I have always had the philosophy that I need to do what I do best and hire out the rest. This philosophy has served me well, but it means that I hire out all aspects of the rehab process. I have been disappointed at the end of many of my projects because I did not make as much money as I thought I would when I bought the property.
Many of my problems stemmed from hiring unqualified individuals either from a technical standpoint, a business standpoint, or both. Most of our problems however were a result of the disconnect between what I believed rehab and construction services should cost, versus what a reputable contractor charges to make a fair and decent living.
Obtaining a Contractor’s License
In Ohio, and I presume in other states as well, there are virtually no standards and no licensing requirements for general contractors. Proof of general liability insurance, workers compensation insurance, a $10,000 bond and $300 is all it takes to obtain a local license. There is no professional or business training required. I think this explains why such a high percentage of contractors fail, and fail quickly. Remodeling is a tough business even for those who are experienced and the best in the field.
What Construction Services Actually Cost
Even now when I walk through house I catch myself estimating repairs based on what we think they should cost, instead of thinking through what they actually cost. Many investors think they are going to get a job done for a certain amount of money by sheer force of will. Some people tarnish their reputations by bullying contractors to do their bidding and are constantly going through new people. We have seen this approach work in the short term, but it is not for us.
Cost and Mark-Up
The major mistakes contractors make when bidding a project include the obvious and not so obvious. One, there is the actual cost of hiring someone to do the work. Sounds easy, but by how much should the contractor markup that work? If the contractor is doing some or most of the physical labor, how much is he going to pay himself? Is he charging enough to cover his or her personal obligations? If well into the job he realizes he is not charging you enough to pay his bills, rest assured he will be distracted from the work at hand.
Second, there is the question of covering their overhead. Even the guy who works out of his house or truck has overhead. Overhead can add 20% to 40% to actual job costs. Overhead items any contractor must consider include at least some of the following:
- Workmen’s Compensation Insurance
- Interest expense
- Tools and equipment
- Bad Debt
- Licensing and fees
- Accounting and bookkeeping
- Legal Fees
- Education and training
- Association Fees
- Service and call backs
- Internet access
- Office expenses
- Office Supplies
- Staff Expense
- Sales and Marketing
If it is obvious you have a job quote that cannot possibly take into account reasonable and customary expenses and overhead, you have a bad quote on your hands.
What about profit? Any business owner should be in the business to make money. Profit, which averages single digits for the most successful contractors, is money the contractor should make above and beyond the market value of his physical labor and overhead. Again, if your job quotes do not reflect considerations for the actual cost of the labor, including the contractor’s, overhead, and profit, don’t be surprised if you struggle getting the job done at all, much less to your standards.
Let’s talk about materials. Is the contractor supplying the materials and if so at what markup – or any markup? Has he factored in the time to secure those materials? At our company we are buying most of our materials ourselves. We do this to control quality, speed up the process, save money, and to avoid being taken advantage of. We want a clear sense of where our costs are between labor and materials.
The Lesson Learned
It should be clear at this point that the lowest bid may not be best bid for your project. Having a basic understanding of the business aspects of construction and remodeling is just as important to your profitability as technical understanding or expertise. A great contractor’s reference book is Markup and Profit: A Contractors Guide by Michael C Stone.
Are you interested in diving deeper in to your personal mindsets and motivations as a real estate investor? Set aside 15 minutes and complete the Making Real Estate Work Mindset Scorecard. You will get instant results and insights to your own personal view of the business you may not even be aware of. www.PropertyManagementScorecard.com
For more information about The ROOST Landlord Advantage™ property management system, visit us at www.ManageWithROOST.com. Or email me directly at Chris@ROOSTRealEstateCo.com.