How do you write a construction contract in a situation with many unknowns?
January 17, 2010 11:13 PM   Subscribe

How do you write a construction contract for a fixer-upper with many unknowns?

I'm under contract to buy house that will need some serious repairs. My financing would be a HUD 203k loan that comes with money for construction, and about 1/3 of what I'd borrow would be construction money. The agent and the contractor are friends of mine (she's a long-time friend, and he's her boyfriend -- but they actually worked together a lot before the romance started). I've seen what they've built, so I trust their work. We've been talking like friends, but now we're at the point where I'd like to spell things out more specifically, but I'm not quite sure what that would look like.

We know roughly what needs done, though we can't know everything until we get inside the walls. They don't seem concerned about possible worst case scenarios and think that given the amount of work we'll be doing, whatever comes up will still fit within the total overall budget (I'd basically hand control of the budget over to the contractor). If nothing comes up, there'll be more money for cabinets and fixtures and finishes, and if it's worse than expected, we'll have to really go cheap, and then I can upgrade later.

How do you write a contract that says this? Does the contract just say that they guarantee a certain outcome regardless of what's encountered behind the walls? Is there any way to specify the role I'll have even as he is taking over management of the construction budget and trying to make it stretch as far as possible? If nothing goes wrong and we end up with extra money, how much is his profit and how much goes to nicer cabinets, etc.? (They're really generous and professional people, and they deserve to make money for their work; I just want to understand how it all works up front so there are no misunderstandings or miscommunications.)

Here's the list of what we think needs done: A portion of the roof might need repaired; the grading and drainage needs work; and a portion of the foundation is slightly below grade and might need capped a bit to raise it up. The back deck and stairs are falling down and need rebuilt. We'd want to strip off the exterior stucco, install exterior siding (hardy board?), tear out old carpets and gut the interior, check the electrical and plumbing (they think these are mostly good, with maybe some missing copper), run gas lines, maybe add a window, sheet rock and paint, install cabinets, fixtures, bathtubs, etc. It's a triplex, so many expenses like stoves and toilets are multiplied times three.

One more related question -- given that I'm more neurotic than them, and would like to feel more assured that we've systematically considered the worst-case scenarios, is there anything else I should be asking about or getting inspected? We had a pest inspection done. I've heard from two people that it probably isn't worth getting a general inspection, given the shabby state of the property (they say things like "your faucet leaks," whereas I already know that the house has no sinks). Is there a good checklist of potential concerns that I could use to better understand what needs fixed, what is solid, and what we don't know about yet?
posted by slidell to Work & Money (18 answers total) 4 users marked this as a favorite
Best answer: You need to reduce the unknowns.

Get a complete inspection, from the outside of the roof, into the attic, into the rooms, and into
the crawlspace, from someone that you select. You would be amazed at what you can tell
about a house from a close, multi-hour inspection. I call it "house forensics". When the
inspection is done, you'll have a pretty good idea what parts of the roof leak, or where
water is getting in over the foundation sill, of which windows have bad flashing, or
what plumbing is suspicious, and so on.

Get bids for all the required repair work. Hire the guy as a general contractor, to supervise
the work. If he doesn't have a general contractor's license, then he has no business in
this deal. Your contract with him will specify the things that will be repaired, and the
budget. You should probably bid out the general contractor's position, after getting
recommendations for contractors with good reputations.

The fact that the agent is a friend of yours, and that the contractor is a boyfriend of hers
is a problem. It prevents you from having the proper attitude with regard to competitive
bids. If they are pitching this as a bundled deal, then it's even more problematic.
posted by the Real Dan at 12:23 AM on January 18, 2010

Best answer: Many aspects of this situation would make me very nervous. The work you think needs to be done is a lot of work. So much work, in fact, that 1/3 of the loan seems unlikely to be nearly enough, unless maybe this building sits on a very valuable piece of property so that the loan is bigger than one might typically imagine.

You're planning to strip off the exterior siding and gut the interior, fix roof and foundation and reshape some of the surrounding dirt. If there have been neglected leaks in the roof and siding and at the foundation then you'll be repairing parts of the framing as well. You will have to bring the electrical stuff up to current codes. There may be some plumbing missing or broken. The list is already long, and will get much longer. From the sound of it, you may be better off razing the place and starting over from scratch; remodeling is always more expensive (per square foot) than new construction, so really extensive remodels rarely make financial sense unless you have some source of unusually cheap labor, e.g. you're unemployed and can do the work yourself, or your dad (a recently retired carpenter) and uncle (a recently retired electrician) both want to help you for free.

Setting aside such doubts for a moment, I'll try to answer some of your explicit questions.

