I preach all of the time about the need to vet contractors carefully before using them on an investment property (or any property for that matter). There are simply too many fly-by-night contractors out there who will you tell you what you want to hear to get the job, but will ultimately burn you in the end. In fact, one of the reasons I really like the turn-key model is that it insulates an investor from ever dealing with contractors. (A turn-key property is purchased with the repairs already completed with no need to manage a rehab or worry about the funds needed for repairs –see article on this topic)
With that said, I’ll be the first person to admit when I make a blunder … and I will openly admit that I recently made a mistake that cost me some money. While we have great long-term relationships with the daily contractors in our investment business, I needed a specialty contractor to do some work at my personal house and I simply didn’t take the time to perform the necessary due diligence on this particular contractor. While this gentleman appeared to be very knowledgeable and professional, he was also less expensive than other more reputable contractors in this trade. Like many investors do on investment properties, I was more interested in using the less expensive contractor in hopes of saving a few bucks – mistake number 1.
After having met with this contractor 3 times and agreeing to pricing, I committed the job to him. Knowing that he was the kind of contractor that worked out of the back of his truck, it did not surprise me that he wanted me to pay for the materials up front. Against my better judgment, I cut him a check for the materials with the understanding that the work would commence a few days later – mistake number 2. Suffice it to say, it has been almost a month and this contractor is nowhere to be found.
I am not proud of the egg on my face from this experience, but I really think it’s worth sharing and reiterating the importance of working with reputable contractors – even when it costs a little more. In fact, this experience has led me to create a personal principle that I believe is worth passing on to other investors:
Never work with a contractor who needs payment before work has started (including materials).
If a contractor doesn’t have the means to float material costs and some amount of labor before receiving a draw, they simply aren’t worth the risk of doing business. I don’t care if it’s your friend, your cousin or even your pastor – a contractor who doesn’t have the cashflow to begin a project is one small crisis away from walking away with your money.
The great thing about a forum like BiggerPockets is the opportunity to learn from others experiences and mistakes. Having been in this business full-time for seven years, I have made my share of mistakes along the way. While I have learned from others, I am hopeful that I can also steer others clear of potential pitfalls. Unfortunately, working with bad contractors just happens to be one of those areas that new investors are especially susceptible to. To those investors I simply want to reiterate the benefits of paying a little more for a reputable contractor rather than compromising quality and honesty.
Photo: US Army Corps of Engineers
{ 25 comments… read them below or add one }
On another note, whenever you work with a Contractor, Tradesman, make sure that each person performing work for you is Bonded, Insured, and has a good reputation. If the contractor is working with you in the REO arena, do NOT hire a relative!!!
With so many camera phones, it makes sense to take a picture of the contractor and a picture of the truck/license plate right at the start. If the contractor objects, that is reason enough NOT to hire him/her.
Great article Ken. This is a lesson many folks learned the hard way.
Great article. I like your new rule & I am going to use it.
I don’t agree with the friend part. I have many friends who contract from me and can’t afford the materials. Let’s face it, rehabs are expensive and orders usually start at $2500. I wish my friends could afford it, that would mean they making good money from me and maybe even learning a thing or two. Some people just will never be able to save. Before they get the money, they’ve already spent it. You hope they are bright enough to listen to advice, but ultimately they decide how to spend it. It’s like the “How to buy a Lambo” thread on BP. Anyway, I maintain good relationships with contractors and trust them. Find people you can trust.
Ken,
Is there a good way for buy and hold investors to find reputable turn-key companies in specific locations? Is there a way for turn-key companies to be vetted and reviewed by other buy and hold investors? Thanks.
As a contractor I agree how about checking up on a contractor. But I disagree about not paying up front. I’ve heard too many stories of quality contractors who did a great job, and didn’t get paid. That’s why I ask for a third up front, that way most of the materials are covered in case the customer doesn’t put up the rest. Trust has to go both ways.
