Cost Plus Contract Protection: The 4-Part System That Saves

William Reid (: 00:00

Hey everybody, welcome back. Part two here on the Cost Plus Contract series. And if you caught episode 56 last week, you already know probably where this is going. And if you didn't, give me 60 seconds and I'll get you caught up. Episode 56 was what we called the decide episode. A Cost Plus Contract is when your contractor gets reimbursed for every cost on your project, plus the profit margin on top.

And there are three flavors of a cost plus contract. There's the straight percentage, fixed fee, and cost plus with a guaranteed maximum price. Those are the three main types of cost plus contract. And in California, the pure version of a cost plus is actually illegal for residential remodels under a particular code, civil code in California.

New construction and disaster rebuilds operate under different rules. And honestly, Cost Plus really only works for three kinds of homeowners. The very experienced, the truly indifferent to total cost, or someone working with a great craftsman who's perhaps really horrible at bookkeeping. They just want to work and you get to do all their paperwork for them, which isn't necessarily a bad idea if you're the right homeowner.

So if you went through the seven questions at the end of episode 56 and your answer was walk away, you're done. You can catch episode 58 next week when we cover the fixed price. Or you can hang around and listen to this to learn the ins and outs of cost plus contracting. And don't forget that I'm starting to upload some micro tools to help you disseminate this information, these podcast episodes, by answering just a handful of questions that will help guide you in the right direction.

But if you decided cost plus is still the path, by your own choice, because that's what your contractor offers, because you're rebuilding after a fire, or because you're doing a complex remodel where cost plus is honestly the right call, this episode is definitely for you. And in my book I talk about cost plus contracts like rappelling down a cliff. You can do it. People do it all the time, but you better secure the rope at the top before you start. And that's what tonight is all about, securing the rope.

So here's what we're going to cover. First, how cost plus billing actually works, the day to day mechanics most homeowners never get explained to them. And then the documentation discipline that turns open book contracting into a real protection instead of a slogan that you hear. And then there's a hybrid model, and what I personally believe is the single most powerful tool you have on a cost plus job. Building a budget, attaching a not to exceed clause, and setting up real cost accounting against that budget.

And after that, I'm going to make the case for why your architect may be the most valuable person on your team on a Cost Plus project. And we'll close with a couple of stories if I have time about how this goes right and how it goes wrong. So grab a notepad. Let's dig in.

So you sign a cost plus contract or maybe you're about to. Let me walk you through what your contractor's billing is actually going to look like or maybe should look like. Because in my experience, this is where most homeowners start to get lost, start to lose control, and it just becomes too late and they get blindsided by costs that come in or costs that are over what your expectations are.

So you get a stack of paper, you don't know what to look at, you sign the check, and a year later you're wondering where the money went. And there are five things to settle with your contractor before the work starts, before the bills start coming, before there's anything to argue about, and frankly before you even sign a contract. These are the kind of conversations that you should have that will eliminate a lot of disagreements and dissension between you and your contractor.

Cost plus contracting can work but it takes a lot of management and a lot of knowledge on your end to be able to make sure that you are still protected. So the first one we're going to talk about is billing frequency. How often are you going to get billed? Once a week, twice a month. You need to pick one and agree to that.

And most contractors bill on their own payroll cycle. So if they pay their crew every two weeks, they usually want to bill you every two weeks and you want to match yours to theirs. So predictable timing means you can plan your reviews, set aside the money, and catch problems early. Unpredictable timing means you're always reacting. You get in a hurry and you start just writing checks, hoping you can catch up with it later.

So it's ideal to settle this before you start construction and even before you actually sign a contract.

The second one is employee hourly rates. This is a little tricky. This is where some of the first surprises come to homeowners if it's not discussed early. Each worker on the job should get billed at their actual cost, the contractor has to cover, not what they pay the person, but what they have to cover. So yes, they have their wages, their payroll taxes, workers' compensation insurance, unemployment insurance, health benefits, maybe sometimes vacation benefits, everything that the contractor pays out because they've employed that worker is part of their cost.

So on a worker who's making $30 an hour in wages, you might end up paying $45 an hour as the loaded rate. That's not a markup. That's the actual cost of a contractor having an employee. So that's what comes out of the contractor's pocket. The markup actually comes later, and sometimes it's at the bottom of the bill, sometimes it's to the side of the bill. On line item billing it just depends on how the contractor works.

