What Is Cost Plus in Construction?
As a professional residential builder, your job is to ensure that your jobs are priced accurately, covering all known project costs and providing enough profit to keep your business running.
That means understanding the different pricing models that contractors use and determining which one works best for your business.
There are two generally accepted industry standards when it comes to pricing residential construction work.
The first option is to charge a fixed fee for your work that includes both the estimated cost of the materials, labor, and trades needed to complete the job and your markup in one total amount. This method is known as Fixed Cost pricing. It gives the client more certainty about their project's total cost, but comes at a greater risk to contractors because that “fixed price” doesn’t allow for as much flexibility for changing costs.
The other way is to charge the exact known cost for each item plus an added percentage as your markup. This is called Cost Plus, a pricing method growing in popularity among residential contractors because of its ability to lessen their financial risk.
What is a Cost Plus Contract?
In a cost-plus construction agreement, homeowners reimburse the contractor for the actual project costs and a markup to cover the builder’s overhead and profit.
Project “costs” include direct costs for materials, labor, and trade partners. The “plus” part is the markup added on top, contributing to the builder’s overhead and profit to keep their business running.
In other words, for every dollar a builder or remodeler spends on those costs, they charge the client $1.XX, with the XX being their markup.
From a client’s perspective, this method offers great transparency into the actual project costs and builder’s profit but gives less certainty about the overall final cost.
Cost-plus agreements offer less risk for contractors because they can start projects quicker and with the reassurance that they will be paid for elements they don’t have hard costs for yet without eating into their profit margin.
Management Fees are a Cost, Not a Plus
One trap many builders fall into when choosing a cost-plus billing method is to assume that project management and site supervision fees are part of the “plus” equation and should come from their contributions to contractor's overhead and contractor's profit.
In reality, project management and supervision are line items in your budget and should be treated as “costs” and subject to the same markup as any other labor. To ensure this happens, it is good practice to refrain from labeling your markup as a “management fee” or “project management fee” on your project estimates, which can confuse clients and cause them to push back.
It's also critical to factor those costs into each change order you create because when a project's timeline increases, so does the project management and supervision time.
Cost Plus vs. Time and Materials
Cost-plus construction contracts are often thought of as interchangeable with “Time and Materials” contracts because they work similarly. But, it’s important to note that a Time and Materials Contract is exactly that - a contract that reimburses contractors for direct costs, like labor and material costs, but does not include any markup.
In a T&M contract, builders will often build in a fee to their labor rates to ensure they are making a profit on the job, but they don’t typically do that for materials, meaning that overall, they profit less than with a traditional cost-plus contract.
How Does Cost Plus Differ from Fixed Cost?
Cost-plus contracts treat each construction project as an “open book” between the builder and their clients, allowing for real stakeholder collaboration. It’s an ideal pricing model for clients and builders who want to start projects quickly, even if all estimated costs aren’t known or all design plans aren’t finished.
But going into a project without knowing the total project costs can be frustrating for clients who want the full picture of what their renovation or custom build will cost. It can also create uncertainty for builders, who may worry that clients will question or reject some of the costs - causing friction downstream.
That’s why, for many years, the standard for residential contractors has been to use a “Fixed Cost” pricing method.
Fixed-cost contracts charge a set price for the entire scope of work. That price includes both the direct project costs and the contractor’s markup. In a fixed-cost contract, the homeowner gives up transparency on what each part of their remodel costs for the assurance that the project won’t go over the agreed-upon price. And the contractor has the opportunity to ensure they are making the job profitable by building in their markup to the final price, and not disclosing each line item cost.
Fixed cost contracts come with their own set of challenges, though. Any remodeler who’s been in business for any length of time knows that the final price of a remodeling project will always differ from the original estimate because “you don’t know what you don’t know” at the project start.
That includes the cost of things like FF&E (furnishings, fixtures, and equipment), which typically aren’t established until much later in construction. Typically, you’ll include allowances for FF&E items in the estimating phase; however, as a fixed-cost builder, setting a threshold for those allowances can be hard because it limits the client’s choices and can create uncomfortable conversations about change orders if the clients choose more expensive finishes later in the process.
