How we picked a general contractor

Our bank has required that we find a general contractor.  They will not do a construction loan with just the bank and the owner.  You have to have a qualified third party to protect everyone’s interest.  Having had a bad experience with the last general contractor, we were reluctant to do that.  But, we have no choice in this matter.

Construction remodel loans are similar in some ways to a regular. Just like most conventional mortgage loans, you can borrow up to 80% of the appraised value.  This is referred to as the ‘loan to value ratio’.

The difference with a construction loan is that this is based on the future appraised value at project completion rather than the current value.

For example,  let’s say you purchased a property for it’s appraised value of $62,500.  You would put down 20% down which is $12,500.  You would have a $50,0000 mortgage.  Let’s then say you then decided to remodel it and finance the cost of the project.  You would put some plans together and based on those the bank would appraise the future value.  If that future value came to $100,000, then you would be able to borrow up to $30,000.

50,000 + $30,000 = $80,000 which is 80% of the future appraised value of $100,000

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Using my 9th grade algebra skills, I came up with this equation to calculate the appraised value we'd need based on these inputs:

(l + e) / .8 = a

L = is known to us and the amount of our current loan on the property which is $545,000

E = the estimated remodel cost that the general contractors we were interviewing would provide us

A =  future appraised value target.

I made a spreadsheet that calculated several things for me, including this and captured the contractor bids into the spreadsheet as they came in.

Based on comparison properties, considering the finished square footage, number of bedrooms, bathrooms and location, and assuming a quality remodel, we estimated that we can get an appraised value somewhere between 1.2M and 1.4M.  That’s just my best guess which, as you have already figured out by reading this blog, is naïve and unuseful.

Let me say now that when we started this project we had no idea the numbers would get so high and this would cost so much.  We were naïve.  We’ve had to decide and re-decide multiple times whether we go forward with this project. Honestly, we never wanted to own a home that was in the 1.2M to 1.4M dollar range.  If we had to do this over, we wouldn’t do this.  Too much risk at to high of a cost.  But here we are.  Neck deep in the Going Queen project.

Also, we are probably lying to ourselves.  We’d probably still do it

We had to come up with some criteria to use to evaluate the contractors to avoid getting taken advantage of again.  We came up with this plan…

We would engage with each contractor and ask them to provide an initial estimate.  The experience of working with them on the estimate, not the estimate itself, would determine who we would select.  We would apply a little pressure in the form of a tight timeframe and a pricing challenge and see how everyone worked with that.

We were thinking that if a contractor got a thoughtful and thorough response back to us quickly, we could assume they were enthusiastic about doing the work and had the bandwidth.  If they took a longer time to respond, their response seemed rushed or that they didn’t include key elements found in our architectural drawings then we might conclude they didn’t have the interest or time for our project.  We felt if they responded to the time pressure and budget pressure confidently and positively, that they might be more flexible and easier to work with.

We decided we would use the ‘loan to value’ ratio as a challenge to each of them to see how they reacted and adapted their approach to it. It was going to be very difficult to get the cost of the remodel within the loan to value ratio.

We met with each of them at the Going Queen and did a walkthrough.  We provided each contractor with the completed architectural drawings and engineering calculations.

We also made the same statement to each of them about the project (I memorized it to make sure every contractor had the same information):

“Our goal here is to complete this remodel within 80% of the appraised value of the property.  We are flexible with how we get there.  We are open to removing cost from the project by simplifying. We do not have to adhere 100% to the plans, however if you depart from the plans we want to understand what you are proposing.  We are willing to make some compromises on material selection as long as we end up with a similar result.  There are areas where we are not flexible, and some areas where we are flexible. Ask if you have questions.
We are Ok with breaking the project up into two phases.  Once we complete the remodel, meet the conditions of the loan and move into the house.  We could then do a phase 2, maybe a year or two later, and address any compromises we felt we made to stay within the 80% of appraised value.
We do not expect this to be a final bid.  This can be a well thought out but rough estimate.  We will work with you to refine the numbers if we choose to move forward with you.”

We felt like this approach would avoid someone giving us an overblown bid.  It would also make anyone who was trying to swing for the fences to decline to work with us.  On the other hand, this would also help identify anyone who might lowball a bid to get in the door and then hit us with bad news later.  Again, we are trying to avoid a repeat of what happened with the first contractor.

By suggesting a phase two where they would come back and do more work for us, we felt anyone who was confident in a successful result would be confident of having a round two project with us.  

Back when we were planning on acting as our own general contractor, we got bids for many parts of the project.  This turned out to be very useful.  The bids we had already received would helped us understand the new estimates.

In the next post, we’ll show you the numbers that came back and our assessment of each contractor.  We’ll also tell you who we selected and why.

Yea, that’s right.  We have a general contractor now.