If you’re doing work that requires the help of contractors, you might have wondered whether it is better to pay them daily or by the scope of work. If you’ve been in this business for as long as we have – or even a fraction of it, really – you have probably come across this dilemma.
Well, you no longer have to lose sleep about it. In this post, we’ll take a look at the benefits and disadvantages of paying your contractors by both methods: daily and by the scope of work.
While we don’t often recommend paying your contractors daily – for the reasons we will get into in a bit – there are good reasons to do so.
For instance, if you have a project with an unknown scope of work, it is perfectly reasonable to pay them daily. For example, you’ve bought a house and you intend to renovate it but you just aren’t quite sure about all the things that you need to do. Or perhaps you’ve purchased a new property in an area that you are unfamiliar with – which means that you don’t yet know exactly how much you want to invest in the property.
In either of these cases, paying your contractors daily makes sense.
You hire your contractors, you tell them that you need work done on this area or that and they’ll get to work and you’ll have to pay them daily. That’s all well and good for small jobs, but for anything that is of any significant size… this is not the ideal method.
You also have to consider that your contractors also have employees they need to pay. So, if they get a job that pays them daily, they may very well bring in all their employees so that they have something to do. This is more likely to happen if your contractors don’t have any other jobs. In such cases, you’ll have a whole crew working on something that really doesn’t need everyone and you’ll be wasting your hard-earned money.
In addition to being a drain on your resources, paying your contractors daily can also have other problems. For one, it makes it very hard for them to coordinate and plan the job. Because they don’t have a scope of work – an idea of what things need to be done, how they need to be done and when they need to be done by – all the work they do will be done aimlessly. They’ll work on your siding one day, your tiles the next and your walls the one after. There will be no consistency to the work, no productivity and ultimately, lackluster results.
Also, don’t forget, if they don’t have another job lined up, your contractors will have no motivation to get things done fast.
Don’t misunderstand. This is not an attack on contractors. The fact is that this has nothing to do with them. It’s all about how you approach your project. The contractors you hire have absolutely no interest in whether you succeed or not – they should, because if you succeed, it can mean more work for them – but they don’t. But this is your project, which means you're the one responsible and you need to be managing your project and ensure that you're setting up your contractors for success.
And how do you do that? One thing you can do is to break down the tasks that you know needs to be done and giving your contracts mini-scopes of work and agree upon a reasonable price. Once you’ve come to an agreement, say “Do Task X for $1000”, the ball is in your contractors’ court. Whether they work for two days or two weeks and whether they bring two workers or twenty – you’ll only pay $1000. Which means that the responsibility is on them to work responsibly.
But do know this: paying your contractors daily will hurt you in the overall scheme of things. The way the whole industry works is this: you will get a better price for overall scope because while there is a lot to be done and a lot of labor involved, a bulk price will ensure that they get the project in its entirety. If you break it down, however, prices tend to be higher because they won't know how to price each individual thing so they usually will overprice them.
Our advice is this: if you're going to be spending a good amount of money and you're doing a lot of work on the property, take the time to put together a scope of work together. Which leads us to...
If you’re paying your contractors by the scope of work, it is infinitely easier to manage your budget. As we've already mentioned, there is the benefit of being given a bulk price. Additionally – again, as we’ve already mentioned – having the scope of work and budget agreed upon also provides a guideline for the contractors to stick to, which allows them to coordinate everything on their end better.
That doesn’t mean you won’t run into problems, though.
Where the trouble comes from when you’re paying by the scope of work is when contractors underbid for the job. They are prone to make human errors and they may not consider certain factors and when that happens, they will underbid and later find out that they’ve made that mistake. If that happens, they’ll start losing money and you can argue about whose fault it is for as long as you want but you need to realize that if your contractors are losing money, it will affect you.
There are three ways it can affect you.
If your contractor is losing money, they may start hitting you with change orders – alterations to the original scope of work that will more often than not change the original contract amount and/or completion date.
If this happens and your contractors are coming to you with change orders, our recommendation is that you don’t fight them on it. We’re not saying agree to the alterations blindly, but instead, understand that this is most likely happening because they underbid and work with your contractors to come to a compromise.
