Proper Handling of Contractors
by Steve Cook
Time and time again, it’s been said that the most challenging element for an
investor in rehabbing a property 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.
Quality Problems
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 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 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.
Materials List
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.
Money Problems
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.
Bio:
Since 1998 Steve Cook has flipped many hundreds of houses as an active
Baltimore-area real estate investor. Steve's unique specialty is the "flipping
homes 1-2 punch", a proven system of real estate investing that powerfully
combines wholesaling and rehabbing houses. Steve Cook is dedicated to helping
others succeed through understanding and aggressively applying his time-tested,
step-by-step approach to flipping real estate.