And getting a sample of past cost plus contract projects from a contractor is really helpful, past examples of receipts and billing and things like that, so you can understand what you should be receiving and how to understand that information. And if a contractor can't produce that and he's a cost plus contractor, I don't know. I would probably walk away because a lot of contractors think that cost plus contracts just relieve them of all liability. And in a sense it does. But if you don't nail down some of these details, it just gets even worse.

So like I said, the markup comes later, and it comes as profit and overhead. We've talked about that in the past couple of episodes. P&O, sometimes you hear it called. And that's where the contractor makes their money.

Now here's what to watch for. Some contractors tack the profit and overhead onto each individual hour. So you might see rough carpentry framing, Fred spent 40 hours, John spent 40 hours, Jose spent 40 hours, and you'll see the line item cost there, right, is what you should be seeing. And you have to look at that first.

Some contractors tack their profit and overhead onto each individual hour. So it wouldn't be $45. It'd be $75 or whatever it is, sometimes all the way up to $100 an hour. Carpenters these days are starting to make more than $30 an hour. So it could be a $50 an hour person plus the burdened labor of around 35 to 50 percent. Then you start putting the markup on it. You could get all the way up to $100 an hour.

And then some of these guys add the profit and overhead again at the bottom of their bill. So you see a running total and then at the bottom you see profit and overhead X percent, which is a percent that you've agreed to ahead of time. Or sometimes you'll see management fee. So again, seeing samples of their documentation is really important to understand what to expect, right? But what you call that is double dipping.

So you're paying the markup twice for the same thing. And the defense is simple. Ask upfront what exactly what's included in the hourly rate. And then you'll know if profit and overhead should show up at the bottom because they should be added once, not twice.

William Reid (: 08:42

Okay, this next one I call payroll honesty. And the agreement should be that every worker on your job is on the actual contractor's payroll with full benefits and proper insurance, period. So here's the loophole to watch for. Some contractors hire day laborers, pay them in cash, and then bill you the full loaded rate as if those workers were on his payroll. They pocket the difference. It's illegal.

It's insurance fraud and it shows up more often than it should. So the risk to you is real. If a day laborer gets hurt on your property and the contractor wasn't carrying proper coverage, you can be on the hook. And your homeowners policy probably won't cover it.

Ask for certificates of insurance for workers comp covering everyone on site and verify them with the carrier directly.

The fourth one is another interesting one. It's how the contractor's own time gets billed. So your contractor spends real time on your project that isn't on the site, ordering materials, meeting with your designer, calling subs, writing emails. Even sending you the bill takes time. So maybe they're billing you to send you a bill, I'm not sure. But the question is to settle how all of that gets billed and accounted for.

So the common arrangement is that anytime the contractor is on site, working with the tools or in meetings with you or your representatives, that gets billed hourly because they're physically working on the site. And a lot of contractors do that. There could be just one contractor with a crew of two guys doing a job and he's actually one of the carpenters on the project, right?

So offsite administration time gets covered in the profit and overhead percentage at the bottom of the bill. And that's not the only way to do it, but pick one and put it in writing. Otherwise you're going to end up arguing about it and trying to understand why you're paying. It could look like you're paying twice for something.

And one quick reminder. When your contractor calls a plumber from another job to your job, they're going to add a percentage to that plumber's cost to cover their time. That's normal. That's how it works. And that's how a general contractor makes their money on all of the costs of a project. And that covers their management time, profit and overhead, right?

Now, this isn't set in stone and some contractors, you will see that they could say, well, our profit and overhead percentage is 22.5 percent and then we have an additional 2.5 percent management fee. Everybody just does it a little bit differently, which is a little confusing, but seeing that ahead of time, understanding how they do it, that can actually become even part of the contract if you're really particular and really want to lock things down.

So keep this in mind. You need to understand how they go through all of their calculations.

And the fifth one is really interesting. It's mistakes, right, because they're going to happen. And three things create most cost plus disputes. And when it comes to mistakes, whose mistake it was, why it happened, and who pays to fix it, right? So this is interesting because on a cost plus contract, theoretically you pay for every single hour that got worked on that project regardless of why, which seems a little strange, especially if mistakes are created by the contractor themselves.

So on a strict reading of cost plus, the homeowner pays for all time and materials regardless of whose fault, and that's part of the risk you signed up for. So on a fair reading, when the mistake is clearly the contractor's, they really should absorb it out of their profit and overhead. And here's the honest part. Most cost plus mistakes happen because of poor plans, thin specs, and missing information.

So when the cause traces back to incomplete documentation, fault gets murky really fast, right? But how do you monitor that? It's almost impossible to monitor unless you have an owner's agent or an architect performing what's called construction administration. If they see them rebuilding a wall or tearing something apart in the middle of framing or something.

Now you're getting into micromanaging the contractor and I don't know if any of us really want to do that. But again, the defense is to have this conversation before you start, agree on how mistakes will get handled, put it in writing. And then when the inevitable happens, you have a framework instead of an argument, right? So mistakes happen. Cost plus says you pay for them and common sense says have the conversation first.

So that's the billing side of cost plus contracting. Five things to settle. Frequency, hourly rates, payroll, contractor's time, and mistakes. Now let's talk about the documentation side because how the bill arrives matters as much as what's on it.

William Reid (: 14:16

All right, documentation isn't glamorous, but it's also not optional. And you're going to find out that a lot of general contractors are horrible at paperwork. And the ones that are horrible at paperwork are the worst candidates for executing cost plus contracts. Now, some of the best contractors in the country are cost plus contractors, but they also have a team and a staff to manage the projects both in the field and in the office. And that can be a really good business model for both sides.

So I'm not here to poo poo cost plus contracting. I'm here to help you understand, are you dealing with a single general contractor that doesn't even know how to run a computer and expect to do cost plus contracting with them? You're going to have a mess on your hands probably at some point during the project. But on a cost plus contract, the documentation really is the protection. So let's talk about how to set it up so you actually know what's happening.

The first thing is that every receipt, every bill, every supplier statement, every time card that gets billed to you should clearly identify your project. It must identify your project, especially from the suppliers and the subcontractor bills that come in. It must be clear that it's for your project. And not to say that contractors are mischievous there. It's just that they're not very organized. So you could end up getting billed for a countertop when you don't even have any countertops in your job or something.

So pick a code for your job. It could be your last name, your street number, it doesn't matter what, just be consistent. Now, a lot of suppliers and subcontractors and general contractors always refer to the project street name. We're over on Magnolia Drive today, we're over on the Smith Magnolia Drive.

But have an understanding ahead of time. What is the project name? And tell your contractor and tell the suppliers. Every supplier, even Home Depot, has a way to tag purchases to a project. This is a normal reasonable request. They do it every day for somebody else.

Don't pay for handwritten bills. Don't pay for receipts that don't identify your job. And if your name isn't on the receipt, your name shouldn't be on the check. So think about it that way.

The second thing is that every invoice from your contractor should identify which work breakdown structure category it belongs to. Now a quick reminder here. We covered the WBS, work breakdown structure, in detail back in episode 52. It's the list of construction categories that organize your scope and your costs, right? So site prep, demolition, foundation, framing, electrical, plumbing, finishes, all the way through.

And why does this matter? So when an invoice is tagged to a work breakdown structure category, you can see at a glance whether spending on that category is on track. So the plumbing budget was $20,000. Plumbing invoices to date are $18,000. The project is 60 percent done. Are we on pace? Yes or no. You can actually answer that question.

So without work breakdown structure tagging, you have a stack of paper. With WBS tagging, you have a project dashboard. That's the difference. Now, of course, in order to be able to do that, you have to have a work breakdown structure. Even though you may be contracting on a cost plus contract, there still needs to be a budget developed for the project.

So a lot of times contractors want to do cost plus because they don't want to take the time to do all the estimating for the project. They just say, well, let's just start and I'll just start billing you. Well, that's real dangerous territory to be in. The contractor should develop some sort of budget to work off of, right? That's actual real numbers, not just guesses from the contractor. But they are not as thorough and detailed as a fixed price contract, which we're going to be covering in the next episode, which will be the direct contrast to what we're seeing here today.

But again, when you go to contract with a general contractor on cost plus, eventually you're going to get to a work breakdown structure. And if you don't have one, you just have one big lump sum. I wouldn't do it. That means that they really have no idea what's going on from the financial side of the project and expect you to just cover everything. So keep that in mind. This is really important.

