Conflict of Interest? Partner is also the General Contractor

[Ed B.]

I recently got involved in joint venture that's now starting to smell. The facts are:

Partner is a general contractor who was supposed do the rehab, with his efforts and also using subs when needed. He's working off rehab estimates he alone supplied. No other bids were obtained from other contractors so I can't compare the competiveness of his numbers. I tend to feel  his rehab budget  was based on  "best guess estimates."  Project is about 75% completed and he's saying the completion is near and should finish under budget. I hope he's right, but I'm also wondering, if his cost estimates were high to begin with, finishing "under budget" is sort of meaningless.  Also, there doesn't appear to be any clarity about who accrues any cost savings. Ideally, I think it should be the partnership. Rehab expenses have been financed with a construction loan, but the invoices he's been submitting for draw requests lack any detail. They simply say things like, "Fencing, $1000 installment, $500 balance due. Bathroom remodel, $2500 installment, $2000 balance due."

Presumably as items are completed the lender inspects to confirm the work is finished before issuing a check, but they are not asking for nor receiving detailed invoices for materials or labor hours worked.  This appears very problematic and ripe for abuse, because as long as the contractor doesn't exceed his rehab estimate, it appears he can accept a draw payment, reimburse himself for materials and labor, and pocket the difference. If he's not giving detailed invoices to the lender, I think he at least needs to be providing them to me, so I can understand when expenses meet, or exceed, or are less than his original estimates.   This is my first partnership where someone else was doing the buying of materials and labor. We have a written agreement that only says he will be in charge of "managing construction," but I definitely want to avoid a situation whereby he makes all the profit as the contractor, but leaving little or nothing to split to his partner. Does anyone else agree that it's a conflict of interest to have the working/managing  on construction partner also be the one who estimated rehab costs, and who is receiving draws without submitting actual cost data to his partner? I want to know how close he's coming to the budget, and most importantly, how much he's paying himself. Without that, I have no idea if he's keeping any excess, or setting it aside to be distributed to the partnership.  Would love any thoughts. Are my concerns legitimate or overblown?   Thanks!

[Ritch Bonisa]

There should be a contract for the work. This is no different than any other rehab. There should be an approved estimate and costs should be known. There should be 10-15% in reserve for unforeseen issues. There should be documentation on what is happening. Like any other rehab where you are using a contractor - funding should be cut loose in draws. Before draw 2 is issued, draw one must be verified and inspected to your satisfaction. Material and labor costs should be up front - that's part of an estimate. There should be a firm budget in place on this. If the contractor - partner or not, can't do all of this, then it's a bad deal. This is just another part of your investment equation - if it doesn't fit - it's a bad deal. This is just like scope of work on a rehab. Investor needs to know what the actual costs will be to rehab a property. If the costs aren't understood, inline and intended ROI can't be hit - it's a bad deal from the word GO.