An important beginning step in developing a construction project is selecting a project delivery system for the project. When a project delivery system is selected, the party performing the physical construction work is determined. The party doing the physical construction work can be either the general contractor, construction manager at risk, or design-builder. Even though pricing mechanisms are more commonly paired with specific delivery systems, an owner has the ability to choose how it pays for the construction being done.
The most common construction pricing methods used are:
- fixed price or lump sum (stipulated sum);
- unit prices;
- cost of the work plus a fee (often known as cost-plus); and
- cost of the work with a guaranteed maximum price (also referred to as “GMP”).
A property owner should choose a construction pricing structure based on factors like:
- the nature and complexity of the project;
- market conditions;
- the status of the design;
- the duration of the project;
- the need for a fixed price before beginning construction; and
- the owner’s development expertise.
Under a fixed price contract, a contractor is retained to perform the work. The contractor gives the owner the total price for the construction including the contractor’s overhead costs and profit. The fixed price contract is usually used in a “design-bid-build” project delivery system and less commonly, but still frequently, used in a construction manager at risk or design-build project delivery systems. Many property owners choose to utilize a fixed price contract because of the budget certainty provided in knowing the total cost of construction, assuming there are no scope changes.
Public works, engineering projects, and horizontal constructions, such as roads, often are built pursuant to unit price contracts. Unite price contracts are best used on projects that consist of repetitive tasks that are easily measured. Some unit price contracts include clauses that allow for equitable adjustments to the unit prices when the quantity of the line item performed is materially different than the estimated bid amount. Unit prices help to reduce bid inflation but require the owner to more strictly oversee construction. Under a cost-plus contract, the payment clauses require the property owner to pay the builder the actual cost of performing the work (payment on a time material basis) and an additional fee that compensates the builder for its overhead costs and includes profit. The cost-plus pricing structure is usually used when the owner wants to start construction before the design is finalized and in situations when the builder has a better bargaining position that enables it to place the risk of market price fluctuations in materials or increases in labor costs during the project. The contractor’s fee can be calculated: (1) as a percentage of the cost of work, payable with each payment requisition; (2) as a fixed amount payable in monthly installments; or (3 )as reimbursement for the actual cost of the fee components.
A GMP contract is a cost-reimbursable contract with a named price that dictates the price for the total construction. These contracts are most commonly used when there is a construction manager at risk. However, a GMP contract can be used in a design-build scenario when the design and construction are done by a single entity. A GMP contract should include the construction manager’s responsibilities during the pre-construction phase and the construction phase. The construction manager is then paid on a cost-reimbursable basis after setting up the GMP. Despite the conceptual budget certainty that accompanies a GMP contract, it is important to be aware of inflation of the GMP by the construction manager or design-builder.
For more information on construction pricing, or for help on your next real estate deal, reach out to the knowledgeable real estate attorneys at KI Legal by calling (212) 404-8644 or emailing info@kilegal.com
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