Handbook of Construction Contracting - Volume 1
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Introduction | Table of Contents | Back Cover

Chapter 1

The Business of Building

No field offers more opportunity than construction. Where else can someone start with little cash, no special education and no special skills and build a multi-million dollar company in a few years? This isn't fantasy. It happens regularly.

I'm not saying anyone can do it. It takes hard work, skill, and a little luck. Every year thousands of general contractors, carpenters, masons, plumbers and electricians go into business for themselves. Some of their companies will remain small. Others will grow quickly. Many will fail within a year or two.

Many of the 1000 largest building companies in the U.S. are run by men and women with little formal education. They learned the business from square one, working as laborers or helpers until they had the skills needed to succeed as construction contractors. Most of these people got into construction by accident. Few started out with the intent of becoming professional builders. Typically, here's how it happens:

You worked part-time on construction projects as a teenager. Or maybe you have an uncle or cousin in construction. You felt comfortable on a construction site. You've seen others go into business for themselves as builders. Your first job may have been remodeling an old house. Or maybe it was building a weekend cottage in your spare time. On that first job you made mistakes. Some mistakes cost you plenty. But this was the "tuition" you paid to learn the fundamentals.

Gradually you learned how to estimate material quantities, how to price your work, how to handle employees, how to sell your services, and how to work with clients, architects, lenders and the building inspector. You learned what to watch for and what to avoid. You learned what works and what doesn't. You learned the importance of doing quality work and building a reputation for professionalism. And, gradually, you learned what it takes to make a good living in the construction industry.

A friend or neighbor saw your first project and wanted you to handle some work for him. You took the job, made a decent wage for your effort and turned a small profit to boot. Encouraged by those results, you started another job when that second job was finished. Before too long, you had several requests to bid some work. Two or three tradesmen were regulars on your payroll. Before long, you were running a construction company, had an ad in the Yellow Pages, a company phone and a weekly payroll to meet.

Construction contracting isn't all peaches and cream, of course. This country has a regular construction cycle that brings prosperity to thousands of builders and then washes thousands out of the business four or five years later.

But if you're looking for a way to be your own boss and make a decent living doing quality work, read on. This book is for you. We'll cover all of the basics of construction contracting. We'll discover what separates the successful builder from those who fail. And we'll show you how to increase your profits and reduce costs.

In this first chapter, we'll take a bird's-eye view of the business of building. We'll outline the shape of the construction industry and present a few concepts that you should understand at the outset. The details come in later chapters. If you've been working as a tradesman or contractor for several years, you may want to skip right on to Chapter 2.

Before I leave the subject of careers in the construction industry, let me point out one important benefit that shouldn't be ignored. Few builders see their bank accounts swell into the millions. Of course, many make a good living. But there are benefits to being in construction that never show up on a balance sheet.

Look at the before and after pictures in Figure 1-1. The finished product isn't the Taj Mahal. But the builder who did the work can take pride in turning an old sow's ear into a comfortable silk purse with modern plumbing and electrical systems. He's provided one of the most basic human requirements, the need for shelter. The family that lives in this remodeled house enjoys more comfort, more convenience and a more attractive environment. That makes for a better life.

If you take pride in doing quality work that makes a better life for others as well as for yourself, you're a "natural" for the construction industry.

Contractors and Developers

Some construction contractors are part-time builders. They have another occupation that provides a regular source of income. When the construction cycle is on the upswing, they put up spec or custom houses or do some remodeling, all the while holding another full-time job. When new homes aren't selling and remodeling jobs are scarce, they concentrate on their other occupation.

Part-time builders have to be good at planning - directing and scheduling work. And they need a reliable full-time employee on site who can make decisions while the owner is occupied elsewhere.

There's nothing wrong with building part-time. Many teachers, for example, find time to run a small construction company as a sideline. Short school workdays and long summer vacations make running a building business on the side entirely possible.

Full-time contractors usually fall into one of three categories: the on-site contractor, the managing contractor and the land developer.

On-site contractors- Many builders have just two or three regular employees. The only office may be the company pickup truck. The owner works alongside the crew. He does any kind of work that comes along: a spec house, a custom house, an add-on, or a remodeling job.

