What is Contractor Fee Percentage?
Contractor Fee Percentage in construction projects is the total amount a contractor is paid for overseeing each stage of a project. This does not include overhead costs such as labor, equipment rentals, and the direct costs of building materials. Like general contractor mark up, Contractor fee percentage is often expressed as a percentage of the total project costs. Thus, if the total costs of the materials are $5000, and the contractor fee percentage is 20% then the contractor fee would be $1000.
The contractor fee percentage is significant in that it is the bulk of the profit for the contractor. Some contractors might offer an incorrect fee percentage that appears attractive , and then make it up in expenses and other fees not covered by the contractor fee percentage. The contract should clearly spell out which expenses and fees are not included in the contractor fee percentage, so a property owner is not surprised by unregulated costs later.
If a contractor fee percentage is covered in a construction contract, it should be clearly indicated in the document. If it is not, it may not be required to be paid.
Contractor Fee Percentage Considerations
The percentage of the contractor fee can fluctuate based on a multitude of factors inherent to the project, ranging from the complexity of the construction, to the time frame within which the project must be completed, to the location of the project, to the level of qualification of the contractor. As a general rule, the more complex, time-consuming, and distant the project, the greater percentage of fee will be chargeable by the contractor.
Projects with unusual or award winning design are often times far more labor and material intensive than a typical project and as such command a larger fee percentage. Similarly, where the project involves the implementation of an extremely short schedule that in the absence of a contractor would not be possible, the contractor will invariably demand a high fee percentage (regardless of the type of contract) in order to incentivize himself to pursue the project. The rationale behind this is that the contractor’s financial benefit becomes the reward for its undertaking of the risk and burden of placing its resources at risk in a way that would allow it to achieve its goals. Of course, this is not to say that the contractor fee percentage should or will be even greater on particularly easy projects. Some contractors are content to profit from their efficiency and craftsmanship while others—perhaps those who implement a "volume builder" approach to a fee system—without as much concern for the quality and aesthetic of the work performed, will continue to layer on desired profit without regard to whether the project in question will be easy to build. The extent to which a contractor functions in either manner varies from contractor to contractor and forms one of the primary reasons for conducting as extensive an interview process as is practicable.
Industry Standard Contractor Fee Percentages
Contractor fee percentages for construction vary widely based on many factors. Generally speaking, the fee percentage is based on the cost of the work excluding overhead and profit on general conditions. The architect’s percentage is added back for fee calculations on construction contracts that combine the architect’s and contractor’s fees. Any amount in excess of the estimated cost of the work is deducted from the contractor’s fee.
Although the industry has not fully adopted a cost-plus markup template that clearly establishes the acceptable range of contractor’s fees, generally accepted cost-plus markups range from 5% to 20% based on the scope and size of the project. For example, the typical fee percentage is around 5% for general conditions below $1 million; 5% to 7.5% between $1-3.5 million; 7.5% to 10% between $3.5-10 million; up to 15-25% on projects greater than $10 million; and upwards of 25% for "special projects."
Certain types of projects have an exceptionally wide range of contractor’s fees. For example, the contractor’s fee to complete public works projects typically ranges between 5-15% on design-bid-build projects that are completed on a lump sum basis, but can be as high as 28-33% or more on design-build projects or public works projects that employ CM at-risk delivery systems. Another example is heavy highway and civil works projects that can expect a fee percentage between 5-10% depending on the project scope.
The cost of the work excluding general conditions overhead or profit that are included in the contract price can include soft costs such as design and construction management fees or hard costs associated with direct material and labor costs.
Contractor Fee Percentage Negotiations
The fee percentage is typically only one part of a contractor’s compensation package. Where possible, an owner should seek to negotiate a fixed fee, with defined and capped contingencies. Owners should carefully examine the contractor’s compensation as it is an important component in selecting the right contractor. When the contractor is an affiliate of the project’s lender, the contractor’s fees, even if in the form of contingent fees, can be inflated.
Ultimately, the contractor’s fee will be paid by the client, which is the owner or the lender, and thus need not directly pay the contractor. Instead, the contractor and its affiliate can internally allocate the affiliated fees to minimize the payment made by the contractor to itself. Therefore, the contractor must craft its affiliated fees in a way that will ensure the end result of the construction is an arms-length agreement, despite the fees being retained by an affiliate.
Contractors sometimes counter by saying they are willing to "pitch in" and do some extra work for no charge. This generally results in the contractor doing work of minor value. The most common example is additional contractor work, done after the construction completion date, in connection with the tenant fit-out of the building. This diminishes the value of this extra work in the eyes of the landlord, because there are more costs and landlord concerns in the period between the construction termination and the tenant’s fit out.
One strategy for reducing a contractor fee is to invite multiple contractors to submit bids for a project, and to allow them to modify the scope of services in exchange for reducing their fees. This can lead a contractor to reduce its fee, and increase its profit margin, by suggesting alternative methods of construction or changes to the design, resulting in the contractor performing the same amount of work for less fee. This tactic raises concerns related to the contractor’s interest in the project because it suggests that the contractor is not acting in the best interest of the owner, and rather is looking out for its own profitability.