Look at the scope of work again – it is just a document, after all, and nothing is set in stone – and see what you can modify to mutual benefit. Anyone who has done any real work in this industry will tell you, the scope of work will change as large projects progress. What you need to do is see how you can change it so that you get what you need while also not paying unnecessarily large amounts of money. If you can’t afford to lose more money on your current project, see if you can’t come to an agreement about future projects. There have been projects we’ve done where we had enough of a profit margin that we didn’t even negotiate with our contractors on the price. Good contractors will understand that a mutually beneficial working relationship is so much better than immediate cashouts. You need to understand it too.
Another big issue that you may face is delays. If your contractors have underbid and they aren’t hitting you with change orders, they made start taking other work on the side to make up the difference and that is going to cut into your time.
You may think that a few delays won’t hurt you all that much as long as the price is kept low, but those delays can affect you. If you’ve borrowed money, the delays might cause you to end up paying more than what you would have paid your contractors.
On top of that, something that you may not consider is the fact that the delays can push you right out of the prime selling season into the slower winter months. And if that happens, it's going to hurt you significantly. We don’t need to tell you that. As the solution to the previous problem, what you need to do is try to come to a compromise with your contractors.
ABANDONING THE JOB
Your contractors may also just abandon the job entirely. This has happened to us before. We’ve had contractors that underbid the job, then tried doing change orders, couldn’t agree to a compromise, delayed for a bit and then just stopped showing up.
This is a good reason as to why you should not pay your contractors in advance. There is no point paying for a job that has not been done yet and we know from experience that people may just take the money you give them and walk away, leaving you out five grand and with a job that is still incomplete. Then, you have to hire new contractors and pay them again and it is a whole process. When you don’t pay in advance, your contractors have to earn their payments and so, they are more likely to actually stick around and get all the work done.
Whichever way you choose to pay your contractors, something that I always tell people is that you need to know not only what you are doing but also what your limits are. If you’re doing your first deal and it’s a historic home or something that's ridiculously crazy – that’s a bad idea. Obviously.
If you’ve not done massive projects before and jump into it, you will lose a lot of money. You might learn something – because you can learn from your failures as much as your successes – but it will cost you. Instead, for your first projects, go small. Start with a cosmetic rehab, maybe a simple floor, and paint. Something light that you can use as a starting point to get to know some people in the business, learn the materials you’ll be dealing with and the ins and outs of the market. Then move to bigger things.
So, it’s vital that you know your limits. But then how do you take on bigger, better projects that pay well? You find people with who you can partner. By finding people who already know what they are doing and partnering up with them, you can learn a lot. The thing is, if you’re working with people who have some experience, you’re also likely to succeed in your projects because they won’t agree to projects that aren’t going to succeed. Remember, they want to make money, too and you can also profit using their knowledge.
Ego comes into play when you want to prove to everyone how "smart you are". You want to show people that you have watched enough HGTV, learned everything that is there and now know the secrets to success.
Greed comes into play when you simply don’t want to share the money. You want to get all the profits from whatever project it is that you are doing and you simply do not want to split anything with anyone.
Both of these will ruin you.
First, there are always people who know better. Your ego is going to get you nowhere, especially if you’re setting out to prove some stupid point. Second, remember that a 50/50 split is still better than a 100% loss.
You need to get over yourself and find yourself a partner that understands what they're doing. You may have found someone who doesn’t want to partner up because they think the project will go nowhere and the right action to take then is to accept their wisdom and move on – trying to prove your superiority will lead to potentially deadly levels of embarrassment.
At the end of the day, you want to make money. We get that. But you’re not going to make any money unless you learn. How do you learn? By looking at what the experts do. Partner with people who know how to make money and learn from them. Learn the strategies, learn the tactics, learn how they manage contractors, how they set up scopes of work -- Learn everything you can. That practical learning is going to help you more than you think.
Our advice to newcomers to real estate investing is this: today, be a sponge. Learn everything. Because tomorrow, you can apply that knowledge and actually make real money for yourself and your business.
Paying your contractors daily is suitable for smaller jobs and projects where the full scope is unknown, but it is likely going to cost you more in the long run.
Paying your contractors by the scope of work is preferable because you get bulk prices, but watch out for the very real consequences of underbidding and be ready to renegotiate.
If you’re just getting into real estate, first know your limits. Find an expert who you can partner with, learn everything you can. Swallow your pride, smother your ego to death and remember that as far as money-making is concerned, the long term rewards of learning with a partner first far outweigh the potential immediate rewards of working alone.
Good luck investing!