This type of builder seldom goes broke. What he's selling is his own time. When the construction market turns sour, he doesn't have the burdensome overhead and crushing loan charges that sink other builders during a recession. On-site contractors just pull in their horns, shift emphasis to other types of work (or take another job) and wait until the market improves.

Most of the construction companies in this country are run by on-site contractors. Every community has at least a few. They're the backbone of the residential construction and remodeling industry in the U.S.

Managing contractors- Of course, many contractors haven't picked up a hand tool in years. They spend more time in the office than on the job. This type of builder is primarily a manager. He plans and directs the operation, from buying the lot (for a spec building), to getting permits, estimating, ordering materials, and selecting subcontractors.

A managing contractor directs the work flow, keeping the work on schedule and within budget. He's an inspector and facilitator, seldom a tradesman or supervisor. He doesn't need to be an expert in all trades. But he has to know the difference between quality work and work that doesn't measure up to standard. Some call this type of builder a "paper contractor."

The managing contractor probably had several jobs going at the same time. He has to if he wants to carry the overhead of his own unproductive labor. That's why this type of contractor is vulnerable when construction slows down. It's hard to shed overhead and debts fast enough to stay afloat in a disappearing market.

Land developers – These are land merchants more than construction contractors. Building is more a sideline than a major focus. Developers buy tracts of land and turn them into residential, commercial or industrial subdivisions. Developers are gamblers. They bring together borrowed capital, land, design and construction services, and prospective buyers, to create subdivisions that they hope to sell for more than they cost.

When a developer miscalculates, his error is likely to be major. But hitting the right market with the right product can create big profits.

In this book, we'll occasionally refer to land development projects. But we'll focus on smaller- scale construction contracting. Even if you intend to develop land on a large scale someday, you'll want to master building smaller projects first. Remember, finishing successful small projects lays the groundwork for bigger jobs.

Speculative Building

Spec builders come in all sizes, from the contractor who's building his first and only spec home to the developer who has a thousand homes under construction on sites in several states. All spec builders buy or subordinate the land, arrange for a construction loan, take out the permits, put up the buildings, and work to find qualified buyers.

The spec builder's nightmare is unsold inventory. The longer a house remains unsold, the smaller the profit. Eventually, the profit may disappear entirely. Very rarely does a delayed sale bring in enough extra money to cover the cost of holding the property vacant for months or years.

Here's a rule of thumb for estimating the total cost to the buyer for a conventional house with only the minimum of modern conveniences:

Multiply the carpenter’s hourly wage by 3. Then multiply this figure by the total area of the house (in square feet).

Here's an example. Let's say the hourly union wage for a carpenter in your area is $20. You want to estimate the selling price of a 1,500 square foot house. Multiply the union wage ($20) by 3 to get a formula wage of $60. Then multiply $60 by 1,500. This gives you a total cost of $90,000, or $60 per square foot. Remember to use a carpenter's hourly union wage in your baseline estimate. (This may not be the same as the actual hourly wage paid on your job.) This "baseline estimate" will usually be high enough to include the lot, profit, and operating expenses like taxes, insurance and interest charges.

Here's another guide to use when considering a spec home project. About one manhour will be needed for each square foot of floor in a home without a basement. Two-thirds of this time will be skilled labor and one-third will be semi-skilled labor.

Let's apply this rule to our 1,500 square foot house. Allowing I manhour per square foot of floor space, 1,500 manhours will be required. We'll need 1,000 skilled manhours and 500 semi-skilled manhours.

If you're a skilled carpenter and hire another skilled tradesman and a semi-skilled helper, the three of you can complete the job in 500 hours. If you sub out part of the work, you'll reduce your crew's time accordingly.

Keep in mind that this is only a rule of thumb. It has to be adjusted to fit the situation. Never substitute a baseline estimate for the detailed, itemized material and labor estimate. You need a complete estimate on every job. Before submitting any bid, list every unit of material. Then determine the cost of all those materials and estimate the manhours required for installation.

Building a spec house has a major advantage: If costs run over budget, you can usually increase the asking price a little. With a custom house, the situation is different. Your income is set by contract. Omit some cost and you're stuck with the bill.

Custom Building

Your client's primary concern will usually be the cost, at least until construction gets underway. Use extreme care in preparing your list of materials (take-off sheet). Make sure you include everything.

