Scaling Builders - What Is Their Capacity?

Question

Our development company has grown by leaps and bounds over the last several years.  We now have the fortunate first-world problem of having far too much work.  I have been turning down projects for about 6 months now trying to give our operations part of our business a chance to catch up with our capital raising capacity.  This is finally starting to pay off and our builders are catching their breath.

This summer in Austin there were historic floods that have seemed to set the industry back several months.  Needless to say this has impacted many of our projects and the timelines for contractors have stretched considerably.  Many of the builders lost subs to jobs where they were restoring flooded projects and in general the subcontractor pool in Austin is very small for skilled labor.  The skilled carpenters who can do detailed finish out work are especially hard to find.

One of our new builders has on-site supers and has a 40-year track record of building projects in Austin.  He knows how to navigate the city and can build projects on time, on schedule, and on quality.  This is VERY hard to find right now.  I'm worried we're loading him up with too many projects though and that he'll get expensive soon if we give him too much work.

My question has to do with locating builders like this.  We have set up some meetings with local contacts that introduced us to builders with full crews, supers, etc. and the necessary overhead to handle our scale.  It is hard to develop a relationship with the builder quickly enough to meet our scale though.  I would like to do one project with the builder, see how things go, and then layer on more projects if things go well.  You have to go through a full cycle with a builder to know how they'll fare on inspections and what their finish out work looks like on the back-end.  Does anyone know of a good way to accelerate this process?  We have part time staff that can vet the builders and know what a quality builder's work should look like.  We also know what stuff should cost and in general what a good production schedule should look like.

Also....do you provide incentives for work being done on time and penalties for work coming in late?  How do you handle things when there are floods or non-planned-for events like extended rain that delay a project?  It seems good to give folks an incentive to build things faster, but not at the expense of quality.  It also seems unfair to hold people accountable for things beyond their control and I don't want builders walking off the job for punitive contractual penalties and forcing us to get someone else to warranty their work.

Any thoughts on these items?

Scott Brafford · Answer

These are good and complicated questions, I'll try to answer them as best I can but feel free to ask more if I confuse things in some way, but want to state the obvious that just like in real estate, EVERYTHING is negotiable in construction.

1) Are you using a standard form contract?  AIA?  Which one?  Most of my projects are GMP (guaranteed maximum price) and run in an open-book format which gives us a lot more flexibility to tweak things.

2) What size of projects are you doing and how many at a time?

3) Are there specific trades you have issues with in finding skilled labor?  You indicated finish carpenters, is that all?

If I were you and that was my weak link / main constraint I would direct hire some guys to do that part and treat them very well.  This can be excluded from your GC's scope, but be specific and the coordination will take some extra teamwork (i.e. maturity).  Note - insurance and liability will also need to be addressed.

If you can't justify full time labor, you could also look to hire install crews out of a local cabinet shop.  When I was a cabinet maker I wound up doing finish work frequently.  I was more expensive, but much, much better than any guy off the street.

You could also hire local (good) guys to do it piece-work on their weekends.  Often the best quality guys are also among the fastest - they are just better.  When I was a carpenter I made great extra cash doing this.  Me and another guy could hang doors, cabinets, and all trim in a house in one day.

If these items are also your contractors point of frustration they will HAPPILY let you handle that scope.

4) Yes, finding new GC's is rough.  Do due diligence as if this was your first project ever by looking at other projects, taking to past clients, etc.  Ask the clients open ended questions and let them talk.  Also make sure to ask your contractor to provide a reference of someone who doesn't like him - they will obviously resist and you will have to assure them that we all have someone who doesn't like us, justified or not.  You are doing this with everyone and will take everything they say with a grain of salt.

I also recommend you ask to see an example invoice, PCO, etc.  That way you can make sure it meshes with your internal system before the headaches start.

I haven't done this, but I imagine you could also flip the standard on it's head and have the builder tour one of your finished products so you can discuss expectations in detail.  Take lots of photos and attach them as an addenda to the contract.  That way come punch-list time there are no arguments.

THE KEY TO DOING THIS WELL is to have all of your arguments ahead of time.  Then it will go smooooth when it counts (*knocks on wood).

5) I rarely use incentives but it really depends on the situation.  How much is it worth to you if they finish early?  How much does it cost you if they are late?  It may not even be worth discussing since a smart contractor makes money is by finishing a project as fast as possible.  Just like your business, the faster you can cycle through deals the better your margins, and the more deals you can do.

