The type of construction contract you choose fundamentally determines who bears the risk when things go wrong. For anyone financing or developing multifamily and commercial projects, understanding these contract structures is essential risk management that directly impacts project performance.
When a construction loan defaults, lenders often step into the borrower’s shoes by taking assignment of the construction contract. At that point, contract terms that seemed reasonable during underwriting can become costly problems. GMP (Guaranteed Maximum Price) contracts dominate multifamily construction at 60-70% of deals, with other structures making up the balance. Each allocates risk differently between owner and contractor.
The Eight Contract Types
Lump Sum (Fixed Price): The Gold Standard for Predictability
The contractor delivers the project at a preset price and absorbs cost overruns. This is the cleanest structure, with lower contingency requirements (2-3%), simpler draw processes, and straightforward administration. Most common for smaller, simpler projects (20-30% of multifamily deals).
The catch: lump sum only works when plans are 90-95% complete at contract execution. If GC net worth is less than 10x the contract value, payment and performance bonds should be required.
GMP: Balancing Certainty with Flexibility
GMP contracts cap the owner’s exposure while allowing construction to begin at 80-85% design completion. The general contractor covers overruns above the guaranteed maximum but maintains transparency through open-book accounting. This is the dominant structure for multifamily (60-70% of deals).
GMPs represent acceptable risk when properly structured with 5-10% contingencies. Red flags include GMPs set before 80% plan completion, contingencies below 5%, or missing audit rights.
Cost-Plus: Maximum Flexibility, Maximum Risk
Contractors receive reimbursement for all construction expenses plus a fee (10-20% markup or fixed fee). Without a not-to-exceed provision, most lenders won’t accept cost-plus deals. Used in less than 5% of multifamily deals, typically only for luxury projects.
The “plus” can be structured as a fixed fee (acceptable), percentage of cost (incentivizes spending), or percentage with a cap. Contracts should include mandatory conversion to GMP once plans reach 80% completion.
Design-Build: Integrated Delivery
A single entity handles both design and construction simultaneously, streamlining communication and accelerating delivery. Common for industrial, warehouse, data centers, and big-box retail projects (5-10% of multifamily).
The trade-off: owners lose independent architectural oversight. There’s potential for value engineering that cheapens finishes versus original plans, and no competitive bidding occurs. Typically structured as lump sum or GMP underneath.
Incentive Contracts: Aligning Interests
These layer performance bonuses (5-15% of contract value) on top of GMP or cost-plus structures. Contractors earn extra payment for early completion, cost savings, safety records, or hitting sustainability targets.
Very common for student housing (must hit fall move-in dates), retail rollouts (every day closed = lost revenue), and mission-critical industrial projects. The underlying contract structure matters more than the incentive layer.
Integrated Project Delivery (IPD): Shared Risk and Reward
A multi-party agreement between owner, architect, and general contractor where all signatories share in savings or losses. Profit pools distribute only if the project hits financial targets. Rarely used (less than 2% of projects), primarily by sophisticated healthcare systems like Sutter Health and Kaiser Permanente.
Requires full cost transparency and commitment from all parties. Many lenders won’t finance IPD deals due to unpredictable cash flow and limited industry experience with the structure.
Time & Materials (T&M): Pay-As-You-Go
The owner pays based on time spent, required materials (with 10-30% markup), and profit rate. Most common for renovation and remodel projects where scope is uncertain.
Without a not-to-exceed clause, this creates open-ended budget exposure requiring heavy oversight and frequent draws. Acceptable only if NTE provisions are included, otherwise lenders may reduce LTV by 5-10%.
Unit Price: Transparent Unit Economics
Pricing is established per unit ($/SF of drywall, $/CY of concrete), with total cost = estimated units × unit price + contingency. Most common for highway and road construction, site work projects where quantities are variable.
Moderate risk—total cost is unknown but unit economics are transparent. Easy to track progress and verify billing. Risk scales with quantity uncertainty.
Contract Selection by Project Type
Multifamily preferences by developer type:
- Institutional (REIT, Private Equity): GMP for fast-track delivery and budget certainty
- Merchant Builders (production): Lump sum for complete plans and value certainty
- High-End Luxury: GMP or cost-plus as design evolves
- Small Developers (under 50 units): Lump sum to satisfy lender requirements
- Adaptive Reuse: Cost-plus converting to GMP
Other property types:
- Industrial/Warehouse: Design-build (5-10% of projects)
- Student Housing: Incentive contracts layered on GMP (very common)
- Healthcare: IPD for complex projects (less than 2%)
- Highway/Infrastructure: Unit price contracts
- Renovations: Time & materials with NTE provisions
The Bottom Line
Start with plan completion:
- 95%+ complete → Lump sum (best pricing, certainty)
- 80-90% complete → GMP (balance of certainty and flexibility)
- 60-80% complete → Cost-plus with mandatory GMP conversion at 80%
- Under 60% → Wait or use cost-plus with not-to-exceed provisions
Layer in project complexity. Simple garden-style apartments suit lump sum. Podium or mixed-use benefit from GMP. High-rises, historic renovations, or disaster recovery may require cost-plus initially, converting to GMP as scope clarifies.
Finally, confirm your lender accepts the structure. Most construction lenders limit approvals to lump sum or GMP. Sophisticated lenders may consider design-build or IPD with proven teams. Almost no lenders accept cost-plus without caps or time-and-materials without not-to-exceed provisions.
The construction contract determines who holds risk when projects deviate from plan. For lenders, the goal is ensuring risk allocation is transparent, properly priced, and backed by contractors with balance sheets capable of absorbing the downside they’ve contractually assumed.
References
- Autodesk. “Types of Construction Contracts.” Autodesk Construction Cloud. https://www.autodesk.com/blogs/construction/construction-contracts-types/
- Block, Kenneth M. and Stuart B. Rosen. “Construction Contract Review From the Lender’s Perspective.” New York Law Journal, March 11, 2025.
- Fident Capital. “Learning Lunch – Construction Contracts” (Internal Training Materials, 2025).
