The Definition of "Contingency Fund"

[Jason Merchey]

What do you all think the definition of a contingency fund is? I am the money partner on a major rehab project - my first. My business partner is an architect and is fairly knowledgeable about the market, which is a bit insular here on the peninsula of Charles ton, SC. He has worked with a GC once before on a project, felt he was spectacular, and so we hired the guy to conduct the rehab - which is probably 30% rehab and 70% new addition. We have a budget of $150,000 with a $10,000 "contingency fund." There is a hard bid in place, meaning to me that the contractor's profits should be eaten up before we go over $150k + $10k, or $160k total.

My question is, on the second bill, for framing, a $3,500 charge was deducted from the contingency fund for wood-related repairs of the existing structure. This is a structure that dates back to 1875 or so, and has been updated who knows how many times since. It was one serious piece of **** though, make no mistake. Bad roof, some of the walls missing, no drywall whatsoever, knob and tube wiring, no plumbing to speak of, etc. It literally has laid fallow since 2006 - I bought it from an investor who was paying on the purchase but just never made the rehab happen due to the downturn. I should also note that the GC reduced his profit margin to less than 10% on this particular bill, which offset the use of the contingency fund. OK, the question: when I received the bill, from an investor perspective, I was surprised, because seriously, wood repairs? Even the least sophisticated observer of this place would have guessed that nearly 0% of the wood could be retained. The piers - even they were bad and needed a thorough repointing to be usable. I mean, the roof decking was these old, blackened cedar planks from God knows when. To think that those were assumed to be fully or partially salvageable, well, it just didn't make sense to me.

My business partner told me that I am thinking of "contingency fund" as "for acts of God and so on," which he believes is a mistaken understanding. I on the other hand am like "So you, an architect, and he, an experienced GC, felt that the house was in better condition than *I* did? Really?" I mean, did no one get up on a ladder and poke the wood with a screwdriver? Luckily, their assessment of the studs (these burly, rough-hewn hardwood from 1870) have survived fine, maybe 80%. Still, the budget for the rehab is like $100 per foot. So I just don't see the unexpected need for contingency. I feel like the bid should have been "$160,000 firm" not "$150,000 and also the extra $10,000" which is kind of how this feels.

Am I immature in regard to how flips work? Is this kind of thing an appropriate use of contingency funds? Or is the wool being pulled over my eyes on this? I would have thought that the funds would be used for, say, the government permitting office starts screwing things up for us, or a pier ends up being a failure, or materials prices rise 5% a month in the two months before framing could begin. But bad wood??

[Rick Baggenstoss]

So would you preference be that the GC price in 70% probable? @Jason Merchey I prefer to go the route where you demo, then recast the budget. You should have in your contingency on an older house a few lines of contingency, e.g.:

Framing Contingency - 70% chance of $5000

Permitting Contingency - 50% of $1000

Other Contingencies - 50% of $4000

Nearly every old construction house has wood rot issues ... predictably bathroom room floors by the toilet, kitchen floor by the sink, and roof decking ~5%. You should have this in your contingency ... because there's a good chance you'll have to do it and a chance you won't.

Rebuilding/replacing piers are 100% observable and should be in the budget. That's an oversight by the architect/GC.

$3500 on framing sounds significant. I'd confirm it doesn't have a ripple effect on insulation, sheetrock, trim, etc. and that's the full cost of the change so you know how much contingency you've chewed thru. The GC may go after the rest of the contingency because of the change.

Last word of advice, I think you should plan with a contingency with your partner, but also have a 'secret' contingency in your model. The contingency, if known, by the GC will almost always be used. You also need a 'timeline contingency' and 'real cost contingency' for truly unpredictable, lower likelihood issues.

By the way, I love Charleston. What a great place to do a project!

Rick