contractor best practices

[Maria Diaz]

Hello, I am trying to vet general contractors. What is the legal maximum allowed amount for a down payment (%) on rehab projects? How do I avoid a mechanics lien on a future property? How do I make sure the subs are paid by the gc? Are lien waivers common in Indy? Any recommendation for GC's or construction companies? Thank you!

[Stuart Udis]

@Maria Diaz You’re asking all of the correct questions. Others may be able to assist with the Indianapolis specific regulations but most investors focus solely on cost when qualifying and selecting their contractors  but that’s a short sighted approach.

Sound contract management alleviates a lot of the concerns you raised. This means a contract between yourself and GC and just as importantly contracts between the GC and your the sub contractors. Within the contracts you can set expectations for payment terms, mechanics liens, insurance and warranties.  Large up front deposits are usually a red flag that the contractor doesn’t have operating capital which often  leads to project slow downs.  It’s  something I personally pay close attention to. I try to set the expectation for net 30 payments to my contractors with limited exceptions. Again if they balk at that, I view it as a red flag. Their ability to financially carry projects is incredibly important. Lien waivers are also helpful tools and always require them as you advance through stages of the project.

Make sure the GC and subcontractors list the property owner whether it’s you as an individual or an entity as additional insured. This is different than merely being a certificate holder and have appropriate insurance (builders risk and general liability). 

[Matthew Paul]

@Stuart Udis You are an attorney , correct ?  Do attorneys take criminal cases without getting paid a sum up front ?  Does a landlord let a tenant move in without first month rent and security deposit ?  

A contractor requiring a deposit of 1/3  is the norm . A contractor isnt there to finance the customers project .  I have been a contractor for 40 years , I have NEVER floated a customers project .  

A sure sign of a dead beat customer is them NOT wanting to pay the deposit , it is a big red flag that they dont have the operating capitol . 

There are too many wanna be flippers and investors that think they can operate on other peoples money . 

The contractor is not the bank . 

[Stuart Udis]

@Matthew Paul We can agree to disagree.  I never said a contractor shouldn't receive a deposit. For a bathroom or kitchen type remodel scope I will side with you, 1/3 wouldn't present any red flags but not for a more substantial renovation scope and certainly not as a general rule of thumb for all construction projects. If a contractor requires 1/3 payment  for a more substantial renovation project that is certainly a red flag. I would flip the script and argue under those circumstances the client is serving as the bank for the contractor and not the way you presented it. I also disagree  property owners who are unable or choose not  to pay 1/3 up front are dead beat customers.  In fact, the best and most qualified customers are the ones who are most bankable and are likely relying on construction loans that draw in arrears. 

The lone exception I can think of would be a scenario where the project  has highly customized materials or materials with long lead times. If that's not the case and the GC still requires 1/3 payment up front,  it means they have other projects that are suffering or lack quality subcontract relationships and can't place them on net 30's and when contractors are moving money around to cover for other projects,  that's a slippery slope. 

[Malcomb Stapel]

@Maria Diaz I can't help you out with the contracts portion, but I will reiterate what @Stuart Udis said, be very careful about providing money up front. If the scenario is the contractor is immediately going to be out for a significant amount of materials on day one, then you could consider it. Or, better yet, have them go to Home Depot and pick everything up, then have the pro desk call you for the charge. This can be a nice compromise where the GC isn't paying for materials out of their pocket and you aren't paying for labor that hasn't happened yet. 

[Sebastian Bennett]

Why in the world would you pay 1/3 up front? That's lunacy. If that's the norm in Maryland I will never go near that state. You hear of landlord/tenant friendly states. How about owner/contractor friendly states lol. MD would be at the bottom of the list it seems. 

[Matthew Paul]

Quote from @Sebastian Bennett:

Why in the world would you pay 1/3 up front? That's lunacy. If that's the norm in Maryland I will never go near that state. You hear of landlord/tenant friendly states. How about owner/contractor friendly states lol. MD would be at the bottom of the list it seems. 

