You've got your eye on the ball.
After weeks of chatting with motivated sellers, combing through the foreclosure lists and maybe even knocking on a pre-foreclosure door or two, you've got “The Deal” you've been looking for.
And now, with closing day fast approaching, it's time (among other things) to find the right contractor to make the magic happen.
Your eye is on the ball. Through what you've learned so far, you've got a pretty good idea of how long it should take, how much it should cost (give or take) and what the finished product will be like (not to mention how much money you'll make).
It's pretty much “understood”, right?
As a fix-and-flip real estate investor, it's a “given” that you want your project to be completed within the planned timeframe and budget, right? I mean, this is your deal, and you know the timeframe and finished product needed in order to make this thing work, and for you to come out the other side with the windfall profits you've estimated are clearly there.
But all too often, the picture changes, doesn't it?
Before you know it, you're over budget and way over time, and trying to salvage your deal. And instead of the “picture perfect” relationship you expected with your contractor, you feel like you're working more against each other than with each other towards a common goal.
What's the Problem?
When it comes to the important-but-trying relationship between investor and contractor, the biggest culprits for things falling haphazardly apart are most definitely…
- lack of communication
- poor communication
- no communication
- misunderstood communication
- conveniently “forgotten” communication
- See a pattern? Yes, that's right. Communication.
What's the Solution?
In my experience, the single biggest defense against allowing communication problems to deterioriate your contractor relationship and rob you of your hard earned profits is using a solid contractor's agreement.
And here are some of the troublesome issues it solves…
Beginning with the issue of communication (or lack thereof), 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 investors facing time pressures or unfamiliar repair problems, both groups fail to convey their desires in sufficient detail. Rehabbers can speak a language unfamiliar to the average contractor and are disappointed when the scope and quality of work aren't what they expected.
More often than not, yucky house investors 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.
Quality of Materials
For example, an investor tells a contractor to put in a new tub surround. He hears the investor loud and clear and, subsequently, makes a trip to Home Depot to buy the $29 tub surround, installs it and (rightly so according to our instruction) thinks he just did a great job.
The investor then receives a call from the contractor saying that the work is finished and drives to the property excited that his project is moving along well. But total disappointment awaits him when he arrives and discovers the appearance of the tub surround. The walls of the surround are wavy, and the edges are rough and unfinished.
In the investor's mind's eye, he envisioned a much more appealing tub surround. However, since he didn't communicate to the contractor that he wanted a quality surround that would have cost $129, he received a cheap one that was purchased for $29. Quality of materials is one area of miscommunication.
Quality of Workmanship
Materials are only half of the equation when it comes to a quality finished product. The other half is workmanship.
For instance, an investor may ask a contractor to paint the interior of a house. The contractor hears “paint” and “get it done cheap.” The contractor leaves, agreeing to do the job without charging much money. The investor leaves thinking, “This one's in the bag,” and begins to mentally spend her profits from the resale of the house as she drives home.
Meanwhile, the contractor does a little figuring. In order to complete the job for the price quoted, he can only afford to contribute a few days labor to the painting. Therefore, he has to buy the paint and get started right away without much “prep.”
When the job is done, the investor receives a call and happily drives over to inspect the work. Once again, though, she is 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 she wanted.
In short, she received a cheap paint job, which is what the contractor heard her request. However, she 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 he wants. He doesn't know the varying levels of quality for materials available for a particular job and assumes he 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 his mind.
For these reasons, investors have tremendous difficulty conveying to contractors their idea of a quality finished product. Therefore, 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.
A specific material list of desired materials to be used in the rehab is a very good idea.
It eliminates potential confusion between the investor and contractor on the quality of materials to be used.
Using the same materials on the list for all rehabs gives you reliability and consistency, producing the same finished product every time rather than dissimilar results which may produce dissatisfaction.
By documenting which materials were used, the investor saves many, many hours deciding which materials to use for each new job.
It allows 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 the project. While it will take some initial time to craft YOUR materials list based on your own preferences, once you finish it, it's done.
Scope of Work
The Scope of Work addresses many concerns regarding the quality of work to be done. While it's not necessary to meet each contractor bidding on the job at the site, each contractor should understand what is wanted in a finished product.
The Scope of Work does this, as well as the investor being specific when explaining his or her vision for the completed rehab project.
Because quality is subjective, don't assume that the investor and potential contractors are on the same page. If the investor wants the walls to be smooth, he must say so. If he wants the ceiling smooth instead of textured, he must say so. The more detailed he is in the Scope of Work, the better contractors will understand needs and the happier the investor will be with the finished product.
Additionally, a Scope of Work that specifically outlines the quality of materials and workmanship expected 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 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 her, and she overoptimistically estimates 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 her paying too much to acquire a project and that results in even more pressure to complete the rehab within her low budget. In any case, with her low estimate in hand, she searches high and low for a contractor who will agree to do the job within her limited budget.
