One of the best ways to make money on a real estate investment and to add another equity possibility to the mix is to buy a distressed property—one that needs some degree of work. Whether it is a complete gut job or simply needs a little TLC, you can often add increased value by buying properties that need improvement.
Why Do You Need a General Contractor as an Investor?
So now that you’ve decided to take on a construction project, you need to decide who is going to do the work. Your options are:
- You personally perform all the work yourself—usually only possible on extremely small projects.
- You act as a general contractor on your own property, which is called being an “owner-builder,” and find and contract with various subcontractors, such as electricians, plumbers, framers, etc.
- You hire a general contractor to run the entire job. They will have their own team consisting of their own employees, a trusted number of subcontractors that they use continually, and various vendors and material suppliers that they use on a regular basis.
When is it Right to Use a General Contractor Rather Than Being an Owner-Builder?
Obviously, not every construction project requires a GC to oversee it. Many smaller remodels or those needing just a face-lift can be handled by a savvy investor—one who has been there before.
But every investor should avoid starting off their construction career on their first rental, never having done it before and unfamiliar with any of the skills needed to do it right—meaning on time and on budget.
Also, note that some states do not allow an investor to work on their own properties but only their primary residence. Check your local laws.
An experienced general contractor will have many completed projects under their belts and will understand how to deal with subcontractors, building inspectors, vendors, and material suppliers to keep your project on schedule and as close to the original budget as possible. A do-it-yourselfer or owner-builder will require years of experience and multiple completed projects to gain this same knowledge.
A general contractor will add a certain percentage to the subcontractor’s prices and some materials as well—the number most commonly heard is 20%. So, for example, if their plumber is getting $5,000 for the plumbing work on the project, the GC will bill you $6,000 for the line item Plumbing. This pays the GC’s overhead and allows a small amount of profit for their management of the whole project.
But you don’t want to give up your hard-earned money to someone just to manage some subs that you could maybe handle yourself, right? On a typical $50,000 remodel, this would amount to $10,000.
Well, look at it like this: A good GC can pay for himself. How? This person will have good working relationships with subcontractors they’ve worked with before, and you can be sure that the GC gives them a few jobs every year. This allows the GC to be sure of their quality of work, as well as making them very loyal to the GC.
Having this structure can result in a subcontractor offering lower prices to a GC than you, the investor, would be able to receive. Not only that, but their ability to work together smoothly can keep the project on schedule.
How Do You Choose the Right Contractor?
Sure, it can be overwhelming, especially for a new investor or homeowner, to decide which of the many general contractors out there to decide to work with. They are all experienced in this new thing (to you) called remodeling, and you have very little idea what is going on.
That gives them an advantage over you, but it doesn’t mean that you cannot start off on a fairly equal footing. You don’t know anything about medicine either, but you can do your due diligence when choosing a physician, right?
Here are some tips that will help you choose a general contractor for your project:
- Get at least three bids. Ask friends for referrals if possible.
- Make sure contractors are licensed if it is required in their municipality. And check with the State’s Registrar Of Contractors to make sure their license is in good standing without any black marks.
- Make sure they have adequate liability insurance and ask that you be named as an additional insured on the project. Ask to see proof of a valid policy.
- This is maybe the most important thing: Make sure they have worker’s compensation insurance, and ask to see proof of this insurance. Don’t just say, “Are you insured?” If they do not, or if their subcontractors do not, all it takes is one fall by a worker, and they can come after you, the homeowner.
- Ask to see a proposal and contract from another job. They should be well-worded and lengthy.
- Of course, ask to see other projects that they have completed or are working on currently. Sometimes, doing a walk-through of a current project can reveal a lot about how they operate and run their job site. Is it neat and clean? Are the customers happy? Ask.
- Ask for a scope of work, which should list everything and anything that is included (and not included) in your project. Being extremely clear from the very beginning will save both the contractor and the investor/homeowner a lot of headaches as the project goes on. The most common cause of construction project delays and cost overruns is a lack of clarity and failed expectations between the parties.
- Never pay more than 10% in advance, regardless of what they may request. In fact, many states have laws that allow a contractor to only receive 10% or $1,000 in advance, whichever is smaller. The contractor can start getting draws on the project once they are on-site and producing verifiable results. Any contractor who balks at this approach should be avoided.
- Insist on lien releases before you give payment to them for their subcontractors, i.e., when the electrician is finished, and the general contractor wants a check to pay them for the final draw, get an unconditional lien release from the electrician (through the general contractor).
- Get a schedule of some sort included in the contract. You will realistically not be able to stick to it, but get it down in writing anyway, including an estimated completion date.
While it is true that an investor/homeowner can potentially save money by doing and/or running a construction project by themselves, I would argue that this is rarely the case. The combination of lost time, lost budget battles with subcontractors and lost opportunities to pick up the savings that general contractors can receive makes it a solid case to find a GC that you can trust and allow them to do what they are trained to do and have a vast amount of experience in.
This means the best thing that you can do to further your project and make more money is to find a great general contractor, and once they fully understand your goals and vision, stay out of their way.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.