 One third is Maryland home improvement contractors ( Mhic)  law . 

[Matthew Paul]

@Stuart Udis A contractor should Never put their funds or credit at risk on a customers project , the only exception to this is if the contractor is offering financing .  The job is always running on the customers money .  The first third gets eaten up rather quick , ordering materials , permits , dumpster , portable bathroom , etc . The job starts when the administrative work starts , not when you bang the first nail . 

Of course the customer is acting as the contractors bank , who else is going to ? 

In my 40 years of contracting we always get 1/3 down regardless of the size of the job , change orders are paid at the time of the change . if its not specifically included , its excluded . 

[Stuart Udis]

@Matthew Paul  As I said earlier, we can agree to disagree. I can understand your point of view on smaller jobs but not as a general rule of thumb. When I build ground up with budgets north of $3M and have $500,000.00 of site work that will takes months to complete, are you saying I should be paying $1M to the GC upfront on day one? That certainly doesn't fly in Philadelphia where I am located.  Any contractor who seeks those terms will be out of business rather quickly. Perhaps that's how your market operates but suspect that's not the norm as you describe it. I don't believe those who read these forums should be taught to pay 1/3 deposits. It will be a real hindrance to their businesses and there's plenty of Contractors who are willing to work without receiving 1/3 up front. 

[Matthew Paul]

@Stuart Udis Its pretty much the norm , I generally do smaller jobs $100K to $250k .  Sure there the unlicensed guys that operate differently . But the contracting businesses get 1/3 down at contract signing . 1/3 when we start on site , and final upon completion .  Its never been a hindrance . 

[Stuart Udis]

I still disagree with you. I am not sure if anyone ever cared to pull together the data but I am quite confident in saying a study that compared licensed to unlicensed contractors would tell the story of unlicensed contractors seeking greater deposits in relation to total project costs than those with all proper licenses. Not trying to pick a fight here, but these forums are quite impressionable on new or inexperienced real estate investors and don't want those who read these forums for educational purposes to believe they should expect or accept 1/3 deposits as the norm. 

[Matthew Paul]

@Stuart Udis Nothing wrong with disagreeing with me . I can only use my state as whats the norm . But too many times on this forum contractors are represented as rip offs . Told to have contractors sign the customers contract . You supply the contractors materials to save money .

There is also the impression if you are an "investor" , contractors will give you a better price. The answer to that is No !  Honestly if you are an investor , my advice is that you dont tell that to the contractor , because the majority of the good ones wont bother working for you  .  They want quality work , cheap price and done quick .  Professionals dont work cheap , or fast .

Well when dealing with a licensed , professional contracting company  , We have to follow the laws of our state . Our professional licenses are on the line .  Our contracts are detailed , very detailed .  ( Our base contract is 12 pages  before we get into specifics of the job ) 

Customers generally get ripped off by going cheap , with the unlicensed contractor , i have seen it too many times , and it actually cost more to do it over than do it right in the first place . 

The contractor isnt your enemy , he is there to give you a finished product at an agreed price . We are not hourly workers , but business owners , our employees are hourly workers . We are there to make a profit  , plain and simple .   

[Dalton Foote]

Based on my experience in the Indianapolis area there has been plenty of different payment formats I have seen. As a previous project manager for large SFH PM companies, to being a licensed GC and an investor myself currently I'm not going to say who is right or wrong because there's many ways you can go about this.

Personally what I have found to be best for our business to build rapport is to get paid in installments for the first couple of flips we do for a new client. This typically looks like 2 weeks of work before sending our first invoice with proof of work that was completed. For example if it is a 60k job and it takes 6 weeks we will usually be able to send 3 invoices for 20k each in phases upon scopes completed. (If that makes sense). Every friday an update is given along with pictures, a look ahead to next week, any issues or any feedback. Once a couple of flips have been completed together and we have built that relationship, we typically just go to a 50 upfront 50 at completion type of deal more typical with homeowner work (Not required, but its usually easier for both sides or we just continue a pay as we go basis). Most of our work are referrals as well and have never had an issue sending or receiving payments. 

