Fixed Price Contract, Part 2 - Allowances

Part 2 of Fixed Price Contracts, Allowances

As a customer, you may want to know how much something costs the builder. With a Fixed Price contract, generally, the Owner doesn’t have the contractual right to this information, and thus, the contractor will generally not share that info. Sometimes, owners want to know the cost of items, so after a quick “Google search”, they think they have the answer. This is not necessarily the case.

One must also consider if the item being purchased includes delivery to the job site, or offloading, does it have the proper specifications for the job, does it have all the proper components attached, does it include taxes…etc.? These are some of the things that affect the price and make it difficult for a customer to know how much something involved in the construction process actually costs. And, the cost for a particular item can vary from contractor to contractor. If it is important to you to know the cost of everything going into your home, perhaps a Fixed Price contract isn’t the best contract for you. The Cost Plus contract gives you that information. But, there are other pluses and minuses to consider, and we’ll go through those next time.

Allowance

Allowances are often used by contractors to set aside money for the owners to use when selecting finishes. Let’s use carpet & flooring as an example. When you are buying a new house from a builder’s model plans, you may not have any idea what flooring you want in your home. So, the builder will generally stipulate an “Allowance”. The allowance is generally included in the sum of the contract price and can be thought of as a budget for you to buy certain things for your home. For this example, let’s say you have a $20,000 flooring allowance, and you go to the showroom and pick carpet, tile, pad, and a tile medallion for the entry. A couple of days later, the builder contacts you to explain that the cost of the items that you picked has exceeded your allowance. At this point, you have two options. The first is to re-select the flooring to lower the cost to within your $20,000 allowance. Or, the second option is to agree to increase the allowance (and thus the contract price) so you can have the flooring you picked. This change should be done via a Change Order.

Now, let’s go the other way. Suppose the carpet, pad, and tile you select is only $15,000. In this case, you would be entitled to a deductive change order of $5,000. Earlier I had said that a Fixed Price contract doesn’t allow for the owner to see a cost breakdown. In the case of Allowances only, you should be able to all costs. Before agreeing to either the additive or deductive change for an Allowance item, request to see the cost breakdown. The cost breakdown will have details on the items you selected: quantity, material cost, and labor cost. Note, that these costs are most likely your costs and not the contractor’s actual cost, and this is ok. Keep track of the pluses and minuses of each of your Allowance selections. If you are under budget in your flooring Allowance, you can use those savings to offset another Allowance item that you may have exceeded the budget. Just make sure that once all allowances are selected you get a Change Order documenting your selections and any additions & subtractions to the contract. Even if the contract price doesn’t change at all, ensure that you have a change order “adding” the detailed scope of work you selected with your allowances at a zero-dollar cost.

The Fixed Price Contact is a relatively simple way to manage the costs during the construction of your new home. This would be the contract to use if you want to buy your new home and then move in when it’s done. It’s easy to understand and has the least amount of reporting: once the price is agreed, the contract is signed, then the builder starts constructing the home, and finally, you move into your dream home. But remember there are three keys to success with this contact:

1. Ensure you understand the price and what it includes.
2. You must have a detailed scope of work as part of the original contract as well as any change orders.
3. Anytime there is a change in cost/price/ or even a no-cost change in scope, document it in writing with a change order.

The other option is a Cost Plus contract. With these contracts, there is much more interaction between the owner and the contractor, and they offer some unique benefits.