This leads to fixed-cost builders having to factor hidden margins into allowances, reducing transparency and potentially frustrating clients who “reverse-engineer” prices on the items they’ve chosen by visiting Amazon or Home Depot online.
As a cost-plus builder, you can discuss allowances for FF&E items on a cash-value basis, making the process more transparent and reducing financial risks for both parties.
For more on the benefits and disadvantages of fixed-price contracts, click here.
Two Types of Cost Plus Contracts
Cost-plus contracts are not “one size fits all,” and it’s important to understand the different variations and how they can affect your bottom line as a residential contractor.
True Cost-Plus (or Percentage of Cost) contracts charge the cost of goods (COGs) plus a markup percentage. When I was in business, we charged a 15% markup on cost-plus contracts. I used to explain that to clients like this:
“For every dollar we spend on your renovation, we charge you $1.15.”
True cost-plus contracts ensure that a builder maintains their profit margin throughout the project by adding the correct markup to labor, material, and trade costs. This means that if the project duration increases, the builder continues to be compensated for both the direct costs and added markup.
Fixed-fee contracts add a pre-determined flat fee to the overall project cost for the builder. The direct cost of goods are still paid, however, the mark-up contribution to overhead costs and profit is fixed. This can also include any change orders added to the project where the contractor does not add any additional fee to these. Fixed-fee contracts give clients a little bit more control over the budget but limit the amount of profit a contractor can make. The loss of profit and overhead contribution affects the builder when a project takes longer than expected.
We recommend choosing a true cost-plus contract type so that you are protected from changes in the project that are virtually impossible to predict at the beginning of the job.
It’s also important to remember that a cost-plus contract doesn’t mean your clients are giving you a blank check. You shouldn’t enter into a cost-plus contract with the mindset that the client will pay for all the extra costs you encounter regardless of how over budget you are.
This means you need to sell clients into a pre-construction agreement and process where you’ll go through a repeatable, step-by-step costing exercise to clarify the full cost of the build before breaking ground.
Cost-plus contracts require continuous tracking of costs by category and should be reported to clients regularly to ensure everyone is on the same page.
For example, when reviewing a cost-plus budget, we analyze it at three levels: cost codes, cost groups (COGs), and the total budget. At the cost code level, we track labor, materials, and trades within each category, noting that we might be over in one area but under in another. At the COG level, we assess trends across all cost codes, such as being over on labor overall but under on trades. Finally, we look at the total budget, comparing the running or trending total to the original estimate plus change orders. This multi-level approach helps ensure we stay on track and manage costs effectively.
Buildwise is the only financial management software program for residential contractors specifically designed for cost-plus builders.
How Does a Cost Plus Contract Work?
With cost-plus contracts, the estimating process is transparent as the builder and homeowner work together to:
Determine the direct costs
Agree on the contractor’s fee (percentage-based or flat fee)
Talk about documentation and transparency requirements for tracking costs
Estimates and budget tracking look different for fixed-cost vs. cost-plus builders, so it’s essential to have a software system that works specifically with your billing method. Buildwise provides estimate layouts specifically tailored to meet the needs of fixed-cost and cost-plus builders.
Try Buildwise FREE for 14 days and see how it can help you prepare estimates suited to your business model.
Advantages of Cost Plus Contracts for Remodelers and Home Builders
Cost Plus contracts can be a smart choice in today’s market because many projects are highly customized and often begin before all the detailed plans are finished.
In a fixed-cost setup, this creates a big risk for home builders. There are too many unknowns that can’t have exact costs assigned, which can lead to a loss of profit. But for a cost-plus builder, the unknowns aren’t as problematic because the client expects them and has agreed to pay the direct costs plus a markup.
Some of the key advantages of using a cost-plus billing model are:
Transparency in Cost Breakdowns
At a high level, the main difference between fixed cost and cost-plus is the transparency of costs to the client.
When working with cost-plus contracts, the client has more transparency than a fixed-cost contract. The risk pendulum increases as you move from a Cost Plus Line Item Breakdown cost-plus (1) model toward a Fixed Cost Lump Sum (4).
Flexibility in scope of work
Cost-plus contracts give the client more insight and control over the process, making the relationship between builders and homeowners more open and transparent.
For example, choosing fixtures and finishes is a big decision for clients since they’ll live with these features for years. This process can take time, especially when working with architects and designers to bring a vision to life.