I do agree with alot of points everyone has mentioned. From a PM, to a investor, to a GC company owner i see it from all sides. Just my two cents here on some comments. Not arguing because i agree with everyones point honestly. I have seen that Net 30 upon completion is typical for large pm groups that supply alot of work to subs generally for turnovers not major remodels. These jobs are 10-20k or less. Every pm group that we have done a substantially larger remodel for we have gotten 1/3 down and the rest upon completion. The Net30 has become increasingly more difficult to find due to the increase in prices from labor to materials. Some bigger groups switched to Net15 over the last 5 years even having a hard time finding subs that can float that many jobs for that long. I do agree with the point that alot of subs (especially from facebook, craigslist, etc) not being able to even pay for materials upfront or front a week or two of labor. That is a major red flag and have immediately cut all of those guys off. Typically that is the difference between licensed and just insured but not always.. It is just the industry and honestly people in general they do not know how to budget or make there money last. ( Isn't it something like 60-70% of people live paycheck to paycheck?)On the flipside you do have to think even legit successful companies also can't float every job that long. For example if payroll is 10k a week, have overhead, material bills, etc and multiple jobs waiting on payment theres potentially a six figure carry that adds up very very quickly.. To hedge that issue I think all parties can agree that verified work completed warrants payment which is why we do the installments to build that trust. At the end of the day your network is your networth. Once you find a reliable partner for these there should be no issues having that trust and expectation. 

I think theres a million ways to skin a cat as they say just know the red flags either way whether you are a contractor, investor, pm group, or homeowner. Hope this helps. Again this is just my experience in Indianapolis and im not saying one way or another is right or wrong :) Nothing to really argue about here. ;) I don't know best I just know what has been mutually beneficial for all sides and no complaints have ever been made doing it this way. Something to think about potentially. We all have to make money. Treat it as business relationship where it is mutually beneficial not just some guy you are trying to control and squeeze every bit of "what can you do for me" out of. We are all here to make money at the end of the day. Understand that and be a realist. Dont screw anyone over because of your ego in trying to have full control. :)

[Dalton Foote]

I just read in more detail the replies... I think we can all agree this is for single family home remodels.. commercial and multifamily is a whole different industry/ballgame when it comes to funding, draws, payments, etc. You can not compare them to one another or expect the terms to be the same.. Just to be clear for new investors.. 

[Shafi Noss]

@Dalton Foote I think this is the key point. 

Large projects happen slower. When I have done new construction between $500k-$1M in cost the contractor asked for 5% upfront, to be reimbursed at the draw that completes framing, and this was fairly standard in its market. 

I also have ownership in a general contracting company in Wisconsin that does single family restoration where a $50k flip job can be done in a few weeks. Here customers happily pay 20-50% up front.

One piece of that is that the 'profit' on each draw is not distributed but used to purchase the next round of materials so the project goes quickly. Without this speed the project is much less economical for the contractor and the client. But what that means is that contractor profit is still 80% backloaded even with the deposit and draw 'profit' (it is getting used for the next round of materials). 

Without the deposit the contractor may have funded 50% of the materials by the time they request the first draw, so the cash exposure is very high. I think each combination of job speed, size, margin, judicial vs. nonjudicial foreclosure, transparency level, etc. each turn the dial up or down on the appropriate deposit size. 

[Dalton Foote]

@Shafi Noss absolutely! Great points and insight here! 

[Shafi Noss]

Yeah and I'm handsome too!

[Matthew Paul]

Quote from @Shafi Noss:

Yeah and I'm handsome too!

 Mirror , mirror on the wall .......