Lesson Learned About Relational Concentration Risk in Real Estate

[E. James Jackson]

Hey Everyone,

I wanted to share a story from my work as an accountant that highlights a critical lesson a client of mine learned.

I've advised many real estate investors, and a group of flippers I work with ran into some significant challenges. They relied exclusively on one contractor. They claimed the contractor did great work, was fast, and never had change orders. However, over time project quality dipped, and timelines stretched. From my perspective, this meant increased holding costs and squeezed profit margins, creating tangible impacts on their projected income, not to mention the opportunity cost. This reliance exposed them to serious concentration risk.

I did not advise much on this at the time, but they went on to find a new "rockstar" contractor where this pattern repeated. They would rely on the contractor for so much, and not consult other GCs because he was doing so well. Trust led to lax oversight, and on a major project minimal progress was made over six entire months (the original construction timeline). The financial hole was substantial, turning a potential profit into a severe loss. After getting a handle on the situation, it took an additional six months to get the construction completed. This project was bigger, but the original six-month timeline turned into an entire year. 

These tough experiences led my client and I to dive deep into risk factors and overhaul their operations. Now, they always secure at least two competitive bids for every project, ensuring alternatives and financial security. They never assign more than three projects at a time to one contractor. They assign a single project manager to each deal, rather than everyone working on all projects (this avoids bystander apathy). We also set up a system of internal controls to monitor timelines and milestone schedules, catching issues within a few days, not months later when the damage is compounded. These changes have led to a far more stable and predictable financial outcomes for their business. If you are interested in more specifics on all of the internal controls and business processes I developed with the client, I am happy to share more details. 

This story is a crucial reminder: don't expose your business and investors to undue relational concentration risk. Over-reliance on a single external party can lead to significant financial vulnerabilities and unpredictable tax implications. It's rewarding to see their operations shift, and I hope this can help others avoid a similar loss.