The third thing in this documentation little segment is the review window. So when a bill arrives, set a window for review. Seven to 10 working days is reasonable. Don't get an invoice that's handed to you on a job site and whip out your checkbook and write a check before you understand what costs are going in. I mean, it's reasonable to wait seven to 10 days to get a payment because it's a cycle, especially like we talked about, the two week cycle. In the beginning, it's a little bit hard to start, but once you get in the rhythm, it works out okay.

So during that window, you want to spot check three line items, look at the dates, and check whether the time card actually matches the calendar and what you know has progressed on your project. Call a supplier or two and confirm the materials match what they say they are for and that they're for your project. This isn't paranoia. This is a professional billing review. Every commercial owner does it and you should too.

And if a contractor pushes back on the seven to ten day window, that's a problem. Reasonable contractors can expect this and welcome it. Their reputation depends on clean bills.

So that's the billing discipline and documentation discipline. Now let's talk about the single most powerful move you can make on a cost plus contract, what I call the hybrid. And this is one that in my opinion decides whether your project ends well or not.

William Reid (: 20:44

All right. So this is the meat of the episode. Back in episode 56, I told you cost plus is a higher risk contract structure. That's true, but there's a way to take a lot of that risk off the table without going to a full fixed price arrangement.

So in my book, I describe it as three methods that inch a cost plus contract toward becoming a fixed price contract. So I want to spend some real time on this because in my opinion, this is the single most important conversation you can have with your contractor before signing.

There's three moves, and four if you count cost accounting as its own move. These don't turn cost plus into fixed price. They inch it that direction a little bit, and inching can sometimes just be enough. So on a true open-ended cost plus contract, your exposure is really unlimited. With these moves layered on, your exposure is bounded, visible, and managed. And that's really the whole game.

So I'm going to walk all four and then I'll show you how they work together. And I already brought this up a few minutes ago. Move one is an overall budget broken down by the work breakdown structure. Ask your contractor to prepare a high level look at the total project costs broken down by work breakdown structure category. They could have their own categories. You could provide them the categories that I've developed that I've used on my projects for decades. And basically it's just the categorization of costs.

Pair their experience with whatever plans and specs you have. Even mediocre plans plus a good contractor's experience can produce a meaningful budget. So what you're after is a single document, two or three pages that lists every category with an estimated dollar value. Site prep, $10,000. Demolition, $15,000. Foundation, $40,000. Framing, $60,000, whatever, throughout the entire project.

And this budget becomes your reference. Everything else builds from here. So if you haven't built a work breakdown structure yet, episode 52 is your starting point and we covered it there in detail.

Okay, here's move two. Not to exceed clause. Now this one, sometimes you get pushed back on. And this is going to tie back to the quality of your plans and other components that the contractor needs to evaluate from a risk standpoint. But once you have the budget, you attach a not to exceed clause to your contract or sometimes you hear it called NTE. So in plain English, it's a written ceiling on the total project cost.

The contract says final cost shall not exceed the budget plus a reasonable percentage except for owner approved changes. And also you can put in there any problems with the plans and the design that forced the contractor to have more work. And I guess that would be classified as a change order. So maybe that doesn't even really matter, right.

So what this does for you is cap your exposure. You could even make it say 20 percent more, right. I'm not sure I'd go much more than that because if he's off on his budget that much, he probably doesn't know what he's doing. But it does cap your exposure. So you know your maximum amount. And the contractor takes on the risk above that cap, which gives them a real reason to manage costs.

The other thing about this is, let's say you're getting three estimates for a project and let's just say you're in this cost plus world. And after you have the three estimates, you have dramatic differences in pricing. Or maybe you don't, but you go to each contractor and you say, would you be comfortable with a not to exceed clause on the contract based off of your amount? Would you be comfortable doing a breakdown by a certain list of categories or by your own categories so we can see where the money's going and we can track the payments against the different categories? Look for the reaction.

If somebody's comfortable, relatively, I mean, I don't think any of them are going to be that comfortable with a not to exceed clause, but the ones that are more comfortable with it, it means that they've probably spent more time doing the budgeting or they just have a lot more experience or a lot more confidence in their estimating skills and their product knowledge and project knowledge. So this is a really good way to qualify a contractor at that stage.

So hopefully you're not having these conversations after you selected a contractor, right? You want to do this before you select a contractor. But like I said, it forces them to think carefully. But I like to wait to ask them that question until after they've provided the estimates if you're going around.

