The Terrors of the Time and Material Contract in Home Construction
There is a form of contracting prevalent in the home construction world that is very dangerous to the American homeowner. It is called the time and material contract. In construction slang it is known as “T & M.” This contract is the cause of run away costs on seemingly inexpensive home construction projects. The wise homeowner will be very, very wary of signing a time and material contract with any home construction contractor.
The basics of the time and material contract are quite simple. The contractor charges the homeowner for the actual time that all workers spend on the homeowner’s project plus all the costs of materials. The contractor’s profit is built into the hourly rate charged to the homeowner by the contractor for all of his workers. Sometimes a wily contractor will have the audacity to add a percentage as their fee or extra profit to the contract.
The T & M contract is almost always suggested by a contractor to an inexperienced homeowner. They will say that the homeowner’s job is just too complicated for a fixed price bid and the best way to do this project is by time and material. It always sounds so reasonable that the homeowner has no reason to believe that things will not go well on their project.
The time and material contract has been around for decades. It became very popular in the late 1970’s and 1980’s on industrial construction projects around the globe. The time and material contract was used on large scale industrial projects where it was thought that the teaming of the owners and the owner’s contractor would result in a win-win situation for both the contractor and the owner. The contractor would have limited risk and the owner would have a project built for about the estimated price.
The time and material contract on these industrial projects took the form of the cost plus fixed fee contract. The contractor was paid for all the hours of all their workers plus the cost of all the materials. The two were added up to give the total construction cost. Then the fixed fee percentage was multiplied times the total construction cost and then added to the whole. The typical fixed fee was in the 2% to 10% range.
Sounds reasonable doesn’t it? It wasn’t though. The catch was whether or not the owner had hired a contractor willing to take a reasonable profit on a project rather than a huge profit at the owner’s expense. It turned out that there were not too many industrial contractors that could resist the lure of easy money at the expense of the owner.
What actually happened is that the contractors used every means at their disposal to drive the hours of labor and material up as high as they possibly could so that the fee would also be higher. As it turned out the construction costs grew much higher. So high that owner’s around the world were almost bankrupted by this form of the T & M contract.
The time and material contract destroyed the work ethic in hard working construction workers by rewarding slowness and laziness. This behavior was condoned and even encouraged by the managers of the construction companies. The reason for this was because the contractor made more money the longer the project took to complete.
The T & M contract also encouraged the use of unnecessarily expensive materials in an effort to drive up the cost. When two equally qualified materials could be used for the construction the most expensive alternative would always be selected because it drove up the construction cost and thereby increased the contractor’s fee (profit).
The time and material contract has largely disappeared from the Industrial Construction world because of its terribly abusive practices and its inherent ability to destroy any construction budget. However, I am unhappy to report that it is alive and well in the home remodel and new home construction world in America today!
The American homeowner needs to stay far away from the T & M contract even if a contractor says it is the best way to work their project. In actuality it is only rarely beneficial to the homeowner but almost always extremely financially rewarding to the contractor. The time and material contract is a recipe for disaster for the typical homeowner inexperienced in home construction management.
How does this relate to the homeowner’s small remodel or new construction project? It relates very well because many contractors convince the inexperienced homeowner (in regards to construction) that it would be really difficult or near impossible to give them a fixed price for their project. They market the following kind of statement, “Your project is too complicated to give you a fixed price. However, I can promise you that if we do your project on a time and material basis your costs will be much lower.” It sounds good but the truth is actually the opposite.
This is because the underlying negative aspects of the T & M contract remain the same for the homeowner as they were on the industrial construction projects. They drive labor and material costs up as high as possible. An unfortunate student of mine found this out the hard way.
I received a phone call in early 2007 from one of my former students (from my class on how to be your own general contractor) whose project was in trouble. He had taken my class earlier when the Pat Fay Method book was not yet completed. Unfortunately his project was in trouble and he needed some help.
He wouldn’t give me any details over the phone but asked if I would come visit him at his house that was presently being remodeled. I arrived at 10 o’clock in the morning and the first thing I saw upon arriving was two framing carpenters taking a smoke break up on the scaffolding.
They were having a great time catching up with each other, laughing and carrying on. I couldn’t help but laugh to myself because it was obvious that these men were working on a time and material contract. The reason I knew this is because carpenters on a fixed price contract would have been working with a cigarette stuck in their teeth pounding away with their hammers or nail guns.