Custom building has advantages and disadvantages. The primary advantage is that your client carries the largest risk. But the builder still carries risk that material prices will increase between the bid date and the date of construction. Lumber and plywood prices, to name just two, can change rapidly. Increases of 15 or 20% over two or three months are common for some materials. Protect yourself. Include price escalation clauses in your contract. Get written bids from subcontractors. Make sure the bid prices are guaranteed for a specified time period. Otherwise, the sub's labor and material price increases end up in your lap.

Before you agree to build a custom home on any site, familiarize yourself with soil conditions. Pay special attention to water levels, rock formations, soil type and topography. If large trees, stumps, and rocks have to be removed, your building costs will be higher. And these costs may not be recoverable.

The less money spent on preparing the site, the better. A $150,000 house sitting on a site that cost $150,000 to prepare looks the same as a $150,000 house sitting on a site that cost just $2,000 to prepare - and it has the same selling price. It doesn't look anything like a $200,000 house. Put your construction money where it shows: in the house, not under it.

Changes during construction can be a headache or a money machine for the home builder. Most owners request changes by the bushel as their custom home is built. Once the house is framed, the owner will want to relocate a partition, enlarge a closet, or install a larger window in the master bedroom. After construction begins, any change in plans will cost more - more manhours, more for materials, and much more for administrative overhead. Make sure your contract provides that changes will be made only by written request and at your "usual selling price" (what you would like to get, not what the competition would bid). And never price extras at your cost plus 10%. Labor and material cost plus 10% is always less than your true cost.

The owner might also decide that your construction materials are substandard and unacceptable. Dissatisfied owners have been known to knock out studs and joists at the end of the workday after the builder and crew have gone home. Have a clear understanding with the owner about the quality of materials. Include in your contract acceptability standards by grade and species.

Few builders have the time to hand pick the lumber used in a house. But make the time to reject materials that don't meet the standards set in your contract. And send back any finish materials that are defective. Reputable builders don't use substandard materials.

Generally you’ll be selected to build a custom home because your bid is either the lowest or among the lowest. That puts a premium on careful estimating. Most builders include a little cushioning in their estimates to allow for errors. Usually this is called contingency. But building in to much slack usually guarantees that someone else does the work. The best procedure is to compile complete, accurate estimates, (including overhead and profit) so that little or no cushion is needed.

Remodeling

Remodeling is a big industry in this country. And it's growing faster than construction in general. Room additions, porches, patios, redoing bathrooms and kitchens, repairing fire, storm and insect damage are all big ticket items.

Profit margins are higher in remodeling work than in any other type of construction. And it's good fill-in work for your crew during the slack times when staying busy is a problem. But it's a different type of construction that requires special skills and procedures.

A healthy dose of skepticism is an advantage in remodeling work. Never assume that anything in the existing structure is built according to standard. It probably isn't. And don't assume that the structure is square, plumb or level. It seldom will be.

Assume that everything hidden is either not on center or will move out of position when you drive the first nail. A water pipe or an electrical circuit will always be right where you plan to cut a door or window. When you remove that old commode, you'll discover the floor underneath is so rotten it wouldn't even support a bedpan! And when you start digging the footing for that room addition, you're certain to uncover an abandoned septic tank. The owner forgot all about it, of course.

The windows you agreed to replace are odd-size and will have to be special-ordered. If it's an older house, you may discover that the studs are 2 x 5's. It would have been nice to know that before the custom-made windows arrived - and before you broke out the old windows!

If you assume that the existing floor is level, you may be in for a surprise. When you cut the opening for the doorway to the room addition, your finish floor on the addition may be 1½ " higher than the existing finish floor. And advising the owner that it's his floor that's skewed won't cut much mustard. Optimistic assumptions cause remodelers a lot of grief. As a remodeler, the only assumptions to make are that it's either too thin, too thick, too short, too long, too small, too large, or too late.

Successful remodelers generally would make good building inspectors. They know what to look for and what questions to ask before work begins. The more thorough the inspection, the more questions asked and answered, the fewer surprises during construction.

Estimating standards used in new construction seldom apply in remodeling work. In new construction, it may take only four manhours to install eight linear feet of base and wall cabinet and top. In remodeling, the leveling, furring-out, working around furniture and appliances, taking materials outside for sawing, and an inquisitive child running free can easily make installation an all-day task.