When you don't have a comprehensive list of what will need to be done, you're dealing with risk. You need to think about how much risk you can tolerate, and how much risk you'd rather pay someone else to take on.

They don't seem concerned about possible worst case scenarios...

Of course they aren't concerned. You're currently willing to accept all of the risk while they charge whatever they want to charge for whatever they want to do. This doesn't make sense. Either you retain both control and risk, and hopefully reap some benefit, or you hand over both control and risk to the contractor, and pay them a premium for accepting that risk.

...(I'd basically hand control of the budget over to the contractor). If nothing comes up, there'll be more money for cabinets and fixtures and finishes, and if it's worse than expected, we'll have to really go cheap, and then I can upgrade later.

How do you write a contract that says this?

You don't. Writing the contractor a blank check and telling him to do the best he can with it is insane. You may as well say to him, "Here's $40K. Keep as much as you like and buy me a present with whatever's leftover... (time passes) ... what do you mean there wasn't anything leftover?" If you want to simply do the best you can with the available funds then YOU must be constantly involved in deciding what to do and not do. You accept most of the risk, but you actively manage that risk and, hopefully, reap some real benefits. To do this, you must be either very knowledgeable about such work, or at least have the aptitude and the time and willingness to do a lot of research.

Does the contract just say that they guarantee a certain outcome regardless of what's encountered behind the walls?

This is the other way to go, but it requires a very detailed description of the outcome. Detailed drawings from an architect. Meticulously detailed lists of specific materials. Brands. Model numbers. Colors. Lists and lists and more lists. You can't hold the contractor to a commitment unless you can illustrate exactly what he's committing to. Going this way puts most of the risk on the contractor's shoulders. He will raise his initially ballparked prices to cover his ass. My guess is that he will raise his prices dramatically.

Is there any way to specify the role I'll have even as he is taking over management of the construction budget and trying to make it stretch as far as possible? If nothing goes wrong and we end up with extra money, how much is his profit and how much goes to nicer cabinets, etc.?

No. You're trying to mix the two basic models I just described, but they don't mix.

Please don't plunge ahead with this. You're not even close to being ready. Get a detailed inspection. Get your head wrapped around what really needs to happen. Get comprehensive quotes from multiple contractors. Reconsider doing business with friends. Reconsider again. If and when you're ready to move, have your lawyer go over the contract very carefully.
posted by jon1270 at 4:18 AM on January 18, 2010 [4 favorites]

I've never worked on a remodel job that didn't run into unexpected problems and cost more than expected.

I can't give you advice on how to structure the contract. You need consult a lawyer who has experience with construction contracts and explain your concerns. It'll be worth it.
posted by nangar at 6:09 AM on January 18, 2010

Best answer: Thirding what has been said above. This situation is setting off all sorts of alarm bells, especially when you say "[t]hey don't seem concerned about possible worst case scenarios and think that given the amount of work we'll be doing, whatever comes up will still fit within the total overall budget." Even a relatively simple repair situation will usually feature unexpected drama--when I had my roof replaced about six years ago, for example, the contractor discovered that several of the beams also had to go. A house in the shape you're describing will almost certainly have scary stuff going on inside the walls. And yes, you absolutely must get an inspection.

These "friends" of yours are not exactly behaving in a friendly manner. I would not go through with this real estate transaction, period.
posted by thomas j wise at 6:19 AM on January 18, 2010

Best answer: They don't seem concerned about possible worst case scenarios and think that given the amount of work we'll be doing, whatever comes up will still fit within the total overall budget

Famous last words. You really have to plan for the worst case scenarios to be confident in your budget. Figure out what the worst case scenario is going to cost, then add 25% for contingencies. Means Residential Construction Guide can be a big help in checking numbers you get from contractors. Just off the top of my head the repairs you've mentioned would probably run about $70-80k.
posted by electroboy at 6:49 AM on January 18, 2010

Best answer: You didn't mention anything about potential hazardous materials whether it be asbestos, lead paint, or a leaking underground storage tank all of which can be costly to address. A competent building inspector will be able to identify those problems and tell you about other unseen problems. Don't use your friend as the inspector. Hire someone independent with experience. A competent inspector will be able to tell you what is behind the walls and reduce unknowns to nearly zero.

You can write a contract that says that you have the right to modify the scope as long as you don't change the initial price agreed on by +/- 2% or whatever. As long as your friend agrees to and signs whatever riders you add then everything is cool. But you will have to be the project manager and maintain the schedule. I would find a third party to help you create a complete schedule with general itemized estimates prior to the signing of the contract. You could then have your friend bid on the itemized estimate to which he would be held liable with the signing of the contract. Also have the third party create the contract based on that schedule.

