In this episode, I discuss rehab draws: the money that you pay contractors for doing work in your investment properties. The draw is the amount of money you give them for work that they have completed. There are a number of ways that you can schedule the draws to be distributed. There is not necessarily a right way, but there are definitely some wrong ways. I want you to avoid doing it the wrong way.
One of the scariest parts about doing your first rehab is knowing how much money to give the contractor and when. Some people really screw this up the first time and end up being very sorry. There are some rules of thumb that you should consider and different ways that you can go about it to protect yourself as much as possible.
Below is a list of things to remember when deciding how to distribute the rehab funds to the contractor. For the purpose of this episode, I am going to assume that you are dealing with a new contractor, one that you have not used in the past. I am also going to work off the assumption that you are using either private funds or your own capital, and have control over how the draws are distributed and how much each draw will be for. If you are working with a hard money lender or another lending institution, they will likely dictate the draw schedule.
- The first draw should only be enough to get them started buying materials. I am of the opinion that you should try to offer them less than what you think they’re going to want, and let them tell you if it’s not enough. Always make sure that the money you give them is for specific aspects of the rehab. In other words, every draw should be for specific work. That way, you can inspect and see that the specific work that was agreed upon is done prior to giving the contractor the next draw. For example, if the entire rehab budget is $20,000, I would suggest offering the contractor $1,500-$2,000 to start purchasing materials and start the demo. Under no circumstances would I give them more than 1/4 of the total ($5000).
- Draws should not be based on time. This means that if a rehab timeline is four weeks, you do not pay them at the end of the first week, then again at the end of the second week, etc. Payments should never be based on timing, because, if work isn’t getting done, it’s irrelevant that a week went by in terms of paying them another draw.
- Never pay for anything that hasn’t been completely finished. If the third draw is supposed to cover painting and flooring, you should not pay the contractor until all of the painting and all of the flooring is done.
- Always hold back a portion of the final payment until you do the final walk-through of the rehab and everything is done to your satisfaction. Be fair, but be firm. If agreed-upon work has not been fully completed, never ever make the last payment. Very often you will be asked to make the payment and then they will do the work the next day. Do not agree to that. I even have this policy with the contractors that I know, trust, and have dealt with for years. It’s nothing personal, but I simply cannot pay for a job that isn’t complete.
The subject of how and when to pay a contractor is very important. Not all contractors are created equal, and some could be tempted to not finish a job if they get enough money upfront. It’s sad, but true. Do not fall prey to an unethical contractor. If draws are distributed after work has been inspected, you should be safe enough.