The construction contract structure determines how risk is allocated between the owner and the contractor for the duration of the project. Different contract types allocate cost risk, schedule risk, and scope risk differently, and the right structure for a specific project depends on the owner’s risk tolerance, the completeness of the design documents, the nature of the project, and the relationship between the owner and the contractor.
Understanding the three primary construction contract structures, lump sum, cost plus, and construction management at-risk (CMAR), and what each means for owners, developers, and construction lenders is foundational knowledge for anyone involved in significant construction projects.
Lump Sum (Stipulated Sum) Contracts
Under a lump sum contract, the contractor agrees to complete the defined scope of work for a fixed, pre-agreed price. If the contractor’s actual costs exceed the contract amount, because they underestimated labor, because material prices increased, because they managed the work inefficiently, the cost overrun is the contractor’s problem. The owner pays the contract price regardless of the contractor’s actual costs.
The lump sum structure’s primary benefit for owners is cost certainty. The contract price is the price, subject only to owner-directed scope changes and genuine unforeseen conditions. An owner financing a project with a construction loan can structure the loan around the lump sum contract amount with reasonable confidence that the final cost will not exceed it, plus contingency for change orders and unforeseen conditions.
The primary disadvantage is cost opacity. The contractor bids the lump sum based on their internal cost estimates, which the owner never sees. The contractor’s profit margin, their subcontractor pricing, and the distribution of costs across trades are not visible to the owner. This opacity means the owner cannot verify that the lump sum was competitively priced or that the contractor’s costs were managed efficiently.
Lump sum contracts work best when the construction documents are complete and well-defined, when the scope is clear enough that the contractor can price it accurately and the owner can evaluate the bid meaningfully. They work poorly when design is incomplete, because the contractor must price unknown conditions with contingency that inflates the lump sum, and because scope disputes arise when the construction documents turn out to be ambiguous.
Cost Plus Contracts
Under a cost plus contract, the owner pays the contractor’s actual costs, labor, materials, subcontractor costs, equipment, plus a fee that covers the contractor’s overhead and profit. The fee is typically either a fixed amount or a percentage of the actual costs.
The primary benefit of cost plus is transparency. The owner sees the actual costs of construction and can verify that subcontractor bids were competitive, that labor hours were appropriate for the work performed, and that the contractor’s fee is applied to actual costs rather than to a marked-up estimate. This transparency is valuable for owners who are sophisticated about construction costs and who want direct insight into how their project dollars are being spent.
The primary disadvantage is cost uncertainty. Because the owner pays actual costs, there is no ceiling on the contractor’s final compensation. If the project encounters unforeseen conditions, if material prices spike, or if the contractor’s labor efficiency is poor, the owner absorbs those costs. The owner’s construction loan must be structured with sufficient flexibility to accommodate cost uncertainty, which means larger contingencies and more conservative underwriting than a lump sum project.
Cost plus works best when the design is incomplete at the time the contractor is engaged, when the project involves uncertain conditions that make lump sum bidding impractical, or when the owner has a strong enough relationship with and understanding of the contractor to trust that costs are being managed in the owner’s interest.
Construction Management at Risk (CMAR)
CMAR is a hybrid structure that attempts to capture the benefits of both lump sum and cost plus while reducing their respective disadvantages. Under CMAR, the construction manager is engaged early in the process, during design development, often before the design is complete, and works collaboratively with the design team on cost estimating, constructability review, and value engineering. When the design reaches a defined level of completion, the construction manager provides a guaranteed maximum price (GMP), a ceiling on the total cost for which the CM will be responsible.
Below the GMP, the project operates on an open-book cost plus basis, the owner sees the actual costs. The CM earns a fee for their management services. If the actual costs come in below the GMP, the savings are often shared between the owner and the CM through a shared savings provision. If the actual costs exceed the GMP, the CM absorbs the overrun.
CMAR’s benefits: the early engagement of the CM allows construction expertise to inform the design process; the open-book cost structure provides cost transparency; and the GMP provides cost protection. These are valuable features, which is why CMAR has become the dominant delivery method on complex multifamily projects in active markets. Innergy Integral’s principal portfolio, including the Allegro at Ash Creek, Paramount, Rendezvous, and Lyon’s Gate projects, was primarily delivered under CMAR.
CMAR’s complexity: establishing the GMP at the right level requires both complete enough design documents to support accurate pricing and a CM-owner relationship built on enough trust to negotiate the GMP fairly. A CM who lowballs the GMP to win the project and then pursues recovery through change orders after construction begins produces a CMAR project that behaves worse than a competitive lump sum.
What Construction Lenders Need to Know
For construction lenders, the contract structure affects how they should evaluate and monitor the loan. A lump sum contract provides a clear total cost commitment that anchors the loan underwriting. A cost plus contract requires the lender to accept more cost uncertainty and to structure the loan with commensurately larger contingency. A CMAR contract with a GMP provides similar certainty to a lump sum once the GMP is established, but requires additional underwriting attention to how the GMP was established and whether the CM has the financial strength to stand behind it.
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