To ensure that your money stays safe and the project moves along smoothly boils down to this: use a proper Schedule of Values when paying your builder. It’s a standard that investors and residential developers swear by, but homeowners often miss out on. In this article, we’ll dig into why the typical, builder-provided schedules often cause problems and the very easy solutions to those problems.
The Problem. The builder gets ahead of the project financially.
All builds have a certain amount of money allocated to the cost of construction (via loan or cash). At any point in time, the project should always have enough money left (in the owner’s hands) to complete the construction work that’s left to do. To achieve this goal, money needs to be earned (by the builder) for actual work completed along the way–and not overpaid.
It’s very easy for a builder to get overpaid and quickly too. It happens all of the time.
What is a Schedule of Values?
A Schedule of Values represents the cash flow of a project. It’s a list of the ‘phases of construction work’ with value (a dollar amount) for each, based on the % of what that phase represents of the total contract price. For example, the value of the framing might be 12% of the total contract price to come up with the scheduled value for framing.
What are Draw Requests based on?
The draw requests are based on those values, with each line item showing how much work has been completed (as a %) at the time of the request. As an example, framing might be 50% complete at the time of the draw request, so 50% of the scheduled value is asked for.
The Right Schedule of Values
A PROPER Schedule of Values has 2 parts:
- Use a Schedule of Values with percentages, per phase, that are in line with industry standards and are correct for each project. Each phase has a scheduled value that is close to the actual construction cost for that item. Each project will vary depending on the design details.
- The Schedule is then used as the basis for draws, which are paid for actual ‘work in place’ (no deposits, advance payments). The actual amount of work completed is verified by a professional 3rd party inspector (an architect or the bank’s inspector). The inspector verifies the reality by inspecting the job- has the asked for % actually been completed.The bank then only pays per the inspector’s report, regardless of what is asked for on the draw request.
There are 2 parts when it is NOT done right:
Typically it is the builder that provides the contract with its attached exhibits, including a Schedule of Values which is then made part of the signed construction contract. This becomes the ‘draw schedule’.
- Most often, the builder provided Schedule of Values is front loaded. Well always, they are always front loaded (which, by the way, you do NOT have to use the exact one your builder provides).
- Then, many times the builder puts in a draw request that is too high, where the line items are a % of work that is not real (too high) and the amount of the draws are over requested.
Both factors can quickly add up to overpaying (sometimes by a lot). One lender I spoke with said he gets tons of clients who are looking to refinance their loans because they are hundreds of thousands of dollars underwater.
Why is overpaying your builder a problem?
There are 2 potential issues created by overpaying.
No.1 – If you want to fire the builder, they leave the project or the builder gets into financial trouble.
If you’ve overpaid the draws, then the builder has part (sometimes a large part) of the money needed to complete the construction and the owner doesn’t.
If, for some reason, you want to fire your builder because there is an unacceptable level of quality (and not being corrected), outright dishonesty, unfair change orders mounting up, or you see that the pace is slow and the house will take months too long, etc.
You are faced with a hard choice if the project has been overpaid.
Either, fire the builder and come out of pocket (more money than originally planned) or keep going with someone who has become unacceptable to you. Think about that…what if it’s been overpaid by 20% (can quickly get to that %) and your contract price is $800,000. You’d have to come up with an extra $160,000! If there were no problems, then that’s fine as the project will get finished and it will all shake out in the end.
However, in addition to you wanting to fire the builder, it also happens that builders go bankrupt (or run out of money), walk off the job, die or get sick. You’re then left in an unfortunate situation financially.
Also consider how this might affect your dealings with the builder during the project. What if he hits you with a completely unfair change order? One that you want to refuse to pay. If you are afraid he’ll walk off the job and leave you in a bad financial position (because you can see that there isn’t much money left to finish it) then you are more likely to say yes to things you don’t want to say yes to. So now, the costs are going up and up while you can’t do much about it.
That’s WHY the industry has proper Schedules of Value and 3rd party inspections. Lenders want to protect themselves and protect the owners, from the beginning. Investors and developers do it this way. For the most part, it’s simply common practice and many builders have investors as clients too. They know the gig.
It’s straightforward when done right. There isn’t overpayment and there’s no discussion around draw requests (too high or not?). You, as owner, put the proper draw request system in place, at the beginning, as part of the contract.
The system (which is the proper Schedule of Values and bank inspections) handle all draws and it is out of the owner’s hands. Let the lender be the bad cop if there are any issues, as you are out of the loop. Yay!
It is super easy to put a proper schedule in place and to arrange for inspections. It’s done all the time! Keep reading to find out how.
No.2 – The project moves more slowly when it is overpaid.
A quick personal story. A house was being built right across the street from my home, so I got to watch another builder in action, up close. He was good, onsite every day. I’d chat with him and found him very attentive to details. We talked shop. I ended up hiring him to build a spec house for me because wearing the developer hat was more than enough work for me personally, so hiring a GC made sense for my first spec home.
During one 2 week period, I watched the crews across the street blowing and going…lots of work getting done. Then, Monday morning came, no crew. Tuesday, no crew. I wondered what had happened. Then, it dawned on me… Oh, he must have gotten paid (overpaid) on Friday!
What I mean by overpaid is that this project ‘probably’ had draws done in phases, with a large down payment, then a draw like 30% at phase 2 (which is a fuzzy definition that only the builder knows). Now that he has gotten a big chunk of money, with not so much left in the job (possibly barely enough to finish it), his motivation has waned. He’s taken his foot off the gas (on this project) to focus on others. Sure, he’ll be back. In the meantime, he’ll offer the owner all sorts of reasons why the subs aren’t there, such as they had to finish another job, or that there is a delay in some material ordered.
That’s how the game is played.
Because I set up my job the right way, when he built the house for me, the crew was there every Monday morning. Project was only $600 over budget and came in on time. Beautiful house too! I was so proud of my first spec house. That’s how the story should go!
A big lever to keep the project moving along at a good clip is to ‘Dangle the Money Carrot’ in front of the builder at all times! Put this fundamental tool in place, at the beginning, and you have essentially prevented numerous headaches and potential pitfalls. Now, of course, this is not a 100% guarantee but a valuable strategy nonetheless.
This is an insider secret for sure! Homeowners…please know that you can readily employ the same strategy!
You may want to read this The Schedule of Values as a Strategy for moving the schedule along! Really.
What does a proper Schedule of Values look like?
Here is an example of the correct way.
You’ve done your due diligence and the values are, in fact, close to the actual cost of the work. Important step!
The 1st draw is for excavation-100% complete and footings are 100%. The bank inspector comes out, sees the work done and agrees with the % complete.
When the values are good numbers (close to the actual cost) AND the % complete is in fact close to what has actually been done, then there is no overpayment. Paid for actual work completed–at the actual cost for that work.
Done this way, there is always enough money left to finish the project.
Here’s an example of the incorrect way. Using a typical builder-provided, front loaded Schedule of Values where the values are too high for most of the items done early on, like the slab.
Then, draw requests are made with a % of work completed that is too high. When there is no 3rd party to verify the actual amount of work in place, then it is left to the homeowner to approve the draw request. Owners generally have no way of knowing whether the % of work requested is true, and they only go by what the builder tells them. The fox guarding the hen house.
Here’s an example of a two part problem: front loaded schedule (builder provided) and too high a draw request.
The % of the contract price for foundation is 5.5% over the real cost. May not sound like a large % for a big ticket item (the foundation) but it amounts to $44,000 too much. Then, without much specifics in the Description of Work, the ‘slab’ is said to be 75% done. You can’t pour only 75%, it is either 100% or nothing.
The amount of the draw is therefore $50,000 ($94k-$44k) more than it should be. Keep going in this manner and you’ll quickly get in deep water.
Properly done, a good bank inspector would catch the fact that the footings and excavation are the only things in place, thereby only approving those two line items, and not the others. The concrete would need to be poured before any approval for slab line items.
Hopefully, this overview helps! It is, however, it is just an overview. There is much more to learn about putting this strategy to good use in your project-check out more info on my site.
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Hope this helps and happy building!
Julie
You've got this!
Remember..
- Find your perfect team (banker, designer, architect builder, etc.) who shares the vision
of what you want and how you want it done. - Trust your gut!
- Acquire the right knowledge, at the right time.
- Build your dream!