Jere – I agree that Trust has to go both ways. However, Contractors have the benefit of filing a lien against the property if a homeowner doesn’t pay. Conversely, if the contractor disappears with the homeowner’s money it’s much more difficult to track them down.
Let’s think about this realistically–why on earth would any one in their right mind put up the material costs for YOUR job, ever???!! It is YOUR material and therfore be paid by YOU! How could you expect someone else to loan you the money for your job for free? What is to stop you from saying “see ya later” after the contractor has bought everything and done half the work?
Tim, there are plenty of reputable contractors that will begin work without receiving money for labor or materials up front. However, to your point – if you’re going to pay for materials up front, at least pay for them directly (ie. Home Depot) rather than cutting a check to your contractor .
As a contractor I don’t agree. Evidently you did not completely vet the contractor. Did you check three references?
Being bonded in Tomball, TX does not mean a thing. I pay $100 to city hall and I’m bonded. It means nothing when someone goes after it.
If you cannot trust me with a downpayment on the job, after you check my references, then how can you trust me in your house? It’s people who do not vet the contractors properly and get stung that let these contractors get by with it. You cannot expect me to put up materials when I have been stung by a homeowner who did not want to pay. Do you know how much it cost to put a lien on a property, plus the cost of my time to do it. Not worth it on small jobs, so 40% up front covers materials, then I’m only out my time when screwed.
Daniel, I’m a licensed contractor myself so I completely get where you are coming from. As a contractor, of course I want to get as much up front as I can to protect myself and my time. However, I’m also a full time real estate investor who deals with subcontractors on a daily basis. When I put on that hat, I’m going to protect my interests as the property owner …. and as such, I choose to do business with contractors that can float the first part of a project on their own nickel.
I agree with you Ken a 100%! There is a lot of good contractors out there that want your business and will do things the right way and act like a true professional. Never give money up front as the contractor could disappear, go bankrupt , start a new business and keep repeating that method to other people. Not a risk anyone should take as there is not enough protection for customers. The contractor can lien the property if the customer doesn’t pay. Use all the right contracts including the scope of work and payment schedule that you and the contractor agree upon. If they want materials up front go get them yourself and have the contractor use them. That way if the contractor bails out you still have the materials. In this business when you don’t do the right things to protect yourself and your investment you will get burned and it will cost you!
Can’t really agree with that one. In some field you just have to charge in advance.
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We, for instance, are proxies and buyers’ agents, and if we don’t charge in advance, we’re often screwed over – people use our services to find the properties they want, then proceed directly to the seller, regardless of any contract preventing them from doing so, simply because they’re overseas and they think wouldn’t be worth our while (which is true, but once you collect a few of those it becomes very easy and worthwhile to pursue, so don’t get any ideas
We’re happy to work for months for our small, measley fee, but that fee is payable in advance, for our own protection – and not due to lack of funds.
At the same time Ken when I do a lot of work for an investor, (which I will be soon myself) I don’t mind a small amount of materials up front. I spent several years working for a Home Vestors franchise. But for the individual home owner it’s a different story.
A well written and informative article but in my opinion, the best thing before hiring ANY contractor is to do a good background – via internet, people who already hired him etc. Even a contractor, who isn’t asking for your money before he starts his work can be very unreliable and your whole rehab can drag for weeks, even for months.
I understand that this is your opinion but you should not be posting things like this and offering it as advice. Just because you had a bad experience does not mean that you need to bash every hardworking contractor. This same article is some how posted on Yahoo!Home and has offended quite a few people; mostly people who are in this job field that are honest and hardworking but obviously don’t have the funds to pay hundreds or thousands of dollars worth of material. My dad is one of them. He has done so many jobs where he paid out of pocket for materials and ended up getting screwed in the end and never getting paid. It’s the ONLY reason why he asks for material costs up front and brings the homeowner every receipt so that they know all the money went to materials. You should think about the little guy working hard to keep his family under a roof but is now losing business because of your misleading advice. Just saying.