With cost-plus contracts, the process is more straightforward for clients and builders.
Clients can take their time deciding without feeling pressured to finalize every detail upfront. Builders, in turn, can bill for the actual costs of chosen items as they are purchased, along with a clear markup.
Potential For Cost Savings When Expenses Come In Under Budget
I always used this phrase to explain our approach: "We only charge you for labor hours performed, materials consumed, and trade partners hired on your behalf. So, if we’re under on any of these, you only pay for what was actually spent.” This is the essence of cost-plus contracts and a win-win for clients and builders.
Clients only pay for the actual costs of their project, with full transparency into how their money is spent. If labor takes less time, materials cost less, or trade partner quotes come in lower than expected, those savings go directly to the client.
For builders, this fosters trust and collaboration, eliminating hidden profits and ensuring efficient project management while benefiting both sides.
Encourages collaboration between builder and client
Cost-plus contracts create an open-book approach encouraging transparency and collaboration between the builder and the client.
Clients see exactly how their money is spent, building trust and aligning everyone. It also enables the builder to take on a dual role as both consultant and contractor, guiding clients through decisions while managing the project. This dynamic fosters a stronger working relationship compared to fixed-cost contracts, where pricing is less transparent and can sometimes create tension over hidden costs of profit margins.
Disadvantages of Cost Plus Contracts
Despite their benefits, cost-plus contracts do come with certain disadvantages that both clients and builders should consider. For example:
Cost Plus Contracts Run The Risk Of Higher-Than-Expected Costs
One of the main disadvantages of cost-plus contracts is the potential for higher-than-expected costs. Since the client pays for the actual costs of labor, materials, and services, the final price can fluctuate depending on how the project unfolds.
What is absolutely critical is that builders must perform a detailed pre-construction process where the cost of the project is fully fleshed out prior to beginning. This ensures that the cost overruns are mitigated as best as possible.
Some of the cost increases happen from unexpected site conditions, changes in scope, or designer/client changes. Schedule delays can also lead to increased labor hours, additional materials, or the need for more specialized trade partners, all of which can drive up costs beyond initial estimates.
While cost-plus contracts offer transparency, this unpredictability can be concerning for clients who may struggle with the lack of a fixed price.
It Requires Diligent Tracking And Documentation
General contractors using a cost-plus billing method must keep detailed records of costs and project progress for their clients. This means they need a more advanced cost-tracking system than what’s usually used with fixed-cost contracts.
Continuously tracking costs by category and reporting that information to clients weekly or bi-weekly allows homeowners to make informed financial decisions in real-time. Don’t bill monthly for cost plus, as too much time passes without budget updates and can cause friction with clients if the budget looks wildly different from one month to the next.
Myth: Builders Aren’t Motivated on Staying on Schedule and Budget
A common concern clients have—thanks to some misinformation online—is that cost-plus builders aren't motivated to keep projects on time or within budget, since they make more if things run over.
To counteract this argument, we talk about the spirit of a cost-plus contract being to shift the risk profile to the center, thereby sharing the risk. And that the builder must enter into this type of contract with a strong sense of being honest and realistic with costs in the estimating phase and not minimizing it for fear of the client's reaction. Because if you aren’t honest early on, you’re setting up your future self for a world of pain!
It Doesn’t Work for Clients on a Fixed Budget
Cost-plus contracts can be challenging for homeowners on a fixed budget because they lack the predictability of a set price. Since the final cost depends on actual labor, materials, and other expenses, it’s hard to know exactly what the project will cost. This unpredictability can stress homeowners with a tight budget, as costs could exceed what they can afford. Even though cost-plus offers transparency, the potential for unforeseen expenses and changes during the project makes it difficult to stay within a predetermined budget.
But remember, regardless of the billing model you employ, you should always ensure you’ve completed a robust pre-construction estimating process to gain investment-level alignment before beginning.
Missing Project Costs
When working in a cost-plus environment, one of the risks for the builder is to ensure you are very organized with a financial management system like Buildwise ensuring you never miss an actual cost from being invoiced. This happens more often than I care to admit and it’s crucial to ensuring you remain perfectly profitable.
