Tune into this week’s episode of the FortuneBuilders Real Estate Investing Show to join JD as he breaks down some of the most critical aspects of flipping houses. In this episode, JD discusses each of the 6 documents that you will need when rehabbing a house. Find out why each document is crucial and how you can properly use each one.
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The 6 Critical Documents for Rehabbing
Hello everyone this is JD Esajian, as my nice nieces and nephews call me uncle JD. But you can call me JD, Mr. Esajian, bro, what up dude? I’m excited for another awesome podcast with some very important information. Super excited to talk. We just got done with one of our Boot Camp Summits at FortuneBuilders and it reminded me as I was teaching that there are some very specific systems that we cover and do on the rehab side of things that we teach, train, have systems around, and run in our CT Homes business, and I thought I’d break down one of those important systems.
That’s specifically the six (1, 2, 3, 4, 5, 6) critical and very important, some might say critical documents that we use in our residential redevelopment business. Now there are more than six for sure, but I’m going to cover six very important, some might say critical documents.
Term of the Week
As always, we have to discuss or tease you with our term of the week. The term of the week is independent contractor agreement. ICA for short. Now, depending on the industries that you’ve been in, or the work that you’ve done, you might have heard of an independent contractor agreement. It’s not specific to real estate per se, but I’m going to talk about it as it relates to our real estate business, and specifically, our residential redevelopment business rehabbing homes in this show. It’s a very important document. It’s the foundation of our relationship with our contractors. And we’re going to discuss that amongst five other very important critical documents. Let’s get into it.
7 Stages of a Rehab
We have seven stages of our rehab process. Meaning, there are seven buckets of things that we should be doing on every property to keep ourselves on task. First and foremost, there’s some initial walkthrough. You go to the home for the first time. You estimate repairs. You determine layouts, etc, etc. I mean, it’s a longer definition, but it is walking through the home.
Then, you create your your scope of work, what are you going to do, why you’re going to do it, what’s gonna go here, what’s going to there, paint, colors, landscaping, all those types of things. Then, there is a process of contractor and job bidding. You have to have contractors or have been marketing for contractors to do that, right? You have to know contractors or find them, get the job, bid it out, confirm your estimate of repairs, make sure that the work that you have scoped can be done for the budget and those kinds of things,
Then there’s a process of contract signing. That’s really what I’m going to focus on primarily on this show: those contracts. Then once the contracts are signed, you actually can start the rehab. The rehab is stage five of the seven stages. There’s a reason for that. While it’s usually the longest stage, and can be the most fun, it can certainly be the opposite of that if you’re not following certain protocols and steps.
So that stage five. Stage six is the contract, close out, final permit, sign off, get final lien waivers, make final payments, punch list. The last stage seven is the final touches, things that you do to get the home ready for the marketplace, cleaning, staging, professional photography, preparing listing, marketing online, those types of things.
Contract Signing Documents
We’re going to focus on stage four, the contract signing stage. Ladies and gentlemen, around the world around the globe, boys and girls, the six critical documents that we should be (if we’re renovating homes) signing with each and every contractor that we are paying.
If you’re just hiring a general contractor and they are doing all the work and they’re managing and hiring the subs, then you would sign this set of six documents with that one contractor. If you are hiring a general contractor to do 40% of the work, and then you are going to independently hire the other subs that are going to do the rest of the 60% of the work, then you would sign the six critical documents, as we call them, with each and every one of those subs that you are paying money to for their services.
There are reasons why we use these documents. Of course, I’m going to talk about that here. That’s the intent of this show.
“It’s important as a business owner that you do things to keep yourself safe and to keep people on task and also run a better business.”
This is one of those things if you’re rehabbing houses and redeveloping property, residential, commercial, buying and holding, because there’s probably going to be some repositioning of the property as well.
First Document: Independent Contractor Agreement
The first document we’re going to talk about is our term of the week: the independent contractor agreement, the ICA. The independent contractor agreement in our system is a three page, sometimes three and a half page document. I have a copy of it right here in my hands.
That is the rules of engagement, if you will, with the party that you’re signing them with. In this case, it ia a contractor or subcontractor. It spells out things like: When are we starting? When are we scheduled to finish? What is the cost of the job that I’m hiring them to do? Do we attach exhibits like exhibit a? What is the scope of work? What is the scope that they’re doing? Exhibit B? How are we paying them? When are we paying them? it discusses how insurance is handled. It discusses how things like change orders are handled, job site cleanliness, taxes and building permits. There’s a lot in here.
