WORKING TOGETHER?!
Oh boy. There’s a good chance this post gets us in trouble with a few people. But we’re going to speak our truth, keeping it positive and keeping it real.
Builder versus Developer? Contractor versus Real Estate Investor? In a cage match, who do you think will win? Hey, if Elon Musk and Mark Zuckerberg can talk about it, why not the titans in real estate investing? Haha!
Here’s the thing. Why is it a cage match at all? Why is it all so adversarial these days? We are all running a business in incredibly challenging times.
In one corner: real estate investors go to great lengths to “build their dream team.” They nurture relationships with lawyers, accountants, mortgage brokers, real estate agents, etc…. But then suddenly when it comes to a builder/contractor/renovator, many investors become transactional. We are seeing colleagues struggle and burn through tradespeople monthly. Newsflash: there is a huge shortage of most of the trades, and it’s going to get worse in the next 5 years. Anyone in our area who is even half-way good has more work than they can reasonably process.
Now before some of you freak out with your “evil contractor” stories, YES there are bad people out there. In almost every profession, just saying.
So how are we all similar? Real estate investors look for deals that will provide cashflow and/or wealth generation. It’s a business, not a charity. Would we ever buy a property with bad fundamentals, with no expectation for profit? Absolutely not! That would be a bad investment. That would be bad business. It’s the same for today’s builders and contractors.
In the other corner: builders/contractors go into a project with a planned profit margin, for example 15%. Some deals will have everything go smoothly, and they’ll make 20%. Some deals will have almost unbelievable delays and cost over-runs and they’ll make 7%. During 2021, with the huge inflationary changes (eg lumber 400%+), some builders and contractors even lost money on some projects.
Sure sounds like real estate investing, doesn’t it? In a portfolio with 10 houses, there might be one that has a bad tenant, one that has an unexpected repair, and one that ends up catching a wave of gentrification. Some properties do better or worse than others—just like some new builds or renovations have better or worse profit margins than others. We all enter these properties/projects with the intention of doing business and creating jobs/homes for our clients. However, it is the nature of being an entrepreneur that there are some wins and some, ahem, sub-optimal projects.
And there is another puzzle-piece that brings us all together. Everyone is struggling with financing these days. “Tighter lending policies” affect us all. Investors and Developers face almost endless hurdles when raising capital and/or using traditional lenders. Then, they finally get that approval, and the construction loan, only to find out that ZERO funds will be released until XYZ stage of the project (for example, foundation completion, or rough in of plumbing and electrical). But THEN, at XYZ stage, a Quantity Surveyor needs to come out to assess the project, and write his/her report, and have it approved by the underwriting team, and have that approval sent to the accounting team … ALL before any funds are released.
What that means is that the Builder or Contractor is essentially the Developer’s/Investor’s lender for the first few months of any project.
Let that really sink in. They’re not just “the trades;” they are actually financing the first significant portion of the project. Unless something different is negotiated in the contract.
Here’s another apparently necessary newsflash: builders/contractors don’t have any magical access to capital at any magical reduced rates. Whether they’re using cash reserves, business lines of credit, or actual loans, all of those initial bills need to be paid in a timely manner, and interest must be paid on the financing. Otherwise the project stalls. Or there are liens on the project at completion. Or eventually the builder/contractor faces bankruptcy—then who finishes the project?
These days banks don’t really want to be the bank. They are doing everything to avoid risk of any kind (and we’re all wondering why there aren’t enough homes being built). The current policies forces builders and investors to take more risks with their own capital. As investors we’re programmed to limit risk too! We carefully nurture relationships with our lenders and work hard to provide strong returns on their investments.
As builders we are mind-boggled by the number of new developers and investors that have a blind-spot when it comes to working their contractors. Simply put: unless otherwise negotiated, your builder is also one of your lenders. Worse (for investors), these days builders have ample choices about whom they will work with. An investor with insufficient capital is quite likely to be ghosted on a project, or flat-out declined for a project if they are deemed too high risk. It’s just business—for both sides.
When we are interviewed for potential new builds and significant custom renovations, we are like many builders these days. We are screening our potential clients just as much as they are questioning us. Plus, we are filtering them through questions that we might ask any lender on an investment property. Can we communicate professionally and in a timely manner? At some point, there will be an unexpected challenge, do we think we can work through it rationally with this investor/developer? We may sign an initial letter of intent. We may ask for “proof of funds.” The intention isn’t to be adversarial; it’s about limiting risk in our business too. And it’s about building strong working relationships.