Buildwise’s real-time expense management features that let you upload and code material receipts and track labor hours help ensure you never miss costs you must bill to a client.
Try Buildwise FREE for 14 days today
Who Should Use a Cost Plus Contract?
Cost-plus contracts are a great fit for custom home builds, remodels with an unclear scope, or projects where material choices might change along the way. They work well when the project details aren’t fully settled at the start, giving the client and builder flexibility as things evolve.
Cost Plus is also ideal for clients who value transparency and want to see exactly how their money is spent on labor, materials, and trades. Cost-plus contracts offer the flexibility and openness needed to handle unexpected changes while keeping everything clear and honest between the builder and the client.
Key Considerations Before Choosing Cost Plus
Before recommending a cost-plus contract, it’s essential to ensure both you and the client fully understand the contract terms and how they’ll impact the project. As a builder, you should evaluate the client’s goals, the project’s complexity, and your ability to handle the detailed tracking and transparency this type of agreement demands.
What you need to consider:
Does Everyone Understand the Contract Terms
Are you and your client in agreement on the terms of your cost-plus contract? Before agreeing to a cost-plus remodeling or custom building project, the builder and homeowner must carefully review details like reimbursable costs, variances and change orders, and payment terms. This helps avoid potential conflicts and ensures a smoother process.
Do You Have the Right Tracking and Technology in Place
Cost-plus contracts provide unique reporting challenges, and most construction management software programs on the market are generic and cater to fixed-cost pricing models. They don't have all the features necessary to track financial metrics for cost plus successfully.
If you use a cost-plus billing method, you need software to help you do that accurately and easily.
Buildwise is the only financial management software program for residential contractors specifically designed for cost-plus builders. Buildwise offers numerous benefits for cost-plus contractors and remodelers, such as budgeting tools specific to how cost-plus is calculated and automated client reporting.
Does the Client’s Budget Align with Their Goals
When it comes to renovating a home, a client’s wishlist is always the biggest, just before they get the estimate. Then, the reality of scope vs. budget hits them. And in a cost-plus scenario, it can be really easy for that budget to spiral out of control.
So it’s crucial to have a solid pre-construction process that helps your clients manage their budget and expectations. A great place to start is with a Project Discovery Workbook. This document helps everyone understand the client's needs vs. their wants and how to align the project scope with their intended investment so they don't make costly changes once construction begins.
Tools to Simplify Cost Plus Projects
If you're a cost-plus builder, you need systems that work specifically for your business and programs that understand the challenges you face when building accurate estimates and billing clients.
Very few dedicated software programs made for the construction industry fit that bill. Most are designed to service fixed-cost construction companies and attempt to "adapt" to cost-plus billing methods.
Buildwise is the only financial management software program for residential contractors specifically designed for cost-plus builders.
Buildwise offers several features for running successful cost-plus businesses, like:
Real-Time Job Costing: Track actual versus estimated costs and see profit margins update live across all cost categories using specific cost-plus calculations not found in other software
Change Order Management: Easily create, share, and approve change orders directly with clients, ensuring additional expenses are billed accurately and on time.
Integrated Time Tracking: Team members submit cost-coded time through an industry-unique mobile app, automatically updating labor hours and eliminating delays in reporting.
Transparent Client Reporting: Generate an automatic client-facing job costing report purpose-built for cost-plus builders, making communicating budget updates to clients easy.
Managing Unbillables: These are inevitable, and no other software on the market offers the ability to track costs you’ve paid for, but for one reason or another, you aren’t charging your clients for.
FAQs About Cost-Plus Contracts
Here are some common questions that homeowners and builders often have about cost-plus contracts:
For Homeowners:
What exactly does "cost-plus" mean?
In a cost-plus contract, you pay for the actual cost of labor, materials, and trade services used in the project, plus a fee for the builder's overhead and profit (often a percentage). This means the project's final cost will vary based on these actual costs.
How can I control costs with a cost-plus contract?
While cost-plus offers transparency, it's important to have regular updates from your builder about how costs are tracking. You can also work with the builder to set clear expectations and discuss any potential changes early to avoid unexpected costs.
What happens if the project goes over budget?
Since the cost-plus model includes actual costs plus a markup, the final price can change if expenses increase. It's important to regularly monitor the progress and discuss any adjustments with your builder. Good communication helps minimize surprises.