So, for example, with the roof repair, he might bid $500 on the removal of the roofing and the replacement of the felt paper and shingles. Any extra unknowns would be an additional cost. With the prior inspection, you should know if there is anything additional which may need to be repaired which can be included in the contract. Break the contract down as much as possible and it will allow your friend to create an accurate bid and price for the work. Money you spend on creating the schedule and contract will be well spent and everyone will be much happier when all is done.
posted by JJ86 at 6:54 AM on January 18, 2010 [1 favorite]

Response by poster: Thanks to everone for taking the time to respond. I agree there's something here that doesn't currently feel right, so I'm trying to think about how to shift toward a more formal relationship that makes sense for both parties.

Would it be possible to get an inspection like the one that the Real Dan describes and use that as a way to create a fairly detailed scope of work and schedule like what JJ86 describes? How do you find someone to provide that inspection and help checking the estimates? (HUD requires an inspector who checks the budget and the work all along the way; maybe they can play this role?)

I think that once we get into the walls and know for sure what's going on, that would be the point at which they are thinking we'd make a very detailed lists of needs and coats that we would then prioritize and see what's left for cabinets. Does something like that make any sense?

The contractor wasn't initially proposing a bundled contract, but when the agent and I started asking about redoing the siding, he said he thought we could do it within the budget if we bundled the work. jon1270, just to clarify, the electrical seems recently upgraded. I'll send you (and anyone else who wants it) the construction budget.
posted by slidell at 7:12 AM on January 18, 2010

An experienced inspector has seen a lot and can usually make a very accurate appraisal of hidden problems. Check the yellow pages and look for certified inspectors with BBB credentials. Then call and ask for references.

For creating a contract and work schedule, again hit the yellow pages and look for architects who can create those for your project. The outlay for these services may not be really cheap but I guarantee the costs will make the keep down the headaches and higher costs of mysteries which could easily crop up with the contract you initially thought of.
posted by JJ86 at 7:18 AM on January 18, 2010

Best answer: I am an architect/builder and I absolutely concur with many of the cautions listed above. This is a very common project type, but it the most common one to end very badly, so it's important to get off on the right foot. My recommendation would be to really put the brakes on until you are able to gather more information. You mention being "under contract" but hopefully there are still contingencies (financing or inspection?) that will let you slow things down a bit.

My biggest concerns for you are 1) a large, wide-ranging scope of work, and 2) working with a friend-of-a-friend who is not vehemently recommending that he see drawings and detailed specs before suggesting that your budget is appropriate. There are specific planning steps you should take from here on out.

1) Most home purchases require a home inspection unless you waive that right. Don't waive your inspection. It should give you a rough draft list of what is wrong with your house per your local code and s/he will get into places with a flashlight and will raise red flags for your contractor to more thoroughly investigate.

2) Contact an architect in your area that does a fair amount of residential work. Ask them to recommend a contractor. Contact that contractor and ask him to look at your project with respect to what your remodel intentions are, but also to use the inspection report as a guide to the state of existing conditions. As opposed to the one you have mentioned, the contractor you contact through this process has accountability to you (as a possible paycheck), to the inspection report (he will be remiss if he fails to further investigate any serious red flags), and most importantly, to the architect who is likely his most important source of work. This situation provides you with the best shot at reasoned numbers at this stage of the process.

3) Ask him to give you a number of what the project is likely to cost. And then ask him to give you a worst-case-scenario number. Do not pressure him to keep it low. If that number makes you balk, I would seriously consider your decision to move forward. That is the number you should be thinking of as the starting point for your budget from this point forward. I am not being flippant here. You do yourself no favors in using any other number. There are many ways for a project to go bad. A project cannot go well unless the money works. You need to be positive your money can get the project done the way you need it to get done. The responsibility at this point in the project is on your shoulders.

4) If you decide to proceed, you need to arrange your contracts. Architects will have boiler-plate contracts that will apply to your general situation which can be modified to apply to the specifics of your project. They are called AIA (American Institute of Architects) contracts and they are the industry standard because they have proven useful and properly scaled across situations and regions.They are also written to protect all parties, but primarily the home-owner and architect. This format leaves your contractor (the one who is really spending your money) accountable to both you and the architect, which is an important relationship structure to maintain should anything go less than perfectly. I mentioned I am a builder. We build projects designed by other architects as well. And we will not do a significant project that does not have this relationship structure, even though it it hardest on the builder. You shouldn't either. If a contractor balks at this type of arrangement, you just learned something invaluable about him at just the right time. Keep looking.