The only time I think this is really important is if you have a hard deadline like a commercial lease with liquidated damages, a balloon payment on a loan, or something similar.

Budget based incentives really depend on your structure.  If it's open book you can do a shared contingency where the GC gets a % of unused contingency.  However, they will then be incentivized to classify things as change orders instead of absorbing them in their scope.  Always remember that people do what you incentivize them to do.

6) Rain delays and other unforseen items are always the cost of the owner.  How a delay is defined and how much it costs needs to be established before hand (see note on having all your arguments ahead of time).  It is also important to establish if it actually impacts critical path - if it rains and they can't pour the driveway, but the interior flooring is critical path, who cares.

How you do this, again, depends on your contract structure.  I typically require a GC to carry 7-18 delay days in their schedule depending on the project, but my projects are typically open book and if the delay isn't used then it isn't paid for.

The prenegotiated delay day cost should just cover the basic overhead expenses and nothing else trailer rental, toilets, insurance, etc).

Long winded, and I'm sure raised just as many questions as it answered.  Feel free to ask more.

SB

Scott Brafford · Answer

30 single family residences at a time is a solid amount of chaos to control.  Nice work.

Obviously I don't know much about how you operate at this point, but if you were my client I would probably negotiate one to three agreements with light commercial GC's.  More is better because you don't want their problems to become your problems, but you need a decent sized carrot at the same time.  I think targeting guys who do TI work with bonding capacity on the 2-5M range would be a sweet spot and they would jump at the chance to do ten homes at a time.  Also, TI contractors are really good at quality finish, finishing fast, and finishing on time.

I would strongly lean towards setting up a Master Service Agreement (MSA) which no small contractor has ever heard of, but is standard practice for the uber-big guys working in refineries.  This agreement would pre negotiate all the terms and some very competitive fees that would most likely waterfall down as your annual volume increases.   Or you may be able to get someone locked into a super low fee from the start.  Especially if you would be consistent business and have potential for growth (both are very attractive to an ambitious GC).  An MSA has lots of obvious benefits as you scale.

I have seen fees in the 3.5-8% range for this type of work.  That is fee + general conditions + insurance + bonding.  You'd add roughly 1.5% for insurance and bond in CA.  General conditions really depends on how you want them to staff the job(s).

SB

Bryan Hancock · Answer

We are flexible on the contract used.  We have a standard one we’re familiar with, but we use the one the GC drafted if they have a good one.  One of our builders has 40 years of experience and is great.  His contract is pretty good too.

Our projects are generally 1600sf – 2000sf.  For duplex/condo projects they’re double that.  We generally have about 30+ doors in process at a time and have had as many as 54 at one point I think.  The best builder candidates will have the capacity to do light commercial work as well since we’re likely to be doing some of this soon.

In general the trades on the front-end of the project are pretty easy to work with.  Where our smaller builders really struggle is with pipelining work once they get too many projects and with finish out work.  Stuff like demolition, foundation, framing, etc. generally goes pretty well.  The better builders can do everything well, but the smaller ones really struggle because they’re too small to have a lot of folks on staff to handle the volume when projects land at the finish out stage in parallel.

We don’t really want to be builders.  We want to hire builders and have them execute well even if it is marginally more expensive.  This also limits our contingent liabilities and warranty risks.  This is all carved out contractually the way we operate right now.

We have one person on staff that is experienced with building that can help us vet builders.  The trouble is that it is very hard to find quality builders that can hit budgets and schedule in the current economic environment in Austin.  Things are VERY busy.  A lot of the stuff you said to do are things we already do with our current vetting process.

An extra month on a project costs us about $5k/month in opportunity cost right now.

Jared Watson · Answer

This is more of a sit down conversation.

Good thing we are both local.

Let me know if you want to grab a cup of coffee

Manolo D. · Answer

There can't be penalties on Act of nature delays, it is not something that can be anticipated, on our end, a weather delay will always be an approved time extension. However, there is a special engineering way to do it. However, it might not be a normal build, walls and support first, additional temporary support if necessary, rood next, then all interior, this prevents rain delays, but it might cost a little more and the additional work delays the timeline.

I wish there is a problem like this in LA.

Scaling Builders - What Is Their Capacity?

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