It can bring spouses together or it can rip them apart. It can be a labor of love or hard labor. It can be a fond memory or an experience to be forgotten. Smart Business spoke to Dennis B. Ellman, a partner at Greenberg Glusker Fields Claman & Machtinger LLP, about how, armed with a bit of knowledge, you can build a home that serves you and your family and have fun in the process.
Assemble the right team. Your financial success was likely achieved by hiring the best. The success of a construction project requires no less.
The Owner’s Representative (OR). Unlike a general contractor or design professional, an OR is a project manager who represents only your interests as the owner. Most are former architects or contractors, so their skill set is well suited to custom home development.
An OR’s responsibilities include negotiating contracts, preparing and tracking budgets, assisting in value engineering, attending weekly job meetings, reviewing invoices from the architect, contractor and consultants, confirming that all required lien waivers and releases have been submitted, reviewing, insurance for compliance with contract requirements, etc.
The Architect. Selecting an architect includes answering these questions: Do I want and can I afford a well-known architect? Does the architect design in the style that I prefer? Will the design meet my objectives or only serve the architect’s likes? What is the average cost per square foot of the homes designed by this architect? Is the architect someone I will enjoy working with?
Architects are typically compensated based upon a percentage of construction cost (between 10 percent and 20 percent), and are paid as their work progresses. This rate structure can lead to mistrust when the architect recommends a more expensive design or more costly materials. Consider suggesting a fixed fee based on the estimated cost or size of the home, which will be subject to adjustment only if significant changes are made.
Understand what the architect’s fee includes. Some include the cost of mechanical, electrical, plumbing and other engineers whose services are required for the preparation of the architect’s plans. Others do not include these consultants, in which case the owner must pay these in addition to the architect’s fee. Engineering fees can often total between 1 percent and 3 percent of construction cost. When comparing one architect’s fees against another, make certain you know what services are included.
The General Contractor (GC). Many custom homebuilders are excellent builders and people of integrity. Others are not. Owners should perform extensive due diligence before engaging a GC. Check personal references, visit homes that the GC has built, and ask your lawyer to investigate prior litigation to which the contractor has been a party.
The Attorney. Make certain the attorney you hire is not a generalist, but has extensive construction contract experience. Ask about projects in which the attorney has been involved. An experienced attorney may also be able to recommend potential ORs, architects and GCs.
Sign the right contract.
Negotiated vs. Bid Contract. There are two methods of engaging a GC. The first is to wait until plans and specifications have been completed and then send them to several GC’s requesting bids. This process should result in a truly competitive price for the construction of your home.
The second method, often referred to as a “negotiated contract,” is one in which the owner, with the assistance of the OR or architect, selects a specific GC and negotiates its fees (profit) and general conditions (project site and supervision costs) prior to plan completion. Once awarded the contract, the GC will be required to obtain a minimum number of bids from each subtrade. This enables the owner to hire a GC as the plans are being developed, leveraging their expertise for estimating costs and value engineering.
Contract Form. The most common construction contract forms are “cost plus” and “fixed price.” A cost plus contract pays the contractor the actual cost to build the home, plus a fee typically stated as a percentage of that cost. There is no cap or maximum price, although an estimated budget should be included. Require that all trades be bid to at least three potential subcontractors.
A fixed price contract sets forth a price for the completed house; it also includes cushion to protect the GC, which you will pay whether or not it is needed. Any changes during construction will likely increase the price.
A hybrid of these two contract forms is the “cost plus subject to a guaranteed maximum price” (or GMP) contract. As implied by its name, the owner pays the contractor’s actual cost of the work plus an agreed upon fee, not to exceed a maximum price. These contracts typically incentivize the contractor to complete construction for as little cost as possible by giving a percentage of “savings” (usually between 25 percent and 40 percent).
There are certain protections that should be included in all construction contracts. Since contractors are paid as the work progresses, the owner should be permitted to withhold a percentage of what would otherwise be due the contractor. This so-called “retainage,” which is typically 10 percent and paid upon job completion, is the owner’s insurance that, if the contractor fails to complete the work, funds will be available to pay any liens and the additional costs in securing a new GC.
A well-drafted construction contract should protect the owner from contractor claims for additional compensation. Representations should include confirmation that the GC has thoroughly investigated the project site, carefully reviewed the plans and found them to be complete and without inconsistencies, and that the contract price includes both work shown and work reasonably inferable from the plans.
Time to Complete. The contract should have a date for completion. The GC’s failure to complete by this date will give rise to damages. Contractors are typically entitled to extensions of time for causes beyond their control, such as inclement weather or labor strikes. Exceptions should be narrowly defined.
Know yourself and have fun
If you labor over the smallest of decisions and then second guess yourself, or if you approach every task as a work in progress changing course every step of the way, consider buying a completed home. Too many projects exceed their budget due to costly changes and owner-caused delays during construction. But, if you are reasonably decisive and secure, then consider a custom home. Remember, the process should be fun. No matter how wonderful the home you build, no one will be happy if it results in family strife.
Dennis B. Ellman advises and represents real estate developers, brokers, investors and affiliated construction and architecture professionals in financing and loan workouts, lease negotiations, construction contracts, project agreements, and all aspects of real property acquisitions and dispositions. He can be reached at DEllman@greenbergglusker.com or (310) 201-7417.