Article
Construction Contracts: A Guide for Owners
Introduction - Contract Types
Selecting the right construction contract is one of the most important decisions an owner can make. Your choice determines risk allocation, cost control, and overall project execution.
Understanding these contracts will help owners manage risk and ensure the work and payment go as smoothly as possible. Their definitions are:
Lump sum contract A fixed total price is set for the entire project rather than individual aspects. Usually reserved for straightforward projects with a clear scope of work.
Time and materials contract Contractors are reimbursed for the cost of materials as well as labor at an established pay rate. Often used for projects without a well-defined scope of work.
Cost-plus contract The owner pays the contractor for costs (materials, labor, overhead) incurred during the project as well as a preset profit margin. Can offset contractor risk for projects that involve design changes throughout.
Unit price contract Divides the work to be completed into separate units, which the contractor bills for individually. Best for repetitive construction tasks without an estimate of the amount of work required.
Guaranteed maximum price (GMP) contract Establishes an upper limit for construction costs, and contractors absorb costs above this set point. Best for projects with relatively few unknown variables.
Design-build A single contract where the contractor handles both design and construction. Best for projects requiring fast delivery.
CM at Risk (CMAR) The construction manager commits to completing the project within an agreed cost. Provides pre-construction services and assumes financial liability if costs exceed that cost limit.
Integrated Project Delivery (IPD) A collaborative contract structure where all stakeholders share risks and rewards to optimize project efficiency.
Keep reading to learn about these eight common construction contracts, along with the risks and benefits of each one.
Chapter 1
Lump sum contracts
Lump sum contracts, or fixed price contracts, outline one fixed price for all the work done under them. Because the scope is clearly defined, these contracts are common for relatively straightforward projects. However, as simple as the one-price approach may sound, lump sum contracts still carry particular benefits and drawbacks.
BENEFITS | RISKS |
|---|---|
Simplified bidding: Naming one total price, rather than submitting multiple bids, streamlines the selection process. | Miscalculations are costly: Since there’s only one set price, unexpected setbacks or changes reduce a contractor’s profit margin. |
Potentially high-profit margins: Finishing under budget means the contractor pockets the savings. | Bigger projects amplify risk: Additional complexities can lead to higher costs and reduce profitability. |
Because lump sum contracts do not typically provide room for covering unexpected costs once the project starts, contractors bear a significant share of the risk. For owners, however, the price stability can be attractive.
Best for:
Owners seeking a predictable total cost for smaller or less complicated projects.
Projects with a well-defined scope of work where design changes are unlikely.
Chapter 2
Time and materials contracts
As opposed to lump sum contracts, time and materials (T&M) contracts work best when the scope is not well-defined. Here, the contractor is reimbursed for the actual cost of materials plus an hourly (or daily) pay rate for labor.
BENEFITS | RISKS |
|---|---|
More agile: Since the customer reimburses for time and materials, unexpected changes and delays are covered. | Potentially time-consuming tracking: Every single material cost must be logged; inaccuracies can reduce profit. |
Simple negotiations: Setting rates for labor and approved materials is straightforward. | May not reward efficiency: Paying by the hour or day can lead to less urgency in completing the project. |
Owners should note that they bear more financial risk when using T&M contracts. If work extends or changes repeatedly, costs can grow quickly.
Best for:
Projects with unclear or evolving scopes, such as complex renovations or exploratory work.
Owners who anticipate design changes and prefer flexibility over price certainty.
Chapter 3
Cost-plus contracts
In a cost-plus (or cost-reimbursement) contract, the owner pays the contractor for costs incurred during the project plus a set profit margin, usually determined as a fixed fee or a percentage of total costs.
BENEFITS | RISKS |
|---|---|
Flexible and adaptable: Owners can request design changes and still pay the contractor for the extra time or materials. | Difficult to justify some costs: Contractors must track all expenses, and some overhead charges can be tough to validate. |
Handles miscalculations: Estimating inaccuracies are less critical than in lump sum contracts. | Requires strong cash flow: Contractors typically pay upfront for materials and get reimbursed later, impacting finances. |
Here, owners carry a greater share of cost risk because they pay for most overruns, but they also gain the ability to adjust design and scope without renegotiating the entire contract.
Best for:
Highly flexible projects with many unknowns or ongoing design changes.
Owners comfortable with open-ended costs, who want the freedom to adapt plans mid-project.
Chapter 4
Unit price contracts
Unit price contracts divide the work into individual “units,” each with a set price. The final cost depends on how many units the project ultimately needs. This structure is often found in repetitive or linear work (e.g., road building, utilities).
