A note from Justin:
Today we have a GREAT guest post from Mike Simmons of the Just Start Real Estate podcast. Mike recently interviewed me for his podcast, which was a lot of fun. I’m a big fan of his stuff and I was really excited that he was able to write up this great post on getting contractor quotes and managing your rehab projects. There are a lot of great gems in this one! I’m sure you’ll find a lot of value.
Take it away Mike!
They say, in real estate investing, that the profit is in the purchase price. This means that the purchase price, and knowing the after repair value (ARV), is where you will either make or lose money in real estate investing.
While getting a property at a good price is extremely important, when flipping houses, you can just as easily go from having a good deal to having a bad deal during the rehab process.
I have personally seen investors who bought a property at the right price and wound up either losing money or barely making any profit at all because the rehab was either poorly estimated in the beginning or the rehab process was poorly managed.
I am not going to cover how to accurately estimate rehab in this article, honestly estimating rehab takes experience. It’s tough to teach experience.
I am, however, going to cover the two main areas you should be most concerned with when it comes to rehab-
The quote process
Once you have an accepted offer on a house and the purchase agreement is executed, in other words, you and the seller have both signed the purchase agreement and the earnest money has been received, it is now time to start quoting the rehab.
It is important that you do a walk-through of the property on your own prior to meeting with a contractor to make a list of all renovations that you want to have done to the property. This should actually be done before you ever placed a bid on the property, but if you are a more experienced house flipper, you may have put a bid in based on your knowledge of your target market and experience. If you are a new real estate investor, it might be a good idea to do a walk-through of any property on which you were thinking of placing an offer.
If you are an inexperienced house flipper, the bidding process should be done with some urgency. Typically you get a seven-day inspection contingency on any house you purchase. You should make it your goal to get in, meet a contractor, and get their quote before the end of that seven-day period. This way, if your rehab estimate was way off, you can back out of the deal and get your earnest money back. Many experienced investors will waive their contingency right in order to make their bid look more attractive to the seller. While this is fine for experienced investors, if you are a new investor, I suggest you leave the inspection contingency in the purchase agreement.
When it comes to estimating rehab remember, the goal of real estate investing is to make a profit. Understand that you will not be living in this house, and the goal is not to make this house look how you would want your personal home to look. The idea is to maximize your renovation budget and to make improvements that will appeal to the general public and maximize your returns. Generally speaking kitchens and bathrooms are going to be where you get the biggest bang for your buck. You want your house to look a little better than your competition.
When people are looking at houses to buy for themselves, they will not just look at one, they will look at several. You want to make sure your house looks better than every house they look at before and after yours! If the other houses your buyers look at have granite countertops, you better have granite countertops. If every house your buyers look at has crown molding, I suggest you have crown molding. Keep in mind, however, if the other houses that you are competing with have Home Depot off-the-shelf cabinets, Formica countertops, and builder grade fixtures and lighting, you only need to be a little better than those houses. If a $15,000 budget will accomplish that goal, then don’t spend $30,000.
Your rehab budget and scope of work should be exactly what it takes to sell your house quickly and for as high a purchase price as the market will bear.
After you have made a list of all of the renovations that you would like done, it is time to start meeting with contractors at the property. You should have a prepared list of renovations or a “punchlist” printed out and made available to each contractor. This punchlist should clearly and completely list all of the items that the contractor is expected to quote. It should also clearly define the materials that the contractor is responsible for and any materials that you are responsible for purchasing.
You should have 3 to 5 contractors quote the job and schedule to meet with them as soon as possible. I have used Craigslist in the past to find contractors. You can and should also reach out and ask for recommendations from other experienced real estate investors. When it comes to hiring contractors for rehab projects there is one thing that you need to remember – friends and family do not make good contractors. [Tweet this] You have to trust me on this one. It’s a rule you should never break, no matter how tempted you may be!
I suggest that you meet with all of the contractors on the same day, at the same time and walk all of them through the property together. Some people question this tactic, but I have used it with great success in the past. It ensures that you are getting all questions answered at the same time and giving all the contractors the same information. If you make separate appointments for all 5 contractors, be prepared to be stood up and waste a lot of time. Like I said, you should try to get all quotes back within your seven-day inspection contingency.
When it comes to contractors I cannot stress enough the value of working with a general contractor (GC). This will allow you to have one point of contact, and the GC will, in turn, hire all of the subcontractors and create a logical, efficient workflow so that all work gets done in the proper order. This will save you a lot of time and headaches of dealing with contractors that can never seem to play well together!
In my experience, contractors struggle with making deadlines. If the contractors commit to getting you a quote within four days for example, call them on the second day and ask them if they have any additional questions and verify that they are on track to submit the quote on time. You would be surprised at how much this helps you get the quote on time. It basically tells the contractor that you are on top of things and organized.
Once you have received the quotes and reviewed the cost and timing it is time to decide on a contractor. Remember there are two main factors when evaluating a quote – the cost and the timing of the project. A lot of investors are so focused on getting the lowest cost that they fail to understand the importance of getting the job done quickly. Holding costs can eat up the savings you gain by going with the lowest bid. There are a lot of factors that can go into how much you eat up in holding costs each month. Depending on how you financed the project, you may have monthly installment payments due each month. Additionally the following monthly holding costs may apply:
- HOA fees
- Property taxes
- Homeowners insurance
- Grass cutting/snow removal
These expenses can add up very quickly. Therefore, the timeline should be a very large consideration when evaluating the quotes you receive from any contractor. If you are not experienced enough to know how long a project should take, it would be worth your while to speak to an experienced rehabber and get their opinion. You should also be able to get a pretty good sense of the timing after reviewing the five quotes. Chances are, the project timeline is going to be similar between each of the contractors. If the contractor you wish to award the job to has a timeline that is a little bit long, talk to them and see if there’s any way they could reduce the timing. It’s not a good idea to press them too hard to condense their timing however. They may agree just to get the job, and then not meet the timing.