So the critical detail is that the cap moves only when the scope changes through a written change order signed by you, never just automatically. And one industry note here, the American Institute of Architects standard contract documents that you can purchase or that they may be using, A102 is the standard for a cost plus contract with a cap. So this is not something I'm making up. This is an industry standard that you should at least be aware of.

And if your contractor knows what they're doing or they do a lot of cost plus contracting, they'll probably be familiar with it. So if your contractor knows what they're doing and they do a lot of cost plus contracting, they'll recognize that form likely. And if they don't, that's just a little bit more information for you.

So a budget without an NTE clause is just like a wish list, right? You're just hoping that it comes in. And an NTE clause without a budget is a number with really no story behind it, the breakdown structure I'm talking about. Together, putting those two together makes for a much more comfortable cost plus contract for you as the homeowner. It can also be more comfortable for the contractor.

Move three is cost accounting against the budget that I just spoke of a minute ago. And here's where the magic happens. And honestly, this is also where most cost plus jobs fall apart, even when they have a budget and an NTE clause. Cost accounting means every dollar that gets spent on the project gets tagged to the work breakdown structure in the budget. And you compare actual to estimates every month.

So let me give you a concrete picture here. Month three of the project. Plumbing budget was $20,000. Plumbing invoices to date, $14,000. Plumbing rough-in is complete. Fixtures are installed. You're in pretty good shape. Now compare that to month three of a different project. Foundation budget was $40,000. Foundation invoices, $52,000. Foundation work isn't done. You have a problem.

And the value of cost accounting is that you surface that problem now, not at the end when there's nothing left to do about it. So cost accounting connects your invoices back to your budget. And without it, the budget is a piece of paper you just signed once. With it, the budget is a living document that shows you what's happening week to week.

So without cost accounting, you have a budget. With cost accounting, you have a project under control.

William Reid (: 28:36

All right, move four is a completion incentive. So here's something that's true about cost plus. It structurally rewards delay, whether it's consciously, subconsciously, it's just human nature. And the longer the project takes, the more the contractor bills. It's just going to happen. And as we all have heard time and time again, projects always take longer than expected.

So the fix is a written incentive for finishing on time and on budget. It could be a bonus for completion by a target date. It could be a bonus for coming in under the NTE cap, the not to exceed cap, with savings shared between you and the contractor. The book frames it this way. An incentive motivates the contractor to finish the project yet maintain an acceptable level of quality.

So a reasonable structure is that if final project cost comes in under the cap, savings get split 50-50 or 70-30 in your favor, whatever you guys agreed to. Frame it to your contractor as, we both win when costs come in lower. And most contractors will go for that because they will win when it works.

So that's four moves. Move one, the budget, gives you the reference document. That's that WBS structure, work breakdown structure. Move two, NTE clause, not to exceed, caps the exposure. Move three, cost accounting, shows you in real time whether you're on track. And move four, a completion incentive, aligns the contractor's reward with your outcome.

So layered together, these four moves can make cost plus operate a lot more like a fixed price contract, but not all the way. Enough to sleep at night, enough to know what's happening, enough to catch problems before they become disasters. So you've got billing discipline, documentation discipline, and the hybrid model, right, the ones I just spoke about a minute ago. The pieces are all there. Now who's going to help you actually use them? Because honestly, most homeowners can't do this alone. And let me tell you about the person who can.

But here's that question. Most homeowners really never ask this question until it's too late. Who's actually going to review my contractor's bills? And most of you honestly don't have the time, you don't have the expertise, and you don't have the stomach to do trust but verify on every line item every month for two years. That's okay. Most homeowners don't. But that doesn't mean you go without one. It means you find someone.

Open book transparency only works if someone is actually opening the book. If nobody reviews, you're paying for paperwork that nobody reads. On a fixed price contract, you don't need a third party reviewer. The price is the price. The contractor takes the estimating risk. On cost plus, every invoice is a small estimate that needs review, multiplied by every month, every category, every sub. That's a lot of review work, real work, skilled work.

And most homeowners who skip this end up going one of two ways. Either they undermanage the project, paying everything that gets billed without question, or they overmanage it, fighting every line item and ruining the relationship with the contractor. Neither is good. And a third party reviewer is really the answer.

Here's the thing most homeowners miss. You probably already have the perfect person for this job. Your architect, your designer, your interior designer even sometimes if you're doing a small project. But generally speaking, your architect is a perfect person to help administer the construction of your project.

