Time and time again, it’s been said that the most challenging element for an investor in rehabbing a property or flipping real estate is working with contractors to ensure that the project is completed within the planned timeframe and budget. While there are numerous reasons for a project to run over time or over budget, the two main culprits are 1) lack of communication between investor and contractor regarding quality of materials or workmanship and 2) mishandling of repair monies by investor or contractor.
Beginning with the issue of communication (or lack thereof), we as investors usually ask for one thing while the contractor hears something totally different. While the reason for this might be that the contractors just aren’t listening to us, this isn’t necessarily the case. Many times, we don’t specify exactly what work we want to have completed. Be it newer investors unfamiliar with available materials and contractor lingo or experienced real estate investors facing time pressures or unfamiliar repair problems, both groups fail to convey their desires in sufficient detail. Rather, they speak a language unfamiliar to the average contractor and then become disappointed when the scope and quality of work aren’t what they expected.
More often than not, we investors in flipping real estate convey that the work should be done as cheaply as possible; however, we fail to communicate what we really want― “quality” work and materials for the cheapest price. Let me explain.
Quality of Materials
For example, we tell a contractor to put in a new tub surround. They hear us loud and clear. Subsequently, they make a trip to Home Depot and buy the $29 tub surround, install it and (rightly so according to our instruction) think they just did a great job for us.
We then receive a call from the contractor saying that the work is finished and drive to the property excited that our project is moving along well. But alas, total disappointment awaits us when we arrive and discover the appearance of the tub surround. The walls of the surround are wavy, and the edges are rough and unfinished.
In our mind’s eye, we had envisioned a much more appealing tub surround. However, since we didn’t communicate to the contractor that we wanted a quality surround that would have cost $129, we received a cheap one that was purchased for $29. So quality of materials is one area of miscommunication.
Quality of Workmanship
But materials are only half of the equation when it comes to a quality finished product. The other half is workmanship.
For instance, we may ask a contractor to paint the interior of a house. From us, the contractor hears “paint” and “get it done cheap.” “OK,” they say and off they go, agreeing to do it without charging much money. We leave thinking, “This one’s in the bag,” and begin to mentally spend our profits from the resale of the house as we drive home.
Meanwhile, the contractor does a little figuring. In order to complete the job for the price quoted, they can only afford to contribute a few days’ labor to the painting as opposed to a week. Therefore, they have to buy the paint and get started right away without much “prep.”
When the job is done, we receive a call and happily drive over to inspect the work. Once again, though, we are disappointed, this time due to shoddy workmanship. Everything is not caulked properly, patches covering prior holes are not smooth, and the trim is not “cut in” like we wanted.
In short, we received a cheap paint job, which is what the contractor heard us request. However, we had really hoped for something much better. In this case, quality of workmanship rather than quality of materials was the area of miscommunication.
Solutions to Quality Problems
In most cases, the investor doesn’t even know what they want. They don’t know the varying levels of quality for materials available for a particular job, and they assume they will receive high quality workmanship regardless of the price quoted by the contractor. The idea that someone might adjust the quality of their work downward to meet a budget never crosses their mind.
For these reasons, investors have tremendous difficulty conveying to a contractor their idea of a quality finished product. A Materials List (quality of materials) and Scope of Work (quality of workmanship) are essential in helping investors clarify their thinking and conveying their desires to a contractor effectively.
As a part of the Scope of Work, I have assembled a “Materials List.” This has several advantages.
First, it eliminates any confusion between myself and my contractor on the quality of materials I want them to use. Second, using the same materials on all of my jobs produces the same finished product every time rather than dissimilar results with which I may or may not be satisfied. Third, I’ve documented what I like and I don’t need to spend time deciding which materials to use for each new job. Fourth, it allows my contractors to call in their orders to Home Depot and have the store workers pull everything for them in advance. This saves them a lot of time as one trip to Home Depot for materials usually consumes 2-4 hours, precious time that could otherwise have been spent working on my project.
While it will take you some time to craft YOUR materials list based on your own preferences, once you finish it, it’s done. It was fairly easy for me as I already knew the materials I use. I just needed to spend about 2 hours one day in Home Depot getting all the relevant SKU numbers and prices.
Scope of Work
In my Scope of Work, I address many of my own concerns regarding the quality of work to be done. While I don’t believe it necessary to meet each contractor bidding on the job at the site, I do firmly believe that you must make each contractor understand what you want in a finished product. Do this by using a Scope of Work and being specific when explaining your vision for the completed rehab project.
Quality is subjective. So don’t assume that you and potential contractors are always on the same page. If you want the walls to be smooth, say so. If you want the ceiling smooth instead of textured, say so. The more detailed you are in your Scope of Work, the better contractors will understand your needs and the happier you will be with the finished product.
