Early on in my real estate career I was a novice investor. I was learning the ropes of the business as I went along. In my early days of real estate investing I would pay contractors and subcontractors in full, and in advance, to do some of the rehab work on my properties. The contractors I paid in full, and in advance, would often do inferior work and/or would not complete the work I assigned to them. I would have to fire the original contractor or subcontractors I hired, and hire, and pay a second time, a new contractor or subcontractors to do the work over again properly.
I lost tens of thousands of dollars because the original contractors I hired to do work did the work incorrectly or the work was not completed at all. On several occasions I was forced to fire the original contractor or subcontractors I hired to do a job and hire a new contractor or subcontractors to correct or complete a job the original contractor or subcontractors failed to complete or do properly. This cost me time and money that I could not afford to lose.
I was paying contractors and subcontractors who poorly completed the work I assigned to them, only to have the city building inspector come out and inspect the work and not approve the work that was done. Few novice real estate investors know anything about window headers, framing, rough end plumbing installation, roof work, etc. Because most novice real estate investors don't know about these types of things, they must do everything possible to safeguard themselves from financial losses due to contractors and subcontractors poor or incomplete work. It is also important to make sure that the work completed by a contractor or subcontractor is completed to the standards of the city's building code.
How To Avoid This Costly Mistake
The best way to avoid this mistake is to first of all make sure you pay your contractors and subcontractors by work progression only. Only pay your contractor enough money to start the work assigned to him or her. Never pay the total amount of the work assigned to a contractor or subcontractors in full, up front. You will surely regret it if you do.
Pay your contractor and subcontractors by work progression and pay the balance owed only after the job has been successfully completed AND after a city building inspector has come out, inspected the work and approved the work completed. Pay your contractor or subcontractors the remaining balance owed in full after you receive approval from the city building inspector. This way you will ensure the work is complete and you will only pay once to have the work completed correctly.
The Rehab Construction Money Secret
Who doesn't put a cushion on the rehab construction cost? I have certainly been guilty of it. I would prefer to have more money in the escrow account for repairs than to run out of money and have it come out my pocket to finish the job.
In addition, there is another little trick that you can use to guarantee the job gets completed and puts tens of thousands of dollars in your pocket immediately after you get your final inspection from the private lender and a Certificate of Occupancy from the city inspectors.
For simple math, let's say that you take out a loan with a private lender to buy a $50,000 home with $10,000 in “real” repairs and an After Repaired Value of $125,000. The lender will loan you 70% of the After Repaired Value = $87,500 less $8,750 closing cost (estimated at 10%) for a total of $78,750.
The “real” repairs to rehab the home are only $10,000. However, you put a little cushion in the estimated repair sheet you submitted to the private lender to reflect a repair cost of $28,750.
Three weeks later you rehab the home and spend only $10,000. You receive a Certificate of Occupancy from the building department, the lender inspects the home, and it passes the inspection.
What about the remaining $18,750 that is in the escrow account? Guess what? The lender has to cut the check to you.
In addition, if you are handy with a hammer and nails and are willing to earn some “sweat-equity,” the Rehab Construction Money Secret works great because you can lower your expenses on your rehab construction cost and put more of the remaining rehab escrow funds in your pocket after you are completed with the project.