So think about it. Your architect already knows the project. They drew the plans. They wrote the specs. They conducted the design meetings and they know what you're building and why. So when an invoice comes in for a tile installation that doesn't match the spec, your architect catches it because they wrote the spec. When the contractor bills for framing hours that don't match the floor plan complexity, your architect notices because they drew the floor plan. When the construction work in the field doesn't match what was drawn, your architect sees it on the next site visit because they're going to be on site anyway.

Invoices come in claiming certain aspects of a project are 100 percent done and they're not 100 percent done. So that has to be further investigated to understand why bills are coming in when work is not 100 percent done. It could be that it will be done within a day and the contractor's trying to cycle through, and that's okay as long as everybody understands, and it's just not this random billing. The more that the contractor knows that you are not looking at the details of the invoicing, all of a sudden the flexibility expands when they think they can be billing you.

And the architects are already on your side. Hopefully they've been your advocate for the whole project. That doesn't always happen with designers and with architects, but that's what's supposed to happen. But they work for you. Their professional reputation is tied to your project being billed correctly.

Adding bill review and onsite supervision to the architect's role is a natural extension of work they're already doing. Most architects are happy to take on this expanded role as long as you pay them. And many architectural firms offer it as a service called construction administration or CA services for short. And don't expect those services when you sign a contract with an architect. That's something that should be discussed because that is not necessarily a standard across the board for every project.

So your architect already knows the project. They drew the plans. They know the specs. They're already on your side. Why wouldn't you ask them to also help you watch the bills?

If your architect can't or won't take on the role, or if you didn't use an architect for design, there's a separate professional called an owner's representative or owner's agent. Same job. They review invoices, attend meetings, audit billing, and supervise construction on your behalf, independent of the contractor.

Owner's agents used to be mostly a commercial construction thing. They've gotten increasingly common in high-end residential, especially on complex remodels, custom homes, and even on disaster rebuilds. So if you're rebuilding after a fire, strongly consider an owner's agent. Insurance companies will only reimburse documented costs.

I'm going to dedicate an entire episode or maybe episodes on owner's agents because really an owner's agent becomes involved in a project way before the billing aspect of construction goes. In fact, if you're planning to build a home or your second home or third home in a remote location or a location far from your primary home, or you're just a busy executive and don't have time, an owner's agent is a really good avenue for you all the way back to even purchasing your lot or purchasing your property, to hiring your design team, to hiring your contractors, to project managing the project, to watching every step of the way during construction.

This could actually save you money, even though you have to pay the owner's agent, and also save your sanity. So I'm going to get to that in some other episode, but this is your backup plan for getting these bills reviewed.

So going back to this construction administration, what does it cost? Architects' construction administration services and owner's agent fees typically, you'll see them put in one to three percent of the project cost. So on a $500,000 job, that's $5,000 to $15,000. I know it sounds like a lot of money, but let me tell you, if you're doing a multimillion dollar project or even a $500,000 project, you'd be surprised how much money that would actually save you. And also the supervision of the construction is really important too because they can foresee problems coming before they happen, things like that.

So it sounds like a lot of money, but until you remember that we just spent 20 minutes talking about how cost plus exposure can run 20 to 40 percent over budget without proper management. On a $500,000 project, that's $100,000 to $200,000 of risk. $5,000 to $15,000 to manage $200,000 of risk is a deal.

And the book makes a point I want to repeat. The fees you pay to an architect or owner's agent to do this can be recouped quickly when they spot billing errors or construction defects. So in my experience those fees really do pay for themselves the first time they catch something.

So that's the playbook. Billing discipline, documentation discipline, the hybrid model, the architect as your reviewer.

All right, so let me tell you about two projects. Both cost plus, both around the same size. One ended well, one didn't. And the difference between them is the whole point of this episode.

I call them the McMillans and they're doing a major remodel. About $600,000 total budget. Older home, some unknowns behind the walls. Their architect strongly recommended Cost Plus because of those unknowns. Smart architect. So here's what they did right. The architect helped them build a budget broken down by work breakdown structure. Every category had a number. They put a not to exceed clause at 115 percent or 15 percent cap.

And the contractor signed off without much pushback after they actually completed a budget. And the architect provided construction administration services. He reviewed every invoice. He attended monthly walkthroughs. And here's how it played out.