Still, many builders prefer remodeling work because it is plentiful and carries better margins. True, remodeling is good business, but only for those that have learned through experience what’s required to earn a profit.

Keeping Records

No matter what type of construction you do, accurate, detailed records are essential. Your job estimate sheets, manhour reports and lists of materials are important documents. Set up some orderly filing system so you can identify costs on previous jobs when estimating future jobs. There should be two profits in every job. The first is the money that goes into your pocket. The second is what you have learned while doing the work. Much of what you learned is in written form: material costs, manhour records, subcontractor invoices. Be sure you have these documents available when you need them.

Every builder has to keep payroll and accounting records, even if they're seldom or never used by the business owner. Federal and state law require every business to keep records that establish payroll and income tax liability. The fact that you're not making any money is no defense. Every contractor needs a good record-keeping system to meet state and federal requirements, if for no other reason.

Fortunately there are several good books that describe how to keep good cost records and meet state and federal record-keeping requirements. The order form at the back of this book lists several titles that cover record keeping for builders.

Machinery Equipment

Most builders should avoid buying expensive, heavy equipment such as backhoes, front-end loaders and bulldozers. The initial cost of the equipment is high, and the upkeep can be disastrous.

For example, new rings for a D7 Cat tractor can cost over $5,000. If you install the rings yourself, the cost will be lower. But you’re a builder not a mechanic. If you need dozer or backhoe work, sub it out. Don’t consider buying a heavy equipment until you’re keeping an excavation sub busy full-time. Most builders will never reach that point.

Staying small doesn’t mean the builder is any less successful. Some very profitable and highly efficient construction companies are run by contractors operating out of their pickup trucks. They handle a steady flow of building and remodeling work with small but experienced crews. Many of these builders are successful enough to finance their own operations, making most borrowing unnecessary.

Construction Loans

Custom home builders usually work with loan proceeds arranged by the owner. As work progresses, your client will be given authority to draw on the construction loan on a prescribed percentage basis.

Spec builders have to find their own construction money at banks and savings and loan associations (S&L's). Spec building loans are normally limited to 75% of the appraised value. If the house is presold, the loan may go up to 95% of either the sales price or appraised value (whichever is lower). But the bank or S&L won't usually dispense more than 80% of the loan until the house is completed.

When you prepare to build your first spec house and apply for a construction loan with a local lender, the procedure will be something like this- You get an application, estimate form, specification sheet and energy requirements form. Samples of these forms are shown in Figures 1-2, 1-3, 1-4 and 1-5. Return the completed forms with a full set of plans, your current financial statement, your two most recent tax returns and either a sales contract or a deed on the land. Next, the bank or S&L will appraise the lot, review the plans and specs, and order a credit report. When all the papers are in order, your application is presented to a loan committee for approval.

When the loan is approved, the lender prepares loan documents. You'll sign a construction loan agreement and a preconstruction affidavit in addition to the note, deed to secure debt, and other legal documents.

At closing, the lender will normally disburse no more than 75% of the lot cost and closing fees. (Be sure to include these fees in your cost estimate.) The rest of the money is placed into an account called "loans-in-process." The bank or S&L will disburse it according to a percentage schedule as work progresses. See Figure 1-6.

The builder who has a reputation for doing quality work and finishing his projects will usually have no trouble getting construction loans.

Lenders appreciate repeat business just like any merchant. Once you’re an established customer, the paperwork will flow much more smoothly.

Getting Started

Almost anyone can become a construction contractor. A lot of us began on a part-time basis with a few tools and a pickup truck. Your attitude is the key. Think quality. Plan your jobs carefully. Don’t be satisfied with trial and error methods. Construction is too expensive and too permanent to leave to amateurs. Think of yourself as a reputable professional builder. If what you’re doing isn’t what a reputable professional builder would do, don’t do it. Instead, do it right and take pride in what you’ve done. Solve problems before they become disasters.

Work hard. Watch your nickels and dimes. Keep you overhead down. Don’t lay down a bundle for a fancy power saw. A modestly priced skillsaw will last through two houses and a couple remodeling jobs. Put a carbide-tripped combination blade in a 7¼" power saw and you can do it all, from framing to paneling and trim.

A hammer is different. It’s the tool builