Rehabbing & House Flipping

User Stats

25
Posts
14
Votes
Joe Latson
  • Lender
  • Denver, CO
14
Votes |
25
Posts

Complete Guide to Creating a Scope of Work

Joe Latson
  • Lender
  • Denver, CO
Posted Jan 5 2022, 07:31

A Scope of Work (SOW) is a description of planned property renovations, with the primary components being a line item budget and a construction schedule. A detailed SOW is important for nearly every type of value-add real estate investment strategy.

Your SOW has many uses:

  • as a guide for your contractors; to help keep your project on time and on budget
  • to help you and others (e.g. appraisers) estimate After Repair Value (ARV), which can help ensure a smooth closing
  • to support successful partnerships with co-investors and lenders
  • to standardize your data, so future investments can benefit from your past experiences

Every SOW should do the all important job of holding your general contractor and subcontractors accountable. A detailed Scope of Work allows you to stay efficient – improving your chances of completing construction on schedule and within budget. On the other hand, a lackluster SOW inevitably leads to further problems. If your construction team doesn’t view you as organized, they are likely to be less organized as a result. Similarly, if your financing partners don’t view you as organized, they may be less confident in your ability to execute your business plan.

Having an accurate SOW is a critical ingredient in determining if your target ARV is achievable, or simply a dream; a clear understanding of the property's post-construction condition is a prerequisite to determining its post-construction value. Not only does a SOW help you estimate the ARV – it helps others estimate value too. One important, yet often overlooked, benefit of a detailed SOW is that it can be shared with an appraiser to improve your odds of a favorable appraisal outcome. Why risk an appraiser guessing how you plan to renovate the home, when you can equip them with a SOW that beautifully illustrates your vision? Predicting ARV is hard, especially if an appraiser does not understand which repairs and upgrades you plan to perform.

SOWs have another important duty – setting the table for your financial partners (equity and debt), so they can gain confidence in your vision and ability to execute. Additionally, the SOW enables them to complete their own financial underwriting. After closing, the rehab budget and construction schedule form the basis for future capital infusions by way of construction draws. Most competitively-priced lenders fund rehab costs using a draw process, which often incorporates an inspection confirming that the completed work is part of the agreed on SOW. Without preparing a thoughtful SOW upfront, investors can be left confused when lenders do not approve a draw for work that is not part of the original approved plan. If the lender is unwilling to approve a related change order, it can create a problematic working-capital shortfall risk, which could have been avoided.

An under-utilized benefit of consistently maintaining a detailed SOW for each project is that the dataset you are building can be used to inform future investment decisions. For example, if you have completed three roof replacements that each cost around $10K, you can be confident in your budgeting for the 4th deal. This is true for all line items in your budget, including soft costs such as insurance. Having an informed grasp on your budget reduces risk and is a secret weapon to help you efficiently determine how much you are willing to pay for an asset to achieve your return requirements. Backflip borrowers can easily maintain this dataset with our easy-to-use construction budgeting software.

For all of these reasons and more, having an institutional-quality SOW is something every investor should strive for if they want to maximize their potential. Imagine if a football coach didn’t think ahead and set a game plan? They would lose every game; and likely won’t last a full season as the coach. Why would a real estate investor expect any different? There are a lot of unknowns, variables, and people involved in real estate investing. The organized investor, like the well-planning coach, are the ones who win.

Components of Scope of Work

The more specific and thorough your SOW, the better. Overall, it should include what work is being done, who is responsible, a timeline for the project, and the project’s estimated costs.

Project Overview & Objectives – this is a high level statement describing the goals of the project. For example:

Our business plan is to reposition the asset as a student housing rental that we will hold for cash flow returns while the overall submarket appreciates. We plan to complete the renovation by the end of June, so we can capitalize on the upcoming leasing season. We plan to implement the value-add strategies below:

  • To achieve Class A rents, we will complete a moderate cosmetic renovation with a focus on the kitchen and bathrooms (based on our competitive set research).
  • To increase and diversify revenue, we will convert the lower level to an individual unit with a dedicated entrance that can be leased separately.
  • To lower ongoing operating expenses, we will install a more efficient HVAC system, and upgrade the building envelope.

Team/Management – a clear understanding of who holds ultimate accountability for each portion of the SOW is a must-have ingredient for a well-executed project. This should be established up-front, so everyone’s expectations are aligned from the onset.

Project Budget – the construction costs are one of the most important inputs in your returns – they inform how much you can pay for an asset, as well as what you need to sell or rent the property for in order to meet your return requirements. Needless to say, it’s important to be as accurate as possible to minimize surprises and maximize your chances of success.

Project Schedule – the schedule is the guide that helps you ensure things are on track, and the right people are involved at the right time in the project. An accurate schedule helps to avoid surprises. Construction involves heaps of coordination between various parties, so a detailed understanding of when each component should start and finish is critical for a well-executed and efficient project (e.g. – paint can’t be complete until after drywall). Additionally, many budget line items are variable based on time – the longer the project lasts the higher the cost is (e.g. property taxes, insurance, interest expense) – so schedule delays can quickly lead to a busted budget.

  • Task List – great project managers don’t attempt to keep everything sorted in their heads; they rely on tools such as tasks lists to stay organized and effective. Before starting a project, it is helpful to understand all of the different things that need to get done, and make sure you are planning from them correctly as far as budgeting, scheduling and manpower allocation.

Loading replies...