Month four, the foundation came in $12,000 over budget. Why? Unexpected soil conditions. Genuine unknown. They documented it as a change order. The NTE cap moved with their approval. The project moved on. Month seven, the architect caught a tile installation invoice that didn't match the specified product. Different brand, different quality grade. The contractor corrected it. No drama because the architect caught it early.

Month nine, they were tracking three percent under budget overall. The cost accounting showed the trend. The final result, the project finished four percent under the NTE cap. The shared savings provision split under the 50-50 rule. And the McMillans got back about $10,000 and the contractor got a bonus and a glowing referral.

The McMillans really didn't do anything magical. They just did the playbook. Budget, NTE clause, architect on the bills. That's it. Now for a contractor to accept those terms on the project, they need to do a lot of due diligence. They do a lot of estimating to a certain degree and then they can stop and get the project started as long as they're comfortable with the not to exceed clause.

Now this doesn't go for every single project. The more intense a project is, the less chances you may have of doing a cost plus project. So it's a conversation that you need to have with your architect and maybe even some contractors to understand if that's even the path to take. But I would probably start with your architect because they're going to be more objective than a contractor.

So then we got Ben and Jane. Ben and Jane wanted to add a primary suite, about a $200,000 project. They had a good contractor, local guy, decent reputation, 20 plus years in the business. And here's what they did wrong. They didn't get a real budget. The contractor said, we'll figure it out as we go. They didn't do a not to exceed clause. I don't do breakdowns.

And then they didn't have anybody review invoices. And they didn't even use an architect, like a licensed architect. They had a draftsman do the basic plans. And here's how that played out. Bills start coming in. Ben and Jane signed them. Six months in, they spent $160,000 and the project was about 60 percent done.

And now here's what's actually happening. It wasn't fraud. It wasn't even necessarily mistakes. It was just normal cost plus drift. The subs were billing extra hours because the plans were thin. Materials cost more than expected because the allowances weren't capped. The contractor's profit and overhead percentage was being applied honestly but to a much bigger base than anyone had expected.

The final result, the project finished at $280,000, about 40 percent over the original mental budget. And Ben and Jane were furious. The contractor felt unfairly accused. This is what really happens. It puts a contractor in a bad spot too. It's a bad thing for both the contractor and the homeowner because they did the best that they could, but yet they end up losing. It's almost like a losing battle when you go into a cost plus contract without any of this information.

To make a client happy with that lack of information and not addressing the budgeting or the breakdowns or anything early, it's almost guaranteed that you're going to have some kind of problems to some degree. But I mean, nobody was a villain in this story. Ben and Jane skipped the structure. The contractor went along with it because that's what the homeowner asked for.

The structure is what would have caught the drift early. The structure is what would have given everybody, homeowner and contractor, a way to see what was happening before it got out of hand. So Ben and Jane were good people. They had a good contractor. They just skipped the structure I've been talking about today. And the structure is what saves you when something goes wrong.

So most cost plus jobs aren't McMillan stories and they're not Ben and Jane stories either. They're somewhere in between, which still causes problems. So what separates the good outcomes from the bad isn't the contractor's character. Most contractors are honest people trying to build something well. What separates them is the structure the homeowner brought to the project. The budget, the NTE clause, the cost accounting, the reviewer.

So cost plus without structure is rappelling without a rope. Cost plus with structure is rappelling with a rope. The cliff is the same height either way. The rope is what changes the outcome. That's your playbook. Let's wrap it up.

So let's bring this all together. On a Cost Plus contract, your protection comes in four parts. Billing discipline, documentation discipline, the hybrid model, and the architect or owner's agent reviewing your bills. Layer all four together and Cost Plus stops being a leap of faith. It becomes a project you can actually manage.

So if this episode helped you, please share it. Specifically with someone who is sitting at a kitchen table tonight looking at a contract, trying to figure out what to ask for. That's the homeowner who needs this most. Send your questions on Instagram, on the website, or just email me directly at wwreid@theawakenedhomeowner.com. And I read everyone and your questions can shape the future episodes that I develop here.

So coming up in episode 58, we wrap the contracting methods arc with the structure that protects most homeowners best, fixed price contracts. What makes them work? What can still go wrong? The surprising places fixed price isn't really the right call. So that's next. And as always, I'm Bill Reid, your home building coach. I'm here to enlighten, empower, and protect you. Now let's go make it happen.