins before the design is significantly advanced, the owner or developer suffers a certain ‘loss of control’ over the design effort.
If the project is a hospital or an FDA regulated food processing facility – with complicated mechanical, electrical, plumbing and fire protection (MEP/FP) systems, negative pressure rooms, and similar intricate features – the project owner or developer might wish to see the design completed and detailed, with shop drawings created, before construction begins.
Trying to start construction on a mechanically complex project without a highly-detailed design is like feeling your way around in a dark room. You need to expect the unexpected. To bump into things. And, hopefully, not discover a staircase by falling down it.
The flip side of that coin? It is not easy to change a mechanically complex project, once construction begins. Once the site is graded, and the fill compacted, and the foundation poured, and the steel erected, it is not so easy to make an “on the fly” design change.
Therefore, if project quality is critically important to its owner or developer, they might be wise to have the design fully developed before construction begins.
There is no one-size-fits-all approach for any project or project type.
Are property owners and real estate developers best served by taking a Fixed Fee approach? Or a “cost reimbursement” approach, typically in a Cost-Plus GMP Agreement?
It all depends on their goals:
- Is speed of project delivery most important?
- Is the quality of design and construction, the finished project, the key goal?
- Is it not exceeding a price point?
- Or is it any number of other things that might be important to a project owner or real estate developer?
I wish owners and developers would take more time thoughtfully consider, at the outset of the project, the upside and downside of both Cost-Plus GMP and Fixed Fee approaches.
To be sure, “cost reimbursement” projects are no panacea; particularly if the goal is chasing “savings” under a GMP, which may never materialize due to the project structure.
Design and construction attorneys can help their for real estate developers and project owner clients navigate these and other difficult decisions regarding Project Delivery Methods and Contract Form Selection, and help increase the odds of achieving their project specific goals.
This publication is prepared for the general information of friends of Baker Law Group LLC in Illinois. It is not legal advice for you, or legal advice regarding any specific matter. Jeremy S. Baker is licensed to practice law only in Illinois. Under rules applicable to the professional conduct of attorneys in various jurisdictions, it may be considered attorney advertising material. Prior results do not guarantee a similar outcome.