BENEFITS | RISKS |
|---|---|
Simplified invoicing: Owners can see how each unit adds to final costs, promoting transparency. | Difficult to predict total volume: If more units are required, the final price can increase beyond expectations. |
Consistent profit margin: Contractors simply bill additional units at the agreed-upon rate. | Remeasurement can delay payment: Owners may need time to verify unit quantities, slowing down the payment process. |
Owners should note that the total cost may be higher if the project calls for more units than initially planned.
Best for:
Projects with repetitive, quantifiable tasks (e.g., paving, piping) where total volumes may be unclear at the start.
Owners needing a clear price per unit and transparency into how final costs add up.
Chapter 5
GMP contracts
A guaranteed maximum price (GMP) contract caps total costs for the owner. Any overruns above the “ceiling” must be covered by the contractor, creating a strong incentive for the contractor to stay within budget.
BENEFITS | RISKS |
|---|---|
Quicker bidding & financing: Lenders appreciate the cost certainty, and owners have a definitive number to compare. | Can be risky for contractors: Any unforeseen expenses above the GMP price come out of the contractor’s pocket. |
Incentivizes savings: When savings are achieved, some GMP contracts offer a cost-sharing approach. | Extended negotiations: Contractors may factor in larger contingencies or insist on a higher GMP to limit risk exposure. |
Since the owner avoids overruns, contractors face more risk—making precise cost estimating software essential.
Best for:
Projects with relatively few unknown variables, such as standardized designs (retail chains, schools) or repeated builds.
Owners who want firm cost limits and to reward contractors for efficiency.
Chapter 6
Design-build
A single contract where the contractor handles both design and construction. This approach is best for owners who value speed and simplicity because design and construction phases can overlap.
BENEFITS | RISKS |
|---|---|
Faster turnaround: Parallel work on design and construction typically shortens timelines. | Less owner input: Once the contract is signed, owners may have limited say in design decisions. |
One point of contact: The same entity is responsible for both stages, often reducing disputes. | Potentially higher total costs: Design services might face limited competitive bidding. |
Best for:
Owners who value accelerated completion and want a single entity overseeing the entire process.
Projects needing consistent collaboration between design and construction teams.
Chapter 7
CM at Risk (CMAR)
The “construction manager at risk” agrees to deliver the project within a fixed price. If costs exceed that price, the CM shoulders the overrun. This arrangement provides early project collaboration but shifts financial liability to the construction manager.
BENEFITS | RISKS |
|---|---|
Early input: The CM guides the design and cost decisions from the beginning. | Financial liability for overages: The CM takes on more risk if the budget is exceeded. |
Reduced owner workload: The CM handles many administrative and coordination tasks. | Potential conflicts of interest: The CM must balance design quality with controlling costs. |
Best for:
Large or complex projects where professional oversight and cost management are critical.
Owners who want pre-construction guidance and a manager financially motivated to avoid overruns.
Chapter 8
Integrated Project Delivery (IPD)
IPD aligns the owner, contractor, and designer under a shared, collaborative agreement. All parties share risks and rewards, aiming for maximum efficiency.
BENEFITS | RISKS |
|---|---|
Team-oriented approach: All parties work together, fostering innovation and reducing conflict. | Requires high trust: This method demands strong collaboration and transparent communication among everyone. |
Shares rewards: Cost savings and other gains are distributed fairly across stakeholders. | Complex legal agreements: Establishing equitable risk/reward structures can lengthen negotiations. |
Minimizes rework: Early integration of all team members reduces design or construction missteps. | Not ideal for small/simple projects: Works best on large, complicated builds where collaboration yields big benefits. |
Best for:
Owners managing large, complex projects such as hospitals, labs, or complicated infrastructure.
Teams willing to invest in transparency, shared decision-making, and cohesive risk-taking to produce better outcomes.
Chapter 9
Standardized construction contract
At its core, every construction contract is an agreement. Owners and contractors should discuss project parameters to reach a shared conclusion about which contract type suits their goals. Ultimately, a good construction contract balances both parties’ needs.
The American Institute of Architects (AIA) produces standardized contract documents in various formats, including those discussed in this article. Working from a professional, vetted contract template helps ensure common terms and provisions.
Read more about AIA contracts
Conclusion
Selecting the right construction contract is crucial to managing risk, controlling costs, and ensuring a successful outcome for your project. By understanding the different contract types, owners can make informed decisions, establish fair agreements, and build positive, long-term relationships with contractors and subcontractors.