5) If you are still eager to press on, I would think about structuring your contract to do an initial phase of demo work on a time and materials basis that would expose your true existing building conditions. Once all is adequately uncovered, the architect and builder can give you plans and numbers that have a much better chance of being accurate from this point forward. Your architect can design efficient structural solutions based on your budget, and your contractor can give you numbers he can commit to without fear of uncovering unknowns. At this point, you can proceed fairly (with respect to the contractor) and also get relatively fixed estimates for your work.

6) As for contracts, there are "Fixed Bid," "Time and Materials," and any variety in between. With the Fixed Bid, you pay a premium for knowing how much it is going to cost ahead of time. Essentially, the contractor will bid enough to cover his worst case scenario. A decent contractor is not going to put himself in jeopardy by cutting this number too close, or in relying on buying you in change orders in order to cover not having done his homework and planning ahead of time. Time and Materials is most fair, to both owner and contractor, but you lose the ability to guarantee the cost ahead of time. This is, IMO, is the best contract scenario for your type of project IF (and only if) you really trust the parties involved beyond doubt.

7) This is getting way too long...sorry. I'll wrap it up by saying I would ask 3 contractors (make sure they know you are gathering competitive estimates) to give you hardcore estimates for your project, select the one you trust most, and then enter into a Time and Materials, AIA contract based arrangement with them.

Good luck. I'd be glad to offer more suggestions over memail if you would like.
posted by nickjadlowe at 9:13 AM on January 18, 2010 [5 favorites]

Definitely use the AIA contracts if at all possible. Writing your own, or having Joe Lawyer draft your contract can turn into a nightmare if it ever goes to court. *You* may know what you want the language to mean, but how it's interpreted by the court is a completely different issue.

Also, if you don't need the full services of an architect, you may consider hiring a construction manager. The bank issuing the 203k loan may have recommendations.
posted by electroboy at 10:31 AM on January 18, 2010 [1 favorite]

i just wanted to chime in here: you can do all of this without a lawyer, architect, construction manager, general contractor, etc. But it means taking on a significant risk and the only way it can possibly work out for you is if you, the owner, take on a lot of these responsiblities. The only way to sign on a dotted line and get a house in X months for Y dollars is if you pay all of these people to take the uncertainty out of the project and that is going to cost you more than I suspect your realize.

and, when it comes down to it even with the best contract, if your contractor is broke, suing him isn't going to do you any good: it won't get the work done and it won't get your money back.

the bottom line is that if you want to make this work on a limited budget, you need to start taking on these jobs right now, it's going to go way beyond getting a good contract and you can't expect your friend's boyfriend, even if he has the best intentions, to take care of it for you.
posted by at 11:49 AM on January 18, 2010

Response by poster: Just a quick update. I really appreciate everyone's guidance and have: gotten a detailed inspection that suggested costs were likely 1.5X to 2.5X of my budget, decided not to work with this contractor after having unsuccessful conversations trying to understand how he was planning to do it so much less expensively, asked a few architects for suggestions of residential remodelers who might be willing to help me fit within a budget, and asked whether there's leeway to increase the construction budget. I'm meeting with one contractor tomorrow.

It might've somehow turned out okay, but it's also possible that you helped prevent a total disaster. Thank you.
posted by slidell at 5:27 PM on January 23, 2010

Response by poster: Final update: I realized that if his estimates were lower than everyone else's, uh, great! since the contract is one in which he agrees to do the work for that amount. The additional inspections did prove to be extremely important in having a full understanding of what needed done. Thanks again.
posted by slidell at 9:07 AM on April 12, 2010

Best answer: I forsee the phrases "differing site conditions" and "change order" figuring prominently in your future.
posted by electroboy at 7:14 AM on April 13, 2010 [2 favorites]

Response by poster: Update: electroboy was close. The key phrase is "failed or neglected to carry out the work as described in the contract." Thank you to all who emphasized the need for a legally-valid contract with an adequate level of detail (I hope!). Arbitration or something similar is coming up.
posted by slidell at 9:13 AM on July 24, 2010

Good luck slidell. I think this AskMe will be very useful as a reference to others in the future. If something is too good to be true, it probably is.
posted by Justinian at 5:14 PM on July 31, 2010

seems... if something seems too good to be true. You know what I mean.
posted by Justinian at 5:15 PM on July 31, 2010

Response by poster: Yes. I am happy to serve as a cautionary tale. Also, I'm sure my future questions will add to AskMe's knowledge base on contract dispute resolution and DIY home repairs.
posted by slidell at 12:32 AM on August 4, 2010

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