Veronica – I believe it works both ways . . . the investor who gets screwed by a shady contractor is in the same position as the honest contractor who gets screwed by the shady homeowner. Though the contractor can slap a lien on the property whereas the property owner’s only way to deal with it is via the courts (and review sites).
I’m sure Ken will chime in with his thoughts as well.
Joshua- I get what you’re saying. I understand that it works both ways but instead of Ken saying “don’t pay contractors upfront”, how about saying something along the lines of how to look for specific licenses and how to do quick background checks of the contractor online through reviewer websites and what not.
Veronica – you obviously feel strongly on this topic and I understand where you are coming from as well – I’m actually a licensed contractor myself. As a contractor, of course I would prefer to get paid up front as a means to protect myself. But to Josh’s point, it works both ways ….. As an investor hiring a contractor, I don’t have the benefit of placing a lien on property … I would have to track the contractor down and deal with the court system.
To your comment on materials – I would agree that it is reasonable to ask the homeowner/investor to pay for some amount of materials up front. However, I would suggest that the payment for materials be made directly from the homeowner to the store. …. and that all materials remain on location.
I’m sorry you think my advice is misleading …. I realize there are plenty of good, honest, hard-working contractors that can be trusted with payments. The problem is – most people still need to protect their interests from the handful of contractors who can’t be trusted.
Ken- Thank you for your response. I’m happy you see my point of view and I can tell that you understand where my feelings about this are coming from. I also absolutely agree with your suggestion about the homeowner buying the materials. I think it should be added to the blog because the only thing I found misleading was “never pay upfront”. In my opinion, words like that can do damage to the small town contractors working check to check, job to job trying to keep bills paid and family members happy with little or no money left in between to pay for someone’s home improvement materials.
Ken, I saw your article on Yahoo, but decided to respond here..
I understand you are a licensed contractor, but do you market and sell your services to the public? When you’ve sold your services as a contractor to the public long enough, you see the other side of the equation.
The biggest mistake you made was choosing your contractor based on price. He probably wasn’t just the lowest price contractor for you – he’s probably been the lowest price contractor on every job he bids. That means he’s not as financially stable as those who charge a fair price for their work. Money changing hands means commitment. Believe it or not, there are people who are willing to sign a contract to pay and allow work to start when they don’t have the money or the intent to ever pay the bill.
And you put too much faith on lien rights. Holding a lien against a property only means that you can collect when the property is sold, refinanced, or if you take it into foreclosure. If you need to lien a property, you’re probably already second or third in line, reducing your odds of collecting at all. And trying to collect on that lien might cost more than the lien is worth – a contractor stands a better chance of collecting those funds in court, just like a homeowner can do against the contractor. It’s smart for a contractor to get lien rights – but a lien on someone’s property won’t feed your family when the homeowner decides not to pay you.
You guys, both contractors and home owners seem to over complicate the situation. As a contractor I personally will always charge a 10% start payment. I will give in my contract a payment schedule of when and how much progress payment are to be made. On the norm I will charge for a rough compilation payment (60%) only after the inspector saying every thing is completed and ready to proceed to the finish stage. Any decent contractor should have credit with whole sale houses and other stores to front cost for materials. If the owner has a problem making a payment at rough compilation I will issue a stop work order. This is to protect both contractor and owner, to make sure I don’t get in to deep into personal cost for the job and that the contractor is being paid only for what has been accomplished. After finish stage, and only after the inspector has signed off on every thing then I will issue the final billing. Which of course should be paid in a timely manner or risk incurring interest penalties. If that doesn’t work then yes I would file a lean on the house, but even that doesn’t guaranty a payment only that the house can’t be sold or further improved on. If you were to ask me to start work with a 0 down payment a alarm would go off in my head saying you may not have the finances to pay me. Its all about putting together a payment schedule in your contract that works for both of you. If you want zero to start work, i would just walk. I need a good faith payment from a client and i dont think 10% is out of order.
I know this is kind of an older posting, but I just came across it. It’s an interesting discussion.