You should always use a contract or written agreement of some kind when working with contractors. The written agreement should cover the following 6 items:
- Total cost of rehab including all labor and materials
- The overall project timeline including date of completion
- The rules and responsibilities of the contractor as well as your role and responsibility as the property owner
- The draw schedule – how and when the contractor will get paid.
- How any extra or unexpected expenses will be handled
- Any restrictions on time of day that work can/cannot be done.
The contract should also contain the full legal name of the contractors company as well as their contractor license number and insurance information and any other applicable licenses that they carry.
Although it doesn’t necessarily need to be in the contract, you should have a conversation regarding how often the general contractor will personally be on site. Your general contractor does not necessarily have to be there all day every day, but you want them to be there regularly to manage their crew and make sure that work is getting done in a timely manner. It is your responsibility, however, to make sure that the general contractor is there when he or she is supposed to be there and that the work is moving along according to the agreed-upon timeline.
This article is not about screening contractors, but understand that it is very important to check references with any contractor that you intend on hiring. You should also verify that they have the proper insurance and that it is current.
“It’s not what you pay a man, but what he costs you that counts.”
– Will Rogers
Managing the rehab
It should be your goal to schedule your contractor to begin working the day you close on the property. Too often I see investors allow precious time to slip by after closing on the property because they failed to schedule the contractor to start the day of closing. Do not wait until after you close on the property to schedule your contractor, they are most likely working on other jobs as well and need time to schedule your job into their plans. It is also at this time that you need to get all of the utilities to the house turned on and put in your name.
As the property owner and investor, you are ultimately responsible for the success or failure of the project. Do not be afraid to ask questions. Make sure that you know what is going on at all times. You should personally visit the job site as often as you need to in order to be fully aware of the work that is getting done and to make sure that the project is progressing on schedule.
The contract that you and your GC signed should outline how and when draws will be distributed. A draw is simply a payment made to the contractor for completed work. This can be handled any way that you and your contractor agree, however there are a few guidelines that you should adhere to –
- The initial draw will happen at the very beginning of the project before any work is done. This payment will allow the contractor to start buying materials and get the project off the ground. A general rule of thumb is that the initial draw should not be more than 25% of the total cost of the project.
- The rest of the funds can be drawn any way that you agree upon with your contractor. However, make sure that payments are only made when work has been completed.
- The final payment should never be made until after the final walk-through with your GC and all work is completed. Never make the final payment until you are completely satisfied with the work.
Regarding the issue of extra or unexpected expenses – this is something that can blow your budget and significantly eat away at your profits. Things can and will come up, but these expenses need to be controlled and approval from you should be required before spending money on any unplanned expenses. If your contractor presents you with an expense that was not in the agreed upon original scope of work, evaluate it carefully. You should not just agree because the contractor tells you it has to be done. Ask questions and make sure you truly understand what you are spending the extra money on. Don’t be unreasonable. If the expense makes sense, and you understand why it is needed, then approve it.
Because I have a relationship with my contractor and we have done many jobs together, I tend to give him a lot more decision-making power than I did when I was starting out. If you have never worked with a contractor before, you should definitely set limits on the amount of money that they can spend without getting prior approval from you. The amount you let them spend without getting approval should be whatever you are comfortable with, but I would suggest keeping the number under $200. That way you don’t wind up getting an unexpected bill at the end of the project for thousands of dollars that you didn’t even know your contractor was spending. In the beginning you can stipulate that any unforeseen expenses required your approval until you are comfortable and have a relationship with the contractor. Be careful however, you don’t want to cause a delay in the project because you were unavailable to approve a $50 expense for example. Losing a day of work is probably going to cost you more than that in the long run.
Like I said, your biggest job as the investor is to monitor and manage your general contractor without getting in the way or impeding their ability to get the job done on time and within budget. Making sure that the subcontractors are on the job site when they’re supposed to be is important. Too often contractors have many projects going at the same time, and if they get in trouble or behind on another job, they may decide to pull the workers from your job and move them on to a different project. This is not okay, and cannot be allowed. If you allow this to happen, before you know it your project is behind schedule.
Although you need to be there regularly, you are not there to work, and you are not there to run errands for the general contractor. It is your project and you are paying the bills. Do not allow your self to be talked into running to Home Depot every 15 minutes. The GC has a timeline and they are professionals. He or she needs to manage the project, get the materials to the job site, and coordinate the subcontractors.
Be sure to look at the quality of the work during the course of the project. There are two main reasons why it makes sense to point any issues out as they come up during the project –
- It will feel far less uncomfortable and confrontational if you tactfully point things out as they come up rather than present the contractor with a long list of issues you would like addressed.
- Pointing issues out as you notice them will make the general contractor aware that you are on top of things and paying attention to details. This should make them more conscious of the details as well.
Flipping houses is a fantastic business to be in. It takes time and experience to get really good at it and comfortable with the whole process. That being said, it is very possible for beginners to jump in and have success early. Just understand that issues can and will arise. It is important to stay calm, evaluate the situation, and then adjust accordingly.