Is there a way to ensure the builder doesn’t overcharge me?
Yes, transparency is key. You should ask for detailed breakdowns of costs and markup rates. A reputable builder will provide regular reports on expenses and ensure you’re aware of any change orders.
Will I always pay more than expected?
Not necessarily, and a lot of the final cost depends on a robust paid pre-construction estimating process. If the project stays on track and no unexpected changes occur, the costs will remain closer to the original estimate. However, cost-plus contracts provide flexibility for unforeseen issues so that costs can fluctuate.
How do I know if the builder is being honest about costs?
Transparency is the foundation of cost-plus contracts. You should receive itemized reports detailing every expense, including materials, labor, and subcontractors. Ensure you have clear communication and ask questions if you’re unsure about any costs.
Is this a good option for my project?
Cost-plus works best for projects with uncertainty or potential changes like custom builds or renovations with evolving designs. A fixed-cost contract might be a better fit if your project scope is well-defined.
For Builders:
Why should I use a cost-plus contract instead of a fixed price?
Cost-plus contracts reduce the risk for builders because you are reimbursed for the actual costs incurred plus your markup. This is especially useful when there’s uncertainty about the project’s scope or costs, ensuring you’re paid for all your work.
How do I calculate my markup?
Markup is calculated by first determining your company overhead and desired net profit, then translating it using your revenue target for the year. To read more about markup and margin, click here.
What if the homeowner is unhappy with the final price?
It’s important to establish clear communication about costs from the beginning. This starts in the pre-construction process, where if you do your homework and push for details, you’ll arrive at a budget much closer to the end price of the project. Even still, things will happen during the job, and you must use a change order process to document additional costs. If you follow this advice, while your client might not be thrilled that the end price is higher than where you started, you succeeded in keeping them informed every step of the way.
How do I handle unexpected costs during the project?
You should notify the client as soon as possible when unforeseen costs arise. Getting approval for any changes or additional costs through formal change orders is crucial. This keeps the process transparent and compensates you for the extra work.
What’s the best way to track costs in a cost-plus contract?
Accurate tracking is crucial. Use construction management software that allows you to record costs in real-time, such as Buildwise, to consistently update your client and maintain control over project expenses.
How do I handle client change requests?
A clear process for managing change orders is essential. Ensure that clients approve any changes in writing before proceeding with work. Change orders should include a detailed breakdown of costs and any additional markup.
Do I make more or less with cost plus
There are several factors determining how much you can make with cost plus. To start, the markup percentage is your greatest lever. If you’re cost plus 10% vs. cost plus 20%, that makes a massive difference. Additionally, if you have an internal team self-performing aspects of the job, you can increase your profitability above and beyond the markup you’re charging. For more on this topic, see this article here.
What should I do if the project takes longer than expected?
Time delays can affect the budget, but you’re compensated for the time and labor costs with cost-plus contracts. Ensure you’re clear with the homeowner about any delays and how they impact the final cost, keeping them informed about any extra time or resources required. It’s always best to issue change orders to “reset” the total budget amount, ensuring financial alignment with your clients.
By understanding these common questions and communicating clearly with clients, homeowners and builders can ensure a smooth, transparent, cost-plus contract experience.
The Bottom Line on Cost Plus in Residential Construction
Cost-plus contracts have become popular for residential builders and remodelers because they offer flexibility, transparency, and the ability to tackle projects with unknowns.
They allow builders to get started sooner, adjust to changes, and ensure they’re fairly compensated. At the same time, clients gain insight into how their money is spent and appreciate the open-book approach that cost-plus contracts provide.
But success with cost-plus contracts doesn’t happen automatically. They require more detailed tracking, frequent communication, and strong systems to ensure you and your clients stay on the same page. As a builder, you must ensure costs are tracked accurately, change orders are clear, and budgets are updated regularly. This helps build trust, prevents disputes, and ensures your profitability stays intact.
Cost-plus contracts may have challenges, like the need for diligent cost tracking and the potential for higher-than-expected expenses, but with the right systems in place, those hurdles can be easily managed. Buildwise simplifies the process, giving you a clear way to manage costs, update clients, and keep your projects on track.