It’s a legal document. And it is designed so that if the contractor is doing their job appropriately, and we’re doing our job appropriately, it keeps everyone safe. It’s so important when you work with someone in this activity, and you’re exchanging services for money, that it isn’t just a handshake agreement. There are lots of reasons why that’s the case. There’s a very technical term. It might even be a medical term. I’m not a doctor, so I can’t verify that. It’s called selective amnesia. Now, again, I didn’t go to metal medical school, and some of you out there might be MDS doctors and have gone to medical school.
Selective amnesia is probably not something you’re going to find in the medical books, but it is what it says people tend to remember. We all do tend to remember things or not remember things, when it suits us in the moment. If you have a discussion with someone, a contractor in this activity, and you say “okay” and you verbalize it: “okay, here’s how change orders get handled. Before you do the work, I need to know about this additional work that has come up that is needed. We’re going to discuss it. We’re going to negotiate the price. We’re going to get it in writing. We’re both going to sign it and we’re never going to add it to the overall contract”.
That’s great. That’s a professional way to handle it, but you don’t sign anything in black and white that states that same thing. People might forget that that was said, either legitimately forget it or conveniently forget it. Either way, that’s why we have it in black and white and why I would recommend that you do something very similar and have the ability to have a contract with the person that you’re paying – the contractor in this example.
We even go so far as when we’re starting with contractors, like for the first or second project, we’ll go over this with them together. It’s one thing to send this to a contractor via email and they say that they’ve read it, and they sign it, and then you get it back and all seems to be good. Then halfway through the job, something comes up that that is not what is agreed to in the contract and the contractor says, “Well, I didn’t read the contract”, and you say, “Well, I sent it to you. You said you read it. You signed it. Here’s your signature”, “Yeah, but I didn’t read it”.
Yes, you have recourse in that example, but the goal of a good contract is to not find yourself in mediation or in a courtroom or have attorneys discussing the outcome. It’s to keep everyone on track and try to prevent that. The independent contractor agreement is one of those documents that is designed to do that. Iit talks about safety requirements and things of that nature as it relates to your local market. That’s why amongst many other reasons you want to have a local attorney look at it. Cancellations, what happens if the parties aren’t agreeing?
If you as as the owner in this relationship (obviously you own the property) decide you want to go a different direction, what happens? Well, the independent contractor agreement states that, if that happens, you as the owner have the right to let that contractor go. If that happens, they’re only entitled to the money for the work that they have completed to that point.
If material is not on the job site, not work that hasn’t been done yet, or hasn’t been started yet, that was overall agreed to in the contract. So we’re only going to pay them for the work and or material that’s on site that was done or is there at the point that you decide to move on. That isn’t always in a contract. Sometimes I’ve read contractor contracts where it states the opposite of that: they’re entitled to the whole lump sum of the contract, whether they finished the job or not. Now in my world, that’s not that’s not the right way to handle it.
Those are some of the important things. It is the rules of engagement in the in the relationship, guided communication. This is an actual story, I met my wife on eHarmony and it was an amazing process, because they guided you through the communication, put in all your information, and then you get this kind of guided communication of when to talk and when to respond. I can’t say that’s the only reason that it worked out and that we got married, but it helped guide the communication.
Hiring a contractor to do work on your project is definitely not a marriage, but it’s a version of a very important relationship, that you want to handle the right way. That’s document number one, the independent contractor agreement, ICA. That is actually also our term of the week.
Second Document: Scope of Work
Now, the second document of the six is the scope of work. The scope of work is a as long as a document as it needs to be that spells out either with photos, item numbers, listed layout changes, everything you want done to the home. Think of a scope of work to your rehab like you would imagine a screenplay is to a movie.
If you haven’t read a screenplay before, it doesn’t just talk about what people say to each other, it talks about the setting and the background and all these things. So when you were to read it, you could basically see what the movie was going to look like on the big screen. Well, the scope of work should be similar to that when someone reads it, like a contractor, they should be very clear what they’re bidding on.
