In our previous Lessons, we learned how to create a detailed Scope of Work for the project which is used to receive bids from our Contractors.
Our Scope of Work and the bids that we receive from our Contractors need to be broken down by Category for 3 critical reasons:
- Helps us better understand how much we are spending and where we are spending our money on the project.
- Helps us better estimate and budget repair costs for future projects.
- Helps us create a Payment Schedule that can be used to pay the Contractors based on work performed.
In this Lesson, we will discuss how to Create a Payment Schedule, how much to pay your contractors, when to pay your Contractors, and how to keep your Contractors motivated to finish the project on time and on budget.
Why Create A Payment Schedule?
Once you have selected a General Contractor for your project, you will need to negotiate the Contract and Payment Terms of how and when the Contractor will be paid for the project. The best way to establish the project Payment Terms is to create a Payment Schedule that you can include with the Project Contract.
Remember, Negotiation Is All About Finding a Middle Ground, Addressing Each Other's Concerns And Establishing Terms That Are Fair And Reasonable For Both Parties (Win-Win).
How To Find Middle Ground
If this is your first rehab project there is a good chance that you and the Contractor have never worked with each other, so you both have concerns and fears about the other party.
The Contractor is concerned that they are going to buy and install a bunch of expensive materials in a property and won't get paid back, so they will be forced to put a Lien on the property in order to get paid.
The House Flipper is concerned they are going to pay the Contractor a large down payment and the Contractor is going to skip town and steal their money.
- Concerned about not being paid for work performed
- Concerned about paying for project costs out of pocket
- Wants to be paid as much as possible, ASAP
House Flipper's Fears
- Concerned about Contractor skipping town with a down payment
- Concerned about timeline, budget, and quality
- Doesn't want to pay until work is completed
In order for this relationship to work, the Contract and the Payment Terms need to address the concerns of both parties.
The best payment strategy to address these concerns is to create a Payment Schedule that breaks down the budget by Category and pays the Contractor once the work is completed.
This Payment Schedule arrangement addresses the Contractor's concerns about paying too much out of pocket, and it gets them paid as soon as the work is completed.
This arrangement also addresses the House Flippers' concerns about paying the Contractor too much money upfront and walking away from the project.
Unfortunately, you will often times run into a Contractor who wants to be paid 50% upfront for the project. They will argue, they need the 50% upfront as a deposit to help pay for the materials on the project.
DO NOT PAY A CONTRACTOR 50% UPFRONT. Paying a Contractor that you have never worked with 50% upfront is completely unreasonable & very risky.
Remember, you want to do business with fair & reasonable Contractors & businesses. If the Contractor is unwilling to negotiate their payment terms to address your concerns then it's probably best to move on.
Key Elements Of A Payment Schedule
A Payment Schedule should have four main components:
- Payment Milestones (what the Contractor gets paid to do)
- Payment Amounts (how much the Contractor is Paid)
- Payment Time Frame (when the Contractor is Paid)
- Payment Type (how the Contractor gets Paid)
#1 Payment Milestones (What The Contractor Gets Paid To Do)
Your Payment Milestones should describe the work that needs to be completed in order for the Contractor to get paid the agreed Amount. Your Payment Milestones should reference your detailed Scope of Work, which details the work that needs to be completed in each Category.
#2 Payment Amounts (How Much The Contractor Gets Paid)
Your Payment Amounts should be broken down by Category based on the Bid Amounts provided by your Contractor.
#3 Payment Time Frame (When The Contractor Gets Paid)
The Payment Time Frame is when the Contractor gets paid after completing a Payment Milestone. Generally, it's easiest to pay your Contractor every Friday based on the work that's been completed that week. If the Contractor did not complete any major Payment Milestone, then the Contractor doesn't get paid. If the Contractor completed multiple milestones, then they get paid for the Milestones that they completed during that week.
#4 Payment Type (How The Contractor Gets Paid)
The Payment Type is how the Contractor gets paid. You have many options for paying your Contractors:
- Cash - Generally, Cash is not preferred because you don't have a paper trail that sh the Contractor was paid. If you do pay Cash, make sure you get a signed receipt/lien waiver from the Contractor.
- Handwritten Check
- Electronic Payments
- ACH Payments
- Credit Card
- PayPal, Venmo, etc.
There are a few other Payment Terms that you should consider to keep your Contractors motivated to finish the project on time and on budget.
One Payment Term to consider is incorporating a Retainage Clause into your Contract. Retainage is a portion of the Payment Amount that is deliberately withheld to ensure that the Contractor completes the work on the project. Generally, 5 to 10% of the Payment Amounts are withheld until the project Punchlist Items have been completed, at which point the Contractor is paid the remaining Contract balance.
Why Use Retainage?
Retainage should be used for these reasons:
- Retainage provides a strong financial incentive to stay on the project, work until the project is complete, and correct any remaining Punchlist items.
- If the Contractor fails to complete the project, the House Flipper can use the retained funds to hire a new Contractor to complete the remaining work.
Liquidated Damages is another Payment Term to consider adding to your Contract and payment Schedule which provides a strong incentive for your Contractors to complete the work on time. Liquidated Damages establish a project Completion Date for when the Contractor agrees to complete the project. If the Contractor fails to Complete the project by the Completion Date, the Contractor gets paid "x" dollars less per day they are late.