Here’s a look at the nuts and bolt of employing the Schedule of Values as a STRATEGY to control costs in your home building project.
You’ll want to read The Only Way to Pay Your Builder for context and definitions, before the strategy training that this article covers.
The Strategy of Using the Right Schedule of Values
To employ the strategy, at a minimum, get the following in place:
- Use a proper Schedule of Values with line item percentages and dollar amounts that are close to actual costs. Do not use the one your builder provided (all SV are front loaded). Use your lender, inspector, hire a GC consultant to come up with these values or to consult with you as you negotiate this with the builder.
- Work with the builder to modify the SV as needed, but only somewhat. Now that you know how the game is played, be open to his input, yet draw a firm line in the sand. A good banker should help you do that (remember the banker can play the bad cop role).
- Although, you do want to use a SV that is fair both ways. Plus, set it up so that inspections and payments happen fast. Many builders distrust homeowners and it is not fair to expect them to front money without getting paid quickly and fairly.
- Use bank inspectors to inspect for ‘work in place’ and have the lender only approve draws based on the inspectors report. You’ll want to vet this inspector. Some residential bankers are not strict (which is why I even have to write this article). Make sure the inspectors have the experience and confidence to verify the % of work complete regardless of the builder’s request on the draw. You do not want one that is buddies with the builder or who will rubber stamp the draw requests.
- The agreed upon Schedule of Values and language stating that draws will be paid per bank inspectors and lender’s approval only should be made part of the signed construction contract. Not an afterthought.
The Hidden Beauty of the Strategy and How it Plays Out.
As an example, let’s say the builder puts in a draw request for 100% of drywall hanging ($20,000 scheduled value), since the rock is at the house and even though it is not completed, he tells you it’s only 2 days, at most, to complete the hanging.
The drywall sub is likely pushing the builder to get paid for 100% on the hanging portion since he’s only got 2 days of work left to do. Drywall hanging is fast!
However, at the time of the bank’s inspection if only the ceilings (and part of the walls) are hung, then the inspector might approve only 40% complete which is $8,000-that leaves $12,000 left for the hanging. A good inspector will do his job and report 40% (regardless of whether there is 2 days or 2 hours of work left). Which means that $12,000 is left until the next draw, which might be weeks away! That is hard on the crew and on the builder. Almost doesn’t seem fair. Keep reading though as to why YOU want it this way, and it is up to the builder and subs to push forward to get to 100% completions so that they get paid!
What happens when there are no bank inspections involved (or minimally involved)?
With no bank inspector involved (or loosely-they come out to rubber stamp the builder’s request if the owner tells them yes), then it’s up to the owner to approve or deny them. It’s challenging (and very hard) to stand face to face with someone who needs the money and promises to finish in 2 days. What do you do? I found this very hard to do, as a builder, when the trades asked me for money even though they weren’t finished. They will give you all sorts of reasons why they really need the money now. On occasion, I did cave but usually with guys I’d worked with many times.
Most owners don’t know what you are looking at anyway. Is it 25%, 50%, 90% done? When the bank is not involved in the manner suggested here, then it is left up to the homeowner to approve draw requests and tell their banker to release the funds. It’s unbelievable to me that some residential lenders do it this way?!
When you have bank inspections – look at how easy it is!
Let the lender be the bad cop. Done, no difficult conversation or decisions to make. When the builder puts in a draw request, trying for more than earned (which he will) then you, as the owner, have no say in the matter. The bank and the bank inspector are in charge.
Even if you will pay all cash, you could set this up with your banker to have the bank inspect and approve draw requests!
ALSO, back to how this keeps the project moving along.
If you stick to a strict draw schedule from the very start (what I call the proper way) then the builder and all the trades KNOW what the deal is on your project. Basically, we’ve got to get it done to get paid. There is no fudging.
Here’s what is more likely to happen with the drywall example above. Say the inspector is scheduled for Tuesday next week. You tell the builder and maybe happen to mention it to the drywall sub (this is tricky so don’t take it as a carte blanche suggestion). Then they’ll do whatever it takes. Show up for work early, bring extra crew, work on a Saturday or whatever to make sure the drywall gets 100% hung before the inspector arrives. Maybe they’ll even try to knock out the drywall finishing too since they know the inspector is coming!!!
The builder will push the sub to get it complete, because he wants that $12,000 now instead of waiting weeks to the next draw. The inherent motivation to get it done is there.
That’s the beauty of the money carrot approach because it drives the project based on COMPLETIONS.
That’s what I mean when I say ‘the builder takes his foot off the gas.’ If he already has $100,000 (or whatever amount as the project moves along) ahead, then where’s the motivation to push? He literally has to dip into his checking account to finish the tasks versus finishing the tasks then asking to get paid for them.
Again, I don’t want to paint a picture of absolute smooth sailing with this approach. However, the investors that I know typically have a great experience using this strategy.
Why would builders agree to this?
It’s common practice with commercial bankers (and some on the residential side) to require a Schedule of Values with industry percentages. Not those front loaded ones that the builder provided and lenders know that. Although, the SV needs to be modified to fit each unique project.
The commercial side of lending for residential homes simply means that it is not your primary residence. Also know that builders vary in the types of projects they do. Some only work directly for homeowners doing custom builds. Others have a mix of custom and build on spec (speculation) for themselves or for investors who hire them. The trades, too, are accustomed to working on a variety of projects.
It’s common practice, all day long, where many of the new homes (and remodels) you see around town are being built with investors hiring builders using a commercial loan. Therefore, it’s not like you are suggesting some unicorn type of payment method. Many builders are familiar with it. Not every builder will be so you can explain why and where it comes from.
What if my potential builder (that I otherwise like) won’t agree to this?
When an owner tells the builder that their lender requires the use of the bank’s Schedule of Values and that the bank will inspect all draw requests, then some builders will respond with ‘oh, one of those projects’. They’ll want some involvement in deciding the values to use but otherwise, they know the score.
Please know that it is reasonable for the builder to be involved to help decide the percentages. Some houses might have a higher % for framing or other items because of the complexity or they may need a big deposit for the cabinet order…that sort of thing. You don’t want to tie the builder’s hands financially, however, now that you know what’s going on…stand firm as much as you can.
If the builder’s response is some variation of ‘no, I only use my Schedule of Values’ then if it were me, I’d strongly consider finding a different builder. One that is less of a ‘only my way’ person. I prefer to control the outcome of my projects rather than leaving it to someone else.
A few misc considerations.
Perhaps, you’ll be paying cash. It’s perfectly legit for you to require payments based on a proper schedule, which you can probably get your hands on. Consider hiring bank inspectors (I think most are 3rd party and should be available for hire). Talk with your banker about treating payments as though it were a commercial loan, where they wire the money or issue a cashier’s check. Personally, I see no need to tell the builder that you are paying with cash and not using a loan. Why?
Your banker may not have the mindset described here and is more accustomed to paying whatever the owner and builder tells them to. You may need to coach them up or ask your banker to reach out to someone in the commercial side of their bank to work with you. Again, this is not a re-invention of the wheel that you are going for. It is, however, you being in charge.
This guidebook is 20 pages long and can save you tons of time and money. In it, you'll find some very unique ideas. Click here for Free Guide to Making All of Your Selections Hope this helps and happy building! Julie You've got this! Remember..
of what you want and how you want it done.