A Scope of Work that specifically outlines the quality of materials and workmanship expected also results in a set of bids that will be easy to compare. Since each contractor is instructed to use the same materials (e.g., same brand of furnace, same type of paint, etc.) and provide the same level of workmanship, the only difference between their bids should be the pricing.
The second and more important of the factors contributing to contractor problems is money. Mismanagement of funds will throw a project into trouble faster than anything else, particularly for those investors with limited resources. Let’s examine several issues surrounding the money aspect of rehabbing.
The opportunity to make some money is what brings the rehabber and contractor together from the start. The rehabber gets involved in a deal in order to renovate a home and make a profit. The contractor does work in order to earn money and make a living. However, their approaches to the project are exactly opposite. The rehabber wants to receive as much work as possible for as little money as possible, while the contractor wants to receive as much as money as possible for as little work as possible. When all is said and done, a happy medium needs to be found.
Low Estimates by the Rehabber
Sometimes a rehabber’s eagerness gets the best of them, and they overoptimistically estimate too little money for a rehab (remember, as much work as possible for as little money as possible?). Occasionally, this low estimate will result in them paying too much to acquire a project resulting in even more pressure to complete the rehab within their low budget. In any case, with their low estimate in hand, they search high and low for a contractor who will agree to do the job within their limited budget.
Most contractors, even ones they have used in the past, say they can’t do the job for what has been budgeted. (Note: This should be a red flag, particularly when contractors that have done well for you in the past decline to take a job due to your low budget). So the rehabber is left in a bad position. They weren’t prepared to spend more, yet have no one willing to do the project for the funds they have available. This is when communication really begins to break down.
Ultimately, the desperate rehabber finds and begins to negotiate with a contractor, stating they can spend $XX,XXX. The contractor counters by stating what they can complete for $YY,YYY, which is usually more than the rehabber anticipated. Then the rehabber pleads their case, asking the contractor to do more for less. The contractor hears them out, and they agree on a price.
However, one BIG problem usually remains. The rehabber typically doesn’t plead their whole case, and so the contractor usually doesn’t hear everything. What results is a shaky relationship between rehabber and contractor where the rehabber unjustly expects more than they will receive and, since the rehabber never told them the full story, the contractor expects to deliver less than what is really necessary.
Solution to Low Estimates
In order to avoid underestimating a job, you as an investor must educate yourself on the prices in your area. Speak with lots of local contractors and investors. Take a few to lunch. Walk through other jobs that investors or contractors are estimating. Spend an afternoon in Home Depot pricing out materials for a rehab. Ask lots of questions. A few lunches and a few walk-throughs and you’ll start to realize that you’re hearing the same repairs and numbers over and over again. Then you’re ready to construct your own estimates.
If you’re still unsure, have a contractor or an investor double-check your numbers. And don’t worry about being exact. No one ever is. Include a “fudge factor” of about 10-20% of your total. And finally, realize that you will never know everything and that you will occasionally encounter a repair which you don’t know how to estimate. In those cases, just find someone who does.
Throughout the process of estimating, remember that your goal is to make an educated guess, arriving at a number that is as close as possible to the final number given the facts at hand. If there are a lot of unknowns, your educated guess will be less accurate. Therefore, you should include a higher number for contingency, or “fudge factor.”
Also remember when estimating that your primary concerns are the big ticket items―roofs, kitchens, heating systems, etc. Little things such as paint, carpet, new light fixtures, and new switch plates are always going to be renovated, so assume that you will always do these things and spend your time estimating the condition and cost of repairing the big ticket items.
Unrealistically Low Quotes by a Contractor
Low quotes can be good, but not if they’re too low. Often a contractor will price a job out. Then the rehabber will ask the contractor to do the work for less. Occasionally, the contractor pads the price. Often, however, there isn’t much room to maneuver, especially they have been asked to work cheaply.
Even so, the contractor wants the work so they lower their already low quote and agree to do it for the price you’re willing to pay. Part of the way through the job, they realize their quote was too low for them to make any money on the job.
So they attempt to turn the job into something profitable by beginning to cut corners. They use cheaper materials, don’t do everything as promised, or simply walk off the job, leaving it incomplete (especially if they’ve already been paid for the work that has been performed).
Solution to Unrealistically Low Contractor Quotes
The solution to this money problem is to beware of the lowball quotes and use common sense. If you’ve approached ten contractors who say it will cost $1200-$1500 and one who says $750 or $800 but they need half upfront, pay a little more and go with one of the ten. You’ll be saving yourself a lot of time, headache and, in the long run, money.
Comparing Incomparable Quotes
Rehabbers often obtain multiple quotes and then use a quote from one contractor to negotiate a lower quote with another contractor. The problem in many of these instances is that the rehabber is not comparing apples with apples.
