One consistent complaint you hear from investors is how hard it is to find good contractors. In the real estate investing world, contractors have developed a bad reputation, some of it is deserved, but many of these contractors have well intentions. There’s even a joke about the first three letters of contractor spelling CON.
When people ask me for a recommendation for a general contractor, the best I can do is provide names of people to interview with a clear warning that I am not “referring” them. Unless the investor is willing to pay a premium, I wouldn’t be willing to bet my reputation by personally referring most contractors.
Related: Why You Shouldn’t Ask for Referrals
To learn how to fix this issue, I spoke with Ryan Garcilazo and Holly McKhann to get their insights on finding, screening and managing contractors. Ryan brings the contractor’s perspective, having flipped over 600 homes, walked 5,000 properties and being recognized by INC 5000 as a top contractor. He is the founder of Rehab Depot. Holly shares the investor’s point of view, with over 200 flips in the competitive Southern California market. She is also a buyer’s agent and host of the “Secrets of Real Estate Investing” podcast.
How to Find a Good Contractor
If you’re looking for a new contractor, I have some bad news and some good news. The bad news is that you’ll never find the “A-level” general contractor for your project. These general contractors are developers with capital and liquidity in their company. They build larger and more lucrative projects like luxury homes, restaurants, hotels, and other commercial facilities. And quite frankly, they have no interest in working for investors with thin budgets and minuscule margins.
Then you have the contractors who focus on retail homeowners. These homeowners aren’t looking to turn a profit. They just want a nice kitchen remodel. This allows contractors to charge a markup of up to 33% of costs to cover their overhead and profit. Investors could never work on retail contractor budgets, as they need to get the most amount of work done for the least amount of money. What’s left is the “B,” “C,” and “D” general contractors, but finding a good one is a challenge.
“A good general contractor should have general construction knowledge to oversee the entire project,” says Ryan. However, in Chicago and the state of Illinois, general contractors do not need to pass any basic construction test to become licensed. All they need to do is purchase insurance, complete an application, and pay a fee to the city. This leads to a host of “general contractors” who have limited construction knowledge, if any at all. Many are common crews who worked together on various jobs in a subordinate capacity and lack the business or construction experience to perform as an effective general contractor.
Avoiding Contractor Pitfalls
The good news is, you can definitely find a good “B-level” general contractor and we’re going to give you the secrets to identify them and keep your project on schedule and on budget. However, first, we have to understand the pitfalls that come with these lower-tiered contractors. This second tier of contractors usually lacks sufficient liquidity and capital in their company so managing draws and cash flow is critical.
“Most contractors are not good money managers,” says Holly. Many of these contractors live check-to-check and may struggle to make payroll or cover material costs. This leads to a vicious cycle of using draws (construction payments) from one project to fund work on another project. If the draws fall off schedule, they fall behind on the job and face upset clients and unpaid crews who are forced to look for another gig.
Unfortunately, this was the situation in my first rehab. The general contractor had projects going with five different investors and was commingling the funds. He used the draws from one project to advance the next one. And when one of the other projects did not receive the anticipated draw due to a failed inspection, the house of cards came crumbling down, all his workers quit and each investor was left picking up the pieces.
Finding Good Contractors and Managing Renovations
So how do you avoid these parallels and find the best amongst this tier of contractors? Holly starts by tapping her peer network of investors to find contractors. Other great tips are to ask subcontractors like electricians or plumbers and visit Home Depot or Lowes early in the morning when contractors are picking up materials for the day.
Once you’ve identified a potential contractor, one of the biggest mistakes investors make is interviewing them at a Starbucks, according to Ryan. Most GCs will just tell you what you want to hear and won’t be comfortable in that type of environment. Instead, visit one of their job sites and start asking about the project. Coincidentally, visiting a rehab project in your local market is also another great way to find a potential contractor.
“Most investors come from a corporate culture,” Ryan says. “But independent contractors work in the blue-collar world and the consequences and expectations are very different.” It’s imperative to put them in a comfortable environment if you want an accurate read on what it will be like to work with them as your contractor.
By observing the crew and asking about the project, you get a much better sense of the GC's knowledge, process, and overall leadership. Here are some key questions you want to ask during the jobsite interview:
8 Interview Questions to ask a Contractor:
When did you start this project?
How many weeks did you plan?
Will you finish on time?
What’s the budget?
How are you tracking?
Where are you getting cabinets and materials?
Who owns this project?
What’s their contact info?
Once, you’ve completed the interview process you’ll want to contact the owner of that project for a reference on the GC. If the reference checks out there are two more steps you need to take before hiring the contractor.
How to Make Sure You Don't Get Ripped Off
You want to run a background check and ensure that the contractor is licensed and bonded. Many contractors may only have a license, but those who are bonded provide the ultimate level of protection for you the property owner.
If you ever have a dispute with the contractor, they can simply place a mechanic lien on your property which would stop you from being able to sell or refinance the property. As the property owner, your options are limited. You can sue but many contractors have no assets to go after and the legal cost may not be worth the hassle. Insurance covers damage to your property caused by the contractor and worker's compensation but it won't cover disagreements or the cost to repair or replace shoddy work.
Working with a contractor who is bonded will provide the best protection as it will protect you if they did not pull proper permits, pay their subcontractors, or perform shoddy work. Many investors learn these lessons the hard way and it can be an expensive lesson. The overhead cost for an insured and bonded contractor will certainly be included in their estimate and passed on to the property owner but it can give you peace of mind as a property owner.
Once you've completed the background check, the next step is to plan and manage the actual rehab. When you get a project under contract, you want to get alignment on the budget and ARV with your 4-person team, which consists of the investor, contractor, lender and real estate agent.
Related: Building Your Championship Team
Developing a Scope of Work
You’ll want to do a pre-walk with your real estate agent and contractor to discuss key details for the rehab. The agent will help the investor understand what finishes are needed to deliver a certain ARV, while the contractor will point out any construction concerns. This information will be used to develop a detailed scope of work (SOW). Holly uses Google Sheets to create and track her detailed SOW and has her contractor update the actual budget weekly. This document tracks costs by each line item so she can monitor expenses and even ask for specific receipts to verify costs.
After aligning on the plan and devising the SOW, there should be a pre-construction walkthrough prior to closing. This final walkthrough will ensure the team is aligned and ready to begin work immediately after the closing.
“If you did not do a pre-walk and pre-con, you did not setup your contractor for success and it’s the blind leading the blind,” says Ryan.
It’s one thing to find a good contractor; it’s another to actually set them up for success. In the same way, a championship team needs a strong game plan to win, you need a strong SOW and rehab plan to have a successful project. It’s certainly a challenge to find good contractors, but these tips will help you identify good ones and lead a successful rehab.