Small reductions in fees can also result in significant overall savings, so bid strategies generally can be effective for large projects. Similarly, if the project is large enough, a contractor may forgo all or a percentage of its fees to secure the work. The concern with this tactic is that it will impact the cost of work, because, if the contractor is not receiving a fee, it may only be willing to incur its subcontractor costs, and it may attempt to offload responsibility for the work itself, or may only be willing to do the work if paid separately.
Again, because the fees are the cost by which the owner can ultimately judge the quality of work, while a contractor fee does not have to be paid by the contractor, a contractor’s fees are subject to less scrutiny than the fee portion of a contractor’s work. The most effective strategy for negotiating contractor fees is to directly compare the contractor’s fees, not just to the contractor’s competitors, but to the costs that the owner and the owner’s affiliates structure their fees.
Contractor Fee Percentage Calculation Towards Total Price
We can now plug our $10,000 into the following equation:
Total Price = Material Cost + Contractor Fee
It is important to note that this calculation is the total cost, including the contractor fee. You should not calculate the total cost of a project as $10,000 plus the contractor fee. A contractor’s fee must be compounded onto the material costs. Otherwise, you will wind up with a lower price point than the contractor intended.
To take the example above and turn it into a math equation, we take our $10,000 and multiply it by (the fee percentage + 1), as follows:
$10,000 x (0 . 15 + 1) = $10,000 x 1.15
$10,000 x 1.15 = $11,500
If you prefer, you could also take the following approach; however, the equation is much longer:
Total Price = Material Cost + Contractor Fee
Total Price = Material Cost + (Material Cost x contractor fee)
For example:
Total Price = $10,000 + ($10,000 x .15)
Total Price = $10,000 + $1,500
Total Price = $11,500
The two methods lead us to the same answer, $11,500. We wound up with the same result, just by looking at the situation from a different angle.
Implications of Contractual Law Issues
Sectie 4 – Legal considerations in contract agreements
When undertaking a construction project, the last thing you want to do is cause trouble for yourself and others. However, if legalities regarding contractor fee percentages are not suitably set out in your contract, disputes can arise. Therefore, it’s vital that you know what to include when drawing up a construction contract.
A construction contract is considered a legally binding document that clearly defines the expectations of all contractors, subcontractors and any other individuals involved. As a result, it must include a precise breakdown of contractor fee percentages. If this crucial detail is missed, chaos could ensue. For example, contractors may go ahead with a large number of building projects in their own name instead of yours. If you haven’t agreed to contractor fee percentages, you might find that you are making a loss.
The only way to truly prevent this is to be as transparent as possible when drawing up a construction contract. Clearly define the contracting company’s obligations and what the contractor will be expected to take care of. Also state how much you’re willing to pay them. If you have agreed to a specific contractor fee percentage, record it in writing.
Ultimately, it’s vital that you consider exactly what needs to be included in your construction contract.
How Contractor Fee Percentage Affects Budget
Factor X of a contractor fee percentage has a big impact on the estimated total cost of a project, including fees, in a new project as well as the estimated cost of the open-contracts the contractor is or will be managing. For example, if your target is a 10% profit margin on your fixed price, then the contractor’s 10% fee and profit margin are the same. But that will not be enough if the contractor has to pay for insurance and bond premiums based on the cost of the project. The contractor may have to pay 1% of the $11 million, or $110,000, in premiums in order to keep this cost off your bottom line.
If the owner and contractor can price insurance, litigation or arbitration exposure, and the like, the difference in the inappropriately inflated ۱۲.۱% percent and the appropriately estimated 10% contractor fee percentage will be less than the contractor’s percentage markup on those amounts, which would be 20%.
In addition, the risk shifted to and managed by the contractor and subcontractor translates to a zero-risk or cost risk premium of 10% for contractors and up to 30% for subcontractors. Similarly, a subcontractor who puts up a performance or completion bond, which is often required, pays 2% or more of that subcontract amount to an agent or broker, plus a 2% commission to the surety. Again, to keep those fees and commissions off your bottom line, the contractor and subcontractor build these added costs into their fee percentages. This is a zero-risk or cost risk premium of 2% or more.
As the risks increase and the contractor or subcontractor becomes responsible for more issues that it cannot really control , this zero-risk or cost risk premium also increases. A 25% zero-risk or cost premium is common.
The contractor or subcontractor may even apply a factor or percentage of 50%, or more, as a zero-risk or cost risk premium. It simply depends on how much of the risk the contractor or subcontractor is taking on and whether at the time a change order is negotiated and issued or when the contract is terminated, the contractor or subcontractor wants to keep bidding on your work in order to offset its fixed costs, including payroll.
Actuaries have developed sophisticated ways to determine the probability of a number of actual construction claims and the corresponding cost that will arise from them. They have concluded in many cases that the expected value of risk is $6 to $12 dollar per $100 or 6% to 12% of the total cost of a project.
So a $10 million project with a 10% markup and a 6% to 12% expectable risk would be $11.6 million for worst case litigation. This $11.6 million is before adding the fees paid to attorneys and experts and the direct costs of litigation, such as copying charges and deposition costs.
In this example, we see that the contractor is being fair to itself. It needs to cover unknown potential risks of less than 1, which is the discount from contract price the contractor expects and the contractor will realize in its income statement at the close of the project.
Remember, if much of the construction industry is charging fee percentages replete with a lottery-like risk when in fact statistically it is winning only a small fraction of the time, the cost of construction will be higher than it otherwise could be.