For example, a quote to install a Trane furnace is not the same as that for a Ducane furnace. Materials and methods can vary widely, and you need to be able to convey specifically what you want.
Solution to Comparing Incomparable Quotes
Most importantly, when seeking quotes, you need to ask each contractor for the same thing. Providing a Scope of Work or “spec sheet” outlining the details of the job in terms of quality of materials and workmanship to each contractor from whom you would like a bid is a great way to accomplish this.
Also, in doing this, each quote that you receive will be very comparable to the others.
Mismanagement of Repair Funds
This is also an area that has derailed many a rehab project in the past. Either investors advance too much money and the contractor disappears without completing the job, or the investor fails to meet his obligations and pay a contractor for their work when it has been completed. In order to ensure that both sides receive what they need, a draw schedule should be drafted and agreed upon before work on the project begins. Let me elaborate.
A draw schedule is important to you as the investor for the following reason. It protects you by preventing the advance of too much money to the contractor at any time throughout the project. For example, if an investor has paid a contractor for the entire job before their work has been completed, there is no incentive for the contractor to finish the job.
Here’s an example from my personal experience. I’ve done this many times (and always much to my regret), and many of you probably have also, but as a human being, my desire to help another person often made me forget past experience. So, often when my contractors would come to me on a Friday and say that they needed some money to pay their help, I would give in. They were usually about 90% done with the job and wanted to be paid for what they had completed.
So rather than holding back the entire final draw, I rewarded them for what they had finished and gave them enough money so that the total amount they had received from me to that point equaled 90% of the contract price. I did hold back 10% of the budget until they completed the job, thinking that I was still protecting myself.
Well, giving a contractor 90% of their due has proved to be the biggest mistake I have ever made as an owner. Once a contractor receives 90% of their contract price, there is very little incentive for them to return and complete the last 10% of the job.
The reason for this is that all of the little details that make up the last 10% can be as difficult and time-consuming to complete as the first 90%. The final tasks of a project are tedious, require attention to detail, and take a special person to finish. Therefore, since a contractor has most of their money, they would rather leave and take another job than finish the last 10% of the work.
Since I was sympathetic to their plight and thought I was “protecting” myself with a 10% holdback, I made the mistake of not holding back the entire final draw time and time again. That is one of the main reasons this contract exists today, to ensure that I (and anyone who uses this agreement) implements a correctly drafted draw schedule to ensure that the investor always owes the contractor more money than the contractor then owes them work.
Now, the contractor, on the other hand, holds the exact opposite view as the investor. They always want to owe you more work then you owe them money. They have been burned by people who haven’t paid before so they want their money upfront. This way, if you fail to pay them at any time throughout the project, they can cease working on the project without losing any money.
As a result, at the signing of an agreement, you may need to do a little convincing. Tell the contractor that one of the reasons for the agreement is to arrive at a mutual understanding so you can manage your draws well and build trust by paying the contractor on time. Also point out that your draw schedule will ensure that the contractor receives his money in a timely manner and to protect them by ensuring that they are paid in full.
In terms of putting money into the contractor’s pocket at the appropriate times, the draw schedule can be very beneficial to the contractor. They are spending time and money to complete your renovation. Most don’t have an endless supply of resources and need your money to pay their bills, feed their families and stay solvent. In addition, just like you feel great when you receive a paycheck, obtaining a check in return for their efforts is rewarding to your contractor.
The draw schedule also protects the contractor by ensuring that upon completion of their tasks, they will receive payment in full. It forces you as the Owner to live up to your obligations and pay the people you have hired. When your contractor has finished their work, they should receive a timely payment IN FULL. I do not advocate the distribution of partial payments under ANY circumstances. Pay your contractor 100% of their money when they are done with 100% of the work they have agreed to perform.
So sell the contractor on the benefits of the draw schedule to him and be reasonable (being too firm may ruin the relationship). Don’t agree to advance more than a normal deposit to the contractor to start the work and don’t deviate from the draw schedule once the work begins. Break either of these two rules, and you’ll be sorry. Follow them, and they will assist you on the path to rehabbing success.
NOT ALL CONTRACTORS ARE OUT TO GET YOU!
At this point, I’d like to caution everyone not to lump all contractors into one category. Not all contractors are poor money managers and not all contractors fail to keep their word. There are plenty of qualified, reputable contractors available who have built strong companies and stand behind their work.
Most quality contractors won’t have a problem agreeing with the language contained the agreements that I use. The reason for this is that they take pride in their work, stand behind their finished product, and manage their money well. If you present an agreement like mine to a contractor for his signature and they have a problem with acknowledging it, then that should be your first red flag indicating that you will have trouble with them in the future.
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