As a contractor and a person who owns a professional contracting company, I can see both sides of this equation. The homeowner or investor doesn’t want to be left holding the bag for a shady fly-by-night contractor. But then the contractor does not want to be left holding the bag for an insolvent homeowner. I personally handle this a couple different ways.
First, on smaller jobs, I’m willing to take a level of risk going in however, I do not offer 0% down financing on anything. I’m a contractor, not a credit union. I charge a minimum of 10% down. It enures that the homeowner or investor has some skin in the game. If you don’t like that, then you are free to pay by credit card with me and allow those policies to shoulder some of your risk. Either way there’s money changing hands, one for protection and two to secure your scheduled slot.
On larger jobs, I break them into phases. Each may be interrelated and dependent, but each are billed separate. It helps to spread the risk again. If you want $80k in rehab work, it may be broken into 5 or 6 different phases. Instead of dealing with $80k, now we are dealing with several $4k to $8k jobs that can each flow into the next phase.
Finally, if you are calling my company to do a larger job, no work gets done until we have verified finances. You may have $100k in work to be done, but before I block off time from my crew’s schedule, I want to see that you have the appropriate level of funds to ensure completion and possible contingencies that may pop up. Depending on the size of the job, you may also be asked to be bonded to cover costs incurred in the event of default. It doesn’t happen often, but it does from time to time.
It sounds tough to deal with, but after being in this business long enough, policies arise to solve problems previously encountered. I’m not trying to be a bad guy or looking to pull one over on you. Business is business. As an investor, you have certain time and expense numbers to hit to make your profit. As a contractor, I have people and wages, insurance, licenses, marketing, legal, and accounting. We both have expenses. I run a top notch operation and provide a high level of service and consultation to my clients beyond just swinging a hammer. I treat all of my clients with professionalism and respect and only ask they do the same for my company.
It’s a tricky balancing act for both of us. There are too many contractors that have no idea what a balance sheet is and won’t be there by the end of the project, much less next year or the year after. Likewise, there are too many investors who watched an episode of Flip this House and want “pop” and “open concept” and whole room additions on a burned out 100 year old farm house for $30 grand. As an investor, consider yourself lucky if you can find a partner in a professional, stable contractor that can understand your motivations and work with you. As a contractor, I thank my lucky stars when I meet up with a knowledgeable and organized investor that understands the business. But until we meet up, be on your guard, but understand when a contractor gives push-back on financing your risk.
Hi.
Ok I found your site when researching this. My parents always told me to never pay upfront for contract work of any kind. But this is my neighbor who has done work with me before. (and I know where he lives… I can see his house and truck out my window. this is a 4k job and he is asking a bit more then 1k upfront. I just wrote him back (email) that the best I’d feel comfortable with is paying when the job is half way complete.
I found the other side first – that is an article with tips for contracters asking for money up front… I just replyed there and I pointed them to here as a referece. This is the sitE: http://thefreelancepinoy.com/getting-paid/9-tips-upfront-payments#comment-16527
My comment is awaiting moderation so I don’t know if it will be posted. As I started out with “Hi. I’m on the opposite of this transaction. I’m looking to have my driveway done and was shocked when the person (who did a little project for me before) asked for a portion up front. I just wrote him and told them all the advice I have ever heard – mainly from my parents who I respect highly – is to NEVER EVER Pay ANYTHING up front for landscaping/contracting/home improvement.” it may not get posted…. (as I may have insulted them.) I admit I was shocked at the article becaues I thought “everyone and his brother” KNEW you were never to pay up front for contracting.
so is there a happy medium? If you have a contract that specifies a full refund if not satisfied or if the person doesn’t complete the work in the time specified – does that fly? Or do you have to take them to small claimes? and if you do – can you sue for lawyer fees as well?(which is why I think most people don’t bother to try to get money back if it’s like <1000 because they would pay way more in lawyer fees…)
Thank you for your time.
- Sharon