After we sat down in the owner’s kitchen I asked why he had signed a T&M contract when I had stressed in the class that it is the worst form of home construction contracting. At first he didn’t answer this question but immediately complained to me about how often they took breaks to smoke, to eat, to talk on their cell phones, and to discuss what they were doing. Some days there would be two workers and other days there would be three to four. He stated that the workers hardly spent any time working at all and that the project just barely progressed. He was so frustrated he was ready to explode.
I let him vent for awhile and when he had gotten it off his chest I repeated the question: why did you sign a T&M contract? His answer was classic. “I signed a T&M contract because the contractor told me my job was too complicated for a fixed price contract. He said that it was the best way to proceed on my project.”
It really was sad for two reasons. One, his project was a simple 960 SF addition to his two story house. One side was being pushed out 8’x 30’ and the front by 12’ x 20’. The scope of work was to add a new foundation, frame the walls, demo the existing, extend the floors, change the roof and add gutters. It also included new windows, new interior doors & walls with the standard electrical, lighting and flooring in the 960 SF remodel. That was it! There wasn’t even any plumbing as no bathroom was added and the kitchen was on the end of the house that was not being remodeled.
The second reason it was sad was because the contractor had two to four men working on the foundation and framing for SEVEN MONTHS! The foundation and framing should have taken no more than 6 weeks. To add insult to injury the framing wasn’t even complete! The contractor was completely milking the project at the homeowner’s expense.
After I read the owner’s drawings of his project, did some calculations, I estimated that this project should cost about $80 per square foot. This is less than the $100/SF that I normally tell homeowners because on this project there was no plumbing work. $80/SF x 960 SF is equal to $76,800. Add a few thousand for contingency and the project budget is $80,000.
This homeowner had already paid the contractor $135,000. He also had given the contractor a $40,000 down payment at the time the contract was signed that was not part of the $135,000. The total amount of money spent by this homeowner was $175,000! Besides the incomplete framing, the homeowner still had to pay for the installation of the roofing, windows, and all interior work. This unfortunate homeowner had already paid out twice what the project should have cost and the framing phase wasn’t even complete. The way it was going he was going to be lucky to finish up for a total cost of $230,000. That would be $150,000 more than the entire project should have cost.
Also, the amount of stress this poor homeowner was experiencing was terrible. He told me he would lay awake all night, he couldn’t eat, and he was irritable to his wife. All because he believed the following what the contractor said was the correct thing to do. In the Pat Fay Method we call that unwise. Unfortunately this scenario plays itself out all across America in every state in the country. This doesn’t just happen to a few people; this happens to hundreds of thousands of people every year throughout America!
I offered to walk outside with the homeowner and fire the contractor right then and there. I promised to stay with him until the workers had cleared their tools and themselves from the site. The homeowner declined my offer because “I can’t fire them because they still have my $40,000 down payment”.
I had taught this homeowner in my class not to pay a large down payment at the time the contract is signed. I had also stressed that no matter what to never sign a T & M contract. (The only exception to this rule is for limited demolition work but the homeowner protects themselves by building in a not to exceed maximum cost to the contract.)
Why had this homeowner gone against what he had learned in the Pat Fay Method class? This homeowner was inexperienced and unsophisticated when it came to home construction. I have learned from working with homeowner’s on their home construction projects that they have a need to have a contractor hold their hand and take care of them.
The big problem with this though is that there are not many contractors in America that want to hold the hand of the homeowner. Like all businessmen, what they want is to make as much profit as they possibly can. Chapter 16 (Lessons Learned from Homeowners) in the Pat Fay Method book discusses this subject in greater detail.
The best contract form the American homeowner can use is the fixed price contract. This is where the homeowner agrees to pay a fixed price for the contractor performing a fixed scope of work completed in a certain period of time. The Pat Fay Method book has an entire chapter (Chapter 9) dedicated to contract documents. Most homeowners don’t realize that they have a right to modify the contract to be sure their requirements are included. After all, the contract is a document for two parties. The contractor brings expertise in some construction skill and the homeowner provides money.
The Pat Fay Method is a professional construction management book written for the homeowner. If you are a homeowner that does not want the above scenario to befall you then invest $40 and read the Pat Fay Method. After all the homeowner is either going to follow the Pat Fay Method or the contractor method. Available at www.patfay.com or email patfayinc@aol.com.