Most contractors, even ones she has 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. She wasn't prepared to spend more, yet has no one willing to do the project for the funds she has available. This is when communication really begins to break down.
Ultimately, the desperate rehabber finds and begins to negotiate with a contractor, stating she can spend $XX,XXX. The contractor counters by stating what he can complete for $YY,YYY, which is usually more than the rehabber anticipated. Then the rehabber pleads her case, asking the contractor to do more for less. The contractor hears her out, and they agree on a price.
However, one BIG problem usually remains. The rehabber typically doesn't plead her whole case, so the contractor usually doesn't hear everything. What results is a shaky relationship between the rehabber and contractor. The rehabber unjustly expects more than she will receive and, since the rehabber never told him 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, the investor must educate herself on the prices in her area. She needs to speak with lots of local contractors and investors, take a few to lunch, walk through other jobs that investors or contractors are estimating or spend an afternoon in Home Depot pricing out materials for a rehab. She should ask lots of questions.
After a few lunches and walk-throughs, she'll start to realize that she's hearing the same repairs and numbers over and over again. Then she'll be ready to construct her own estimates. If she's still unsure, she should have a contractor or an investor double-check her numbers. She shouldn't worry about being exact, but be sure to include a “fudge factor” of about 10-20% to her total.
Finally, she needs to realize that she'll never know everything and will occasionally encounter a repair which she won't know how to estimate. In those cases, she should just find someone who does.
Throughout the process of estimating, remember that the investor's 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, an educated guess will be less accurate. Therefore, a higher number for contingency, or “fudge factor” should be included.
Big ticket items – roofs, kitchens, heating systems, etc. – are the primary concern and time estimating their condition and cost of repair is important. Little things such as paint, carpet, new light fixtures, and new switch plates are always going to be renovated.
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, but normally there isn't much room to maneuver if the contractor has been asked to work cheaply. Even so, the contractor wants the work so he lowers his already low quote and agrees to do it for the price the rehabber is willing to pay.
Then, part of the way through the job, the contractor realizes his quote was too low for him to make any money on the job and he will begin to turn the job into something profitable by beginning to cut corners. He uses cheaper materials, doesn't do everything as promised, or simply walks off the job, leaving it incomplete (especially if he's already been paid for the work that has been performed).
Solution: Use Common Sense
The solution to this money problem is as simple as to beware of the lowball quotes and use common sense. If the rehabber approached ten contractors who say it will cost $1200-$1500 and one who says $750 or $800 with half upfront, it's better to pay a little more and go with one of the ten. It will save a lot of time, headache and, in the long run, money.
Comparing Incomparable Quotes
Rehabbers often obtain multiple quotes and 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, so rehabbers need to be able to convey specifically what he or she wants.
Solution to Comparing Incomparable Quotes
Most importantly, when seeking quotes, the rehabber needs 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 submitting a bid is a great way to accomplish this. Also, in doing this, each quote that the rehabber receives will be very comparable to the others.
Dealing with a Draw Schedule
Mismanagement of repair fund is also an area that has derailed many rehab projects.
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 his 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.
A draw schedule is important to the rehabber because it protects the rehabber 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 the work is done, there is no incentive for the contractor to finish the job.
The contractor, on the other hand, holds the exact opposite view as the rehabber. He always wants to owe you more work than you owe him money. He has been burned by people who haven't paid before so he wants his money upfront. This way, if the rehabber fails to pay them at any time throughout the project, he can cease working on the project without losing any money.
As a result, at the signing of an agreement, the rehabber may need to do a little convincing and 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. The rehabber should also point out that the draw schedule will ensure that the contractor receives his money in a timely manner and ensure that he is 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. He is spending time and money to complete the renovation and doesn't have an endless supply of resources. He needs the rehabber's money to pay his bills, feed his family and stay solvent.
In addition, when he receives a paycheck, he will feel rewarded for a job done. It also protects him by ensuring that upon completion of his tasks, he will receive payment in full. It forces the rehabber to live up to his or her obligations and pay the people he or she hired.
When the contractor finishes his work, he should receive a timely payment in full. The contractor should receive 100% of his money when he is done with 100% of the work agreed upon.
Key points to remember:
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.
Not All Contractors Are Out To Get You!
Remember 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.
But even with the best of intentions, miscommunications will happen if you don't reduce your terms to writing. Trust me – it happens!
Using Your Contractor's Agreement to Screen Your Contractors.
Most quality contractors won't have a problem agreeing with the language contained in the agreement. 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 a good, written agreement to a contractor for his signature and he has a problem with acknowledging it, then that should be the rehabber's first red flag indicating that he or she may have trouble with the contractor in the future.