As an investor your profit margin is much more important when you work with contractors then it may be for the average home buyer that feels a kitchen remodel will bring them money when they sell their home in 5 or 10 years.
The Contractor that you hire can make or break your profit in a number of ways.
Timelines– First is the contractor reliable enough to give you a specific time line for completion and then stick to that timeline. The longer you own an investment property the more you will have to lay out for mortgages, taxes, utilities and other basic but costly items. Additionally if one contractor is not reliable like an electrical contractor installing wall outlets then other contractors such as your drywall and painter can not complete their work on time.
Timelines in all of your contracts should be written in a way that the contractor will benefit by completing their work faster then the contract requires, paid even if they make the due date and penalized if they extend their work past the due date. This should also include any re-dos that are required by the home inspector. If a contractor does work that comes in early but they fail their inspection and extend the contract past the due date of the original contract then they are late and they should not be compensated for early performance.
Materials Costs and Markups
Another way that you can lose a lot of money with a contractor is if they markup the prices of the products they are working with in order to inflate the total cost of the contract. A contractor may come in with a bid that is low but they may not include the same quality product that the contract specified. For instance you want your windows installed you contract for 15 Anderson Windows and the contractor gives you a price based on the cheapest grade Anderson Window and not the standard or better grade window. Materials must be specific to the exact items and you must not make allowances for substitutions by the contractor unless you make an inspection of the product and agree with the price.
The contractor may also markup materials so high from their initial cost that you as an individual could get the same product retail for less. It is a common practice by Contractors to markup the cost of materials from their exact wholesale price. Contractors will topically get a 10% discount of most items and if they have a good purchase record they may enjoy discounts of as high as 40% to 60% on some items.
A 10% initial markup by the contractor should be considered normal because it costs the contractor money to arrange for the shipments and deal with the supplier. If the contractor must purchase items at retail prices which may also be normal in many situations then the contractor should be allowed 10% or maybe a little more over retail price to recover their costs of supplying the products for the job. However when contractors make unusual markups on materials it is usually a way to offset their labor costs. They may be working by the hour or by the contract but they know that if they markup their materials they will factor in a larger profit margin.
Honestly a contractor or business that charges an average $30 to $60 an hour to the customer is not paying his employees that for their labor. Their labor markup should cover profit and labor costs and it should not be shifted into the Materials cost.
As an investor you must work with your contractor and let them know that price and performance is an issue and just like they get discounts from their suppliers you will need discounts that the contractor may not give to an average home owner. This is a reasonable request and should not be objected to if that contractor wants to work with you in the future. An individual Home Owner may only do one kitchen every 10 years but you as a house flipper / investor will hopefully be installing many kitchens every few months.
Liens and other problems
Not everyone realizes that when they don’t pay their contractor the contractor has a right to place a lien on the property to regain the cost for the labor and materials they supplied.. Unlike the Bank that will repossess your Car if you don’t make a payment even if an electrical contractor could go into the home and rip out all the wires and fixtures they could never really regain the the cost of labor and the materials would become garbage so depending on the price of the contract you could see yourself in small claims or superior court when you fail to make payments to your contractors.
Something else thats even worse is when your General Contractor fails to pay their sub contractors. If you have a General Contractor or any contractor that uses other businesses those sub contractor can place a lien on your home when the General Contractor fails to make a payment. This can happen even when you have paid the General Contractor but they fail to make a payment to the Subcontractors that they hire.
For an example a HVAC company is too small to hire a licensed Electrician within their company so the HVAC company comes out installs your new Furnace and Air Conditioner but hires another company to do the Electric hookup. The HVAC company goes out of business the next day and fails to pay the Electrical Contractor………. Guess what that electrician can place a lien on your home under many State Laws. The Heater and Air Conditioner may have been installed and working for weeks but when you go to sell your investment property the Electrician applies a Lien and you can’t sell the house until you have given the electrician a Double Payment for their services and then you will have to go back after the now defunct HVAC company to sue them for not paying their Sub Contractors…..
Inspections
Work that a contractor performs that requires an inspection should have a performance and inspection clause … such as: Demolition, Electrical, Plumbing, Framing of Walls and in some States other Fields such as Landscaping for retaining walls over 4′ tall, roofing and siding and even something as simple as an above ground pool.
Whether you apply for the permit or the contractor does it is important that your contract requires not only performance based on what you want but also that the work passes inspection.
As an example as an investor you may say that for aesthetics that you want your porch balusters on your railings to be 4 and a half inches apart but it will fail inspection and then the contractor will have to redo the work. In this case the contractor should have informed you that the building code requires a 4 inch or smaller opening on railing balusters and your contract should require that his knowledge as a professional should be relied on when making these choices. If the contractor makes a mistake and alters your design that is one thing but if they follow your design and it still does not pass inspection the contractor should have been able to catch that problem before cutting the materials and performing the work wrong.
Payment Pulls
Payments are always an issue when you are dealing with contractors if the task that you hire them for is under $500 and will take less then a day you may want to pay up front and rely that they will do the work especially if you are there to inspect the work. I would only suggest this if you know the contractor well and they have a proven track record.
If you are working with an unknown contractor and the job is larger and will extend for many days then you will want to set up a payment pull sheet that allows the contractor to complete portions of the work and then request payments as the job proceeds. This protects you and the contractor. The contractor can use these payments to pay subcontractors or their employees or to purchase materials.
You should also decide if you will pay for materials up front or as the work progresses or at the end of the job. There are situations where a small contractor may not have the funds to justify them carry the costs for a large job.
For the most part it is better to not pay for Materials or Labor up front but there may be justifiable reasons to make prepayments.
An example If you were having a total remake of a backyard and this included a concrete patio to be poured it would be reasonable to pay the contractor for the pull to install that portion of the job and after the concrete work was inspected if need be pay right then for the concrete materials.
If you were to pay the contractor for materials before the final inspection the contractor may walk away when the work fails inspection if your contract does not include a performance and inspection clause. It is a risk you may have to take but not one you should do without forethought.
So, in conclusion when working with a contractor it is important to not prepay for labor or materials. If you do pay for materials then the materials must meet your exact specs and be used for that days work. The only exception would be special order items and in that situation it is in your best interest to pay directly to the supplier so the materials instantly become your property and then allow the contractor a small markup after the total contract is completed.
If you hire contractors for work that must be inspected you do not pay them if their work fails inspection. If you decide to prepay for some items your contract should withhold a third or more until the work passes inspection.
If your contractor has Subcontractors they must submit waivers to place liens on your property and final payment to the main contractor must be withheld until you receive those waivers from the subcontractors.
All contractors should show Liability insurance coverage and workers comp insurance coverage if not they should not be allowed to work on your property because their mistake or accident could end up costing you payments for health life or property damage.
All in all a tight contract that is in your favor is in your best interst at all times especially when the contract must be performed on a tight timeline.