How Contractor Problems Kill Real Estate Deals and Why Commercial Margins Change Everything | Jeph Burnett
The Contractor Problem Doesn't Go Away. Here's How to Survive It.
I was talking with an investor recently who said something that stopped me.
"Everything from this process is survivable except contracting."
He's right. And he's been through enough deals to have earned that opinion.
He laid it out simply. Loan terms a little high, you can beat that. ARV off ten percent, you can beat that. But go through two contractors working off draws, burn through seventy percent of the draw money, and find out only thirty percent of the work is done, that one is hard to come back from.
He's seen it. I've seen it. I've seen it a hundred times.
Here's how it happens.
The inspector and the GC have a relationship. It's not a conspiracy. It's just human nature. They see each other on every job. The GC tells the inspector he'll be done tomorrow, waiting on this, waiting on that. The inspector signs off. The draw goes out. The borrower hands over the money because that's what you do when the inspector says it's done.
Except it's not done.
And the lender isn't protecting you the way you think they are. They'll give you the draw money directly sometimes. His advice, and mine, don't hand it over until you've seen it with your own eyes. Video. Pictures. Boots on the ground who work for you and nobody else.
His solution to the contractor problem was discipline on the buy side. Auction. Cash. Fifty to sixty cents on the dollar. Get in so far below market that even when the contractor games start you've got enough cushion to survive it. Wholetail the ones that only need lipstick. Skip the GC entirely on the right properties. Floors, paint, maybe central air. In and out before the relationship with a contractor can go sideways.
That's a legitimate strategy. It works if you execute it with the discipline he's describing.
But it takes an enormous amount of time, market knowledge, and tolerance for the residential rehab grind. You're fighting ARV inflation, contractor games, days on market, and a buyer pool that has opinions about paint colors. Every variable works against you. The margin for error is razor thin and it stays that way no matter how good you get.
Which is why after forty-plus deals doing it the way you're supposed to, agent, contractor, hard money, repeat, I made a hard pivot.
Commercial real estate and repositioning.
Not because the contractor problem goes away. It doesn't. Contractors are contractors. The games are the same.
But the math is fundamentally different.
In residential the value is in the comparable sales. You don't control that. The market does. You improve the property and hope the comps support what you put into it. When they don't, and right now a lot of them don't, you've done the work and absorbed the loss.
In commercial the value is in the income. You control the income. Improve the asset, stabilize the tenancy, reduce vacancy, raise rents to market, the value goes up on a multiplier that residential never touches.
A $50,000 improvement that adds $1,500 a month in net operating income doesn't add $50,000 in value. At a six cap it adds $300,000.
That's the same contractor headache. Completely different outcome.
And when the spread is that wide, catching a contractor problem early doesn't kill the deal. It costs you a conversation and maybe a scope revision. On a residential rehab with a thin margin it costs you the whole deal.
The investor I was talking to has good instincts. Buying at a steep discount. Building local teams. Controlling what he can control. Those instincts translate directly to commercial. The difference is the playing field stops working against you quite so hard.
The contractor problem is real. You can spend your career learning to survive it on thin margins.
Or you can widen the margins until surviving it isn't the whole game.
When you are ready, let’s talk. calendly.com/jeph-reit