It should be very clear what they’re doing, what they’re not doing, etc. So that’s what the scope of work is and that gets initialed. When you decide to use a contractor in this relationship, and you’re signing contracts that gets initialed for you, the entire scope if that’s what they’re doing, or their portion of the scope of work and it gets added to the ICA independent contractor agreement as Exhibit A. That’s the second critical document of the six.
Third Document: Payment Schedule
Number three is the payment schedule. Payment schedule is the number three critical document. What the payment schedule does is it takes the scope of work that we just talked about and it breaks it up into major benchmarks and milestones, and then applies and appropriates payment for that work for that time period. So we pay as work gets done.
That’s very important. We don’t pay for work that hasn’t been done yet. We pay as work gets done. Typically speaking, we break up the payment schedule on a weekly basis. It’s not a weekly draw, though. It’s broken out and predetermined with your contractor of the amount of work that’s going to get done each week and an appropriate payment for that amount of work. I like weekly because when you’re paying someone weekly for the work that they’re doing, you have a little bit more of their attention than if you’re paying them every two weeks or every three weeks.
This person in this relationship as an independent contractor is not a employee. That’s another thing that the independent contractor agreement states. Although you may be paying them every week against a predetermined payment schedule, you have paperwork that states that they are an independent contractor and they’re free to do other jobs and probably are doing other jobs but you happen to be hiring them for that job for this scope and that payment schedule.
Number three is the payment schedule. Very important to help the contractor know when and what they need to do to get paid so you keep the job moving along. I do recommend with a new contractor that you create that together. It helps lay out the job. It helps provide accountability to the contractor if and when things don’t get done. It’s a very professional way, in my opinion, to start the relationship and to help create buy-in with the contractor.
Fourth Document: Insurance Indemnification and Hold Harmless Agreement
The fourth critical document that we use with our contractors is related to insurance. It’s called the insurance indemnification and hold harmless agreement. That’s a mouthful, say that five times fast “insurance indemnification hold harmless agreement”. I’m not gonna even do it, but it’s hard.
Alright, so the insurance identification, a hold harmless agreement is a one page sheet that states for our business: what’s the type of insurance that we need? What’s the minimum requirements for the liability coverage amounts? It talks about things like: they will keep the insurance policy and for full for us during the course of the work?. It talks about what we need, as the owner (ou and I) to be ableto be added to their insurance policy as an additional insured, and the job site location being stated on the paperwork as well.
Then the contractor signs that agreement and address of the home etc. Now, that’s not the only insurance paperwork that we get, that’s just one of the six critical documents: document number four. In conjunction with that, call it 4-A or 4-B, is we do get added to the contractors insurance policy as a additional insured, which notifies the insurance company that they’re doing work on our project and our company name gets added and then the job site location gets put on that as well.
When we get a copy of that before they start work, not after. Then we attach that to the insurance identification hold harmless agreement, and we attach it to the independent contractor agreement as Exhibit B. Exhibit B in our contract is the insurance identification hold harmless agreement, but it’s also the fourth critical document in the six that we have in our system here within FortuneBuilders. That’s insurance. That’s number four: insurance identification hold harmless agreement.
Fifth Document: W-9
Numero cinco. That’s number five, coming at you live is a tax related document. It is something that we sign with our contractors. We don’t sign it every job necessarily if we use a contractor more than once a year. I typically recommend we get this signed once a year with each contractor.
The other documents that we’ll talk about, we get signed with every contractor that we’re paying on every job that we hire them for every year if we use them more than once. The W-9 which is an IRS document is something that we get signed with our contractors at least once a year at beginning of the year and first time we use them that they complete.
We hold that so that at the end of the year our accountant can 1099 them, which is another tax related activity, and they can send our contractor a 1099 with the information that they put into the W-9 which is in effect and notifies the IRS whoever’s the owner made these payments to this contractor.
This is the total amount. They were an independent contractor because they are in this relationship and that person, the contractor and in this discussion that we’re having is responsible for their taxes on that income money that you pay them. Now, if you don’t get a W-9 and the information needed there to be able to 1099 them at the end of the year, there are situations where the IRS can come back to you for the contractor’s taxes if they don’t pay them.
I’m pretty sure that everyone listening and watching right now is positive that they don’t want to pay someone else’s taxes. And in fact, you’re probably (depending on what state you live in or what you’re doing) tying to minimize your tax liability or tired of paying your own. What I can tell you is that you’re going to feel not good if you’re paying someone else’s taxes. So get a W-9 signed with your contractors that you’re hiring and paying at least once a year so that you can 1099 and your accountant can certainly help with that activity.
It’s a very common, extremely common activity in the independent contractor relationship, not just as it relates to contractors or general contractors or subcontractors doing construction work, but really in any independent contractor employer relationship. That’s something that has to get done. That’s a tax related document.
Sixth Document: Lien Waver
Now, ladies and gentlemen, boys and girls listening and watching around the globe, or wherever you’re listening from, the sixth critical document is the lien waiver. Yes, I said it: lien waiver. Some call it a final and unconditional waiver of lien. Others might call it a partial and conditional waiver of lien depending on when you use it.
In this relationship of contractor and owner, which is what we’re talking about here with regards to real estate and construction, in for recourse for contractors that don’t get paid or or haven’t gotten paid or material suppliers for that matter, is they can file a mechanic’s lien against a property. That’s a material supplier or contractor’s recourse if the owner or whoever’s responsible isn’t paying them or hasn’t paid them for their services. They can attach a mechanic’s lien against the property, which is a cloud on title.
Now, title is the chain of ownership that has gone on if you’re selling the home or when you go to sell the home. Most people will not buy a property from me unless you have free and clear title, you have the sole responsibility or ability to sell that home and there’s nothing clouding that or changing that. When a mechanic’s lien gets filed, that changes that free and clear title and now basically says “hey, this person has hasn’t paid me yet” and you have to deal with it before you can get free and clear title.
This is good to know, and you should determine this in your state: it’s very easy to file a mechanic’s lien with little or no documentation. Other states, it’s not very easy to do it. Either way, it can be done properly and legally by someone that hasn’t gotten paid. Now if it’s easier in your state, and contractor does it erroneously which could happen, then you have a clear paper trail of what was and wasn’t done so you can easily handle that.
If for some reason, they’re accurate, well, then something went wrong, something went awry. And you are going to have to help solve that because you need to sell the property and want to sell it free and clear title. I said it already, but I’ll say it again, because it’s noteworthy and worth remembering is that not only can general contractors or subcontractors file a lien, material supplier can as well. Let’s say you hire a subcontractor, and they go get material somewhere and they don’t pay that material supplier and you don’t know about it, they can also attach a lien to a property and cloud your title on your property.
Now, do I agree with that kind of reasoning? Well, I mean, as a seller of a property, I wish that wasn’t the case, but as a contractor, or in this example a material supplier, I do because it it’s their ability and way to be able to recoup their money. Either way it needs to be dealt with if that happens. Know that and you may also want to get this lien waiver signed by material suppliers.
What a what a lien waiver does, I’m not going to read it to you or spell out what’s in it, but basically, what it says is, “hey, look, this person was hired to do this work this person, the other person paid them to do this work. Both parties are done with this agreement and the contractor signs it saying they have been paid in full and they are releasing their ability to lien the property”.
It’s a very clean way to in the contractual relationship. You can also get one signed by a material supplier if you suspect that you need to and any and all subcontractors. Furthermore, if you want to, you can do a partial lien release throughout the course of the project pay getting one signed as you make payments.
Now I don’t do that with every contractor after we we’ve used them a couple of time because if I still feel I have to do partial lien releases and get it verified that they pay their material suppliers, then there’s something up, and I’m gonna go find a different contractor that’s better suited. It doesn’t mean they’re bad or not good, it is just not good for our system.
That’s the final an unconditional waiver of lien that we would get signed by any contractor that we paid. We could verify the material suppliers got paid and get one signed to. It’s a nice, neat clean bookend to the contractual relationship with our our general contractor or subcontractors or whoever were directly contracting with and making payments to on our projects. Those are the six very important, critical documents, which is what we call them in our system here at FortuneBuilders.
That’s what I wanted to cover today, folks, and a very important snippet of system within our community so you can become more familiar. For those of you that are rehabbing and for those of you that are thinking about rehabbing or those of you that know someone that’s rehabbing this is really what you should be doing. That’s the topic today, ladies and gentlemen. I’m super pumped for everyone to be watching and listening. Be sure that you share, comment, like, subscribe, all that good stuff to throwbacks and feedback to us and share the message that we’re helping to create the education that we’re putting out there. Thanks, everyone for tuning in. Appreciate it. Guess what? I’m going to see you on another podcast very, very soon. Talk to you later.