Why investors should be their own general contractor

[Stacy G.]

This is in follow up to a recent post by Engelo Rumora "The Top 3 People Most Likely to Rip You Off in Real Estate Investing"

Probably one of the more misunderstood words in construction is "general contractor". Based on my experience, what most people consider a general contractor is really a project manager. And therein lies the problem because many tradesman who advertise themselves as general contractors are not nor are they good project managers or business managers.

Merriam-Webster defines general contractor as "a person or business entity that contracts to be in charge of a building project usually involving the use of subcontractors."

When I started my career with a production home builder (general contractor) there was not a single employee in the company who lifted a hammer. But, we were definitely in charge of every house we built hiring designers, salespeople, bookkeepers, purchasing agents along with project managers. The latter being the person in the field who managed the vendors and trades in order to get the job done. The project manager was responsible for controlling costs and expediting completion of the project on behalf of..........you guessed it, the general contractor!

As an investor a project manager is the person you need on your team. Otherwise you are paying for overhead in the form of expenses which may not be necessary to your project as well as losing control of a critical aspect of your investment, construction costs. Plus you have the person overseeing the day to day operations of your business focused on your success.

NOTE: this is post should not be considered legal advice and is written from the perspective of conducting business in Texas. Rules & regulations in your state may be different and you should seek appropriate counsel on how to address state or local requirements for acting as your own general contractor.

Below is from a "whitepaper" I wrote for new investors a few years back looking for advice in how to best manage their rehabs. 

Begin whitepaper (edited version)

Why You Should Be the General Contractor: The Advantage for Real Estate Investors

As a real estate investor your goal is to know your business inside and out while rehabbing properties at the lowest possible cost. You can’t do that if you are leaving it to someone else to act as the "general contractor" of your rehabs without gaining knowledge. Worse yet, you are paying a premium for the management of a key part of your business. Doesn’t make a lot of sense does it?

Retail real estate and remodeling is a general contractor industry. And there is a perfectly valid reason for that model. Owner/occupants are engaging in a one-time transaction in which they require a professional to be their expert in all areas of the project. It makes sense for them to engage in a turn-key solution.

But, real estate is your business and in your business YOU should be the expert in the industry or at least partner with the right kind of experts.  What investors typically need is a project manager, but what they typically hire is a general contractor. Below are some reasons why the GC model is potentially not in the investors best interest.

What many GC's do is manage the scope of work & bidding process to get the job…….period. Lowest bid usually wins (and makes a newbie investor initially happy). A GC does not have a direct interest in the investor’s profitability. Their interest is in their own bottom line. Some are more honest than others, but you can’t change the facts. The GC’s objective is to position their bid such that an investor purchases a property and hires them to do the work. It is a GC's primary goal as they do not make money unless an investor makes a purchase. The investor's profit is not their principal concern.

The better solution? Hire a project manager who is invested not only in the rehab, but the overall profitability of the deal.

A good project manager is invested not only in a single project, but in the investor's long-term success. It should be a true partnership. You need them to provide an honest onsite evaluation of your prospective deal and rehab budget as we all know in certain cases investors (especially newbies) are so inclined to get a deal, they are blinded to whether it truly is a “deal”. Your project manager should strive to give you an honest evaluation of the rehab costs to prevent bad deals from happening, not the number you want to hear. No one has a crystal ball, but most investors prefer their (potential) bad news to come when they are analyzing a deal not after they are stuck in one.

Using a project manager has the potential to attract better subcontractors. Your project manager should not be focused on scoping the rehab at one price only to seek out the lowest quality/price sub or have a good quality sub shave their price so he can work in more profit for himself. They should use subcontractors on your job who charge a market rate for quality work. Plus there is a huge difference between retail and wholesale subcontractors. Your project manager should have relationships with wholesale subcontractors who have the same philosophy as the investor. Do quality work, but focus on what needs to be done to get the best return at the best sales price (ARV).

Here are some key points to remember when using a project manager:

- A project manager should be knowledgeable in real estate investing and provide advice to help you evaluate deals, not just bid on repairs to get the construction work.

- A project manager's fee should run you less than 25-30%+ a GC has in their bid for overhead and profit

- A project manager can provide you with a rehab budget are based on estimates which you both try to beat, not a fixed scope of work

- A project manager should negotiate with subcontractors on your behalf to get the best quality at the lowest price, not the cheapest work. 

- A project manager should be knowledgeable in permitting and other compliance processes to ensure a project does not get delayed, or worse yet work has to be redone, due to improper management of those requirements.

- Subcontractors should be paid at cost for their labor by the investor with no markup or commissions paid to the project manager.

- Materials (excluding some turnkey items like roof or HVAC) are should be purchased by the investor at cost with no markups or commissions to the project manager.

- A project manager should not markup change orders, plus they should work for you to get those done at the lowest cost (or even for free).

- A project manager's should be paid a flat fee (with or without bonus) such that their interests are aligned with yours to make the most profit on each deal.

Let’s get to the meat of the matter: A project manager working for an investor should have no incentive to use substandard materials or subcontractors. A project manager should not have an incentive to scope a project in such a way to make a profit off of change orders, markups, etc. A project manager should have no incentive, and I mean no incentive, to delay or otherwise not complete a project as quickly as possible as time should be money to them. Lastly, a project manager should have every incentive to help make their investors make money so they use them again and again.

End of whitepaper.

In summary, you will find many of your experienced/successful investors either hire project managers on a deal by deal basis or have project managers as full-time staff. So, if it doesn't make sense to them, it probably shouldn't make sense to you!