It is important to get input from your legal counsel regarding the terms of your agreement, the particularities of your home construction project, and any state-specific requirements or case law. Here are some general items that we encountered during our builder selection process and negotiations.
When I looked at the new residential construction contracts sent to me by builders, I was evaluating several issues, including:
- Payment - what payment structure did the contract contemplate
- Changes - how are changes orders or differing conditions handles
- Insurance - what type/level of insurance is provided
- Warranty - what is the length of warranty and any exclusions
- Indemnity
Payment - I don't mind anybody I hire making money, and in fact, I WANT them to make money. After all, how hard or careful would you be on a project where you were not making very much $$? However, I do want to know where the contractor is making their profit. There are many different compensation models out there, but most residential home construction contractors either offer to build based on (1) fixed price, or (2) cost-plus. In general, fixed price means the builder provides a price that the builder expects based on certain assumptions. You (buyer) generally does not know what amount the builder pays any subcontractors nor do you really know what amount of profit the builder makes. Cost-plus means that the builder will provide the buyer with the actual invoices from the builder's subcontractors, and mark them up (with the builder's profit).
What surprised me, and what is worth reviewing, is how allowances are handled. Most builders will provide the buyers with a set amount for allowances (such as $6000 for appliances, $5000 for landscaping, etc.). Most builders explained that the term allowance means that we just shop for what we want--we get a credit for spending less and we pay out of pocket for going over on our selections. Makes sense, right?
Well, consider this: if the builder states that your appliances are to be purchased from a particular vendor, does that mean the builder marks up the price of the appliances? Most builders answered no but their contracts read differently. Specifically, every contract we were provided by builders referred to allowances as reimbursable costs, which included the direct price for the item plus an amount for reasonable builder profit. If I was going to pay markup on appliances, my preference would be to just remove them from the builder's contract and buy them outright. For example:
$6000 allowance for appliances WITH a 15% markup would mean that I would actually get $5,100 in appliances and pay $900 in markup to the builder.
Carefully read your contract and really have the builder explain how the words mean what he/she describes.
Changes - I noticed that every builder contract I was provided stated that the builder was going to be paid a flat fee (ranging from $150 to $500) for EACH proposed change we asked the builder to price during construction. Um, NO! Also, I wanted to make sure that all changes required both parties to sign prior to executing the change.
Insurance - During construction of a house, the builder will generally provide builder's risk insurance. This insurance will generally cover any property damage or bodily injury that occurs prior to substantial completion (final walk through). However, it is important to clarify that any builder supplying this insurance should take the risk of paying the deductible and should take the risk should a claim not be covered. Also, many of the contracts that were sent to us required the buyer to be responsible for losses in excess of the builder's risk insurance. Again, I struck that language for several reasons: (1) what if the builder does not get enough builder's risk insurance or buys a low-cost policy with tons of exclusions?, and (2) there are many normal exclusions from builder's risk insurance coverage that I still don't want to be responsible for paying. Imagine this scenario: you are building a house and the builder's electrician starts a fire. Then the builder calls you (the buyer) and says "there was a fire by my sub, so I am going to need an additional $25k to cover the deductible." Yeah, no.
Also, I wanted to make sure the builder named us as an additional insured on his casualty insurance policies. If an employee of a subcontractor is injured during construction, the last thing I want is for me to be paying legal fees to defend ourselves in court.
Warranty - I specifically wanted to know what the warranty period was and more importantly, what the exclusions were.
Indemnity - It seemed like many of the construction contracts that were sent to me required us (the buyers) to pay to protect the builder in the case where we (or someone we invite) to the construction site is injured by the builder. I made this mutual.
Other considerations - My main experience with construction contracts is that disputes mainly arise in two different areas: (1) is something an adder or included in the base price; and (2) how did the defect arise (was it poor workmanship or caused by someone/something else). On the first, it is very very important to lay out base items specifically. I will write a separate blog post to refer to all the items we had to clarify in the specs.
Well, consider this: if the builder states that your appliances are to be purchased from a particular vendor, does that mean the builder marks up the price of the appliances? Most builders answered no but their contracts read differently. Specifically, every contract we were provided by builders referred to allowances as reimbursable costs, which included the direct price for the item plus an amount for reasonable builder profit. If I was going to pay markup on appliances, my preference would be to just remove them from the builder's contract and buy them outright. For example:
$6000 allowance for appliances WITH a 15% markup would mean that I would actually get $5,100 in appliances and pay $900 in markup to the builder.
Carefully read your contract and really have the builder explain how the words mean what he/she describes.
Changes - I noticed that every builder contract I was provided stated that the builder was going to be paid a flat fee (ranging from $150 to $500) for EACH proposed change we asked the builder to price during construction. Um, NO! Also, I wanted to make sure that all changes required both parties to sign prior to executing the change.
Insurance - During construction of a house, the builder will generally provide builder's risk insurance. This insurance will generally cover any property damage or bodily injury that occurs prior to substantial completion (final walk through). However, it is important to clarify that any builder supplying this insurance should take the risk of paying the deductible and should take the risk should a claim not be covered. Also, many of the contracts that were sent to us required the buyer to be responsible for losses in excess of the builder's risk insurance. Again, I struck that language for several reasons: (1) what if the builder does not get enough builder's risk insurance or buys a low-cost policy with tons of exclusions?, and (2) there are many normal exclusions from builder's risk insurance coverage that I still don't want to be responsible for paying. Imagine this scenario: you are building a house and the builder's electrician starts a fire. Then the builder calls you (the buyer) and says "there was a fire by my sub, so I am going to need an additional $25k to cover the deductible." Yeah, no.
Also, I wanted to make sure the builder named us as an additional insured on his casualty insurance policies. If an employee of a subcontractor is injured during construction, the last thing I want is for me to be paying legal fees to defend ourselves in court.
Warranty - I specifically wanted to know what the warranty period was and more importantly, what the exclusions were.
Indemnity - It seemed like many of the construction contracts that were sent to me required us (the buyers) to pay to protect the builder in the case where we (or someone we invite) to the construction site is injured by the builder. I made this mutual.
Other considerations - My main experience with construction contracts is that disputes mainly arise in two different areas: (1) is something an adder or included in the base price; and (2) how did the defect arise (was it poor workmanship or caused by someone/something else). On the first, it is very very important to lay out base items specifically. I will write a separate blog post to refer to all the items we had to clarify in the specs.
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