Unexpected Invoices And Extended Timelines Can Impact Your Real Estate Investment Deals
I have been having some troubles with one of my rentals. Long story short, we had to evict a tenant late last year. As sometimes happens, the property needed a lot of work done to get it rent ready again. Jump forward to April of this year and I am still getting emails from my property manager that the property needs more repairs. After a few calls and emails to the property manager, the property manager’s boss and even the boss’s boss, I felt like the end was in sight for the repairs and the property should finally be safe and habitable for the new tenant, as well as restart the cash flow to replenish the reserves that had been depleted to get the place back in good condition.
Taking a step back and trying to figure out how this could have happened, why the work dragged on and why invoices kept coming in, I was reminded of the term “Scope Creep”.
What Is Scope Creep?
Scope Creep can be defined several different ways and can apply to different industries. For the sake of this article, I would define “scope” as the scope of work or the repair budget. In other words, what does the project entail work-wise and what will that work cost. Scope Creep then, is when the scope slowly and steadily creeps up in a project’s requirements and costs. I have seen this happen to folks on day one of their project when they immediately realize they did not have a line item for demo on their budget. As real estate investors, we deal with repair budgets and scopes of work all day, every day. As most of us know, projects almost never go as smoothly as planned. So, how then can we prepare for the inevitable Scope Creep and what can we do to prevent it?
What Causes Your Budget to Creep Up?
There are 5 common causes of Scope Creep in the real estate investors world that I’ve come across:
- Lack of clarity and depth to the original scope
- Not including relevant parties and professionals in the planning and estimating process
- Underestimating the permitting process and holding times
- Not accounting for the small cosmetic features and the associated labor
- Not having a contingency!
We are all feeling the pressures of a hot real estate market. Time is of the essence when it comes to making offers, so often we have to make compromises when it comes to the time and effort we can put into our offers. We may not have the time to visit a property before we make that offer for fear the property will be under contract before we can walk it. We might waive the home inspection because we know others in the market are waiving theirs. In our rush to get offers out the door we forget to add simple items to our budget like demo, towel bars or backsplashes. By the time we realize our mistake, we may have already closed on the property and now, our scope begins to creep. We still must start the project with demo and the finished product must have a place to hang towels. The electrician realizes that the property doesn’t just need new switches and outlets but should be fully re-wired. We probably would have caught this and budgeted appropriately if we had gotten that home inspection. We might have even been able to negotiate a bit of a discount because of it.
How Can We Minimize Scope Creep?
Knowing that Scope Creep is real and should be expected, what can we do to better prepare and mitigate it?
Here are 5 ways to slow Scope Creep:
- Planning is a must – take your time on the first site visit
- Cultivate a network of professionals to help and support projects
- Overestimate how long things will take, from the city review process to installing vinyl flooring
- Prepare samples of different scopes so as not to miss line items and costs
- Add in a contingency of at least 10% on every project
To the extent that you can, take some time now and create a standard scope of work. Build this based on previous scopes from previous deals. What went well and was budgeted for, what jumped up and surprised you? What were the large and small change orders? If you have not done a deal yet, walk around your own home and begin to list out everything that a home should have. Go to open houses and take notice of all the items that seem newer and remodeled compared to your own home. Reach out to your network, (or begin to grow it!) and ask for their input. Talk to home inspectors, contractors, structural engineers, other folks wandering around Home Depot and of course your favorite hard money lender (ME!). Ask for feedback from other investors at the next REIA meeting as to how long projects are taking and how the permitting process is evolving. Work with your agent to strategize how you can still make strong offers but also allow for home inspections (still buying it as-is but need to inspect for the unseeable items) and more access before closing.
Expect Changes And Expect Scopes To Creep
Looking back on the turnover at my rental, I realized I hadn’t done a lot of these items. I didn’t sit down with my property manager to discuss the condition of the home. I didn’t walk the project myself. I didn’t strategize with the property manager who the potential tenants might be and what extra requirements a Section 8 tenant might need from the home in order to be approved. It was easy to get upset and point fingers, but when you point one finger, there will be three more pointed back at you. I was the one that I should have been upset with because I didn’t take the time and I didn’t put in the effort to prevent Scope Creep.
Scope Creep is inevitable as projects naturally evolve over time. Markets change, trends change, costs change. There is nothing new about this. We need to be prepared and expect these changes and for our scopes to creep. With a bit more preparation we can reduce the amount our projects creep and control our costs. Take the time now to build your team and processes to ensure a quick and smooth project. We at Pine Financial Group want to be part of your team! We are investors ourselves and love nothing more than helping our clients succeed! I would love to connect with you and see how we can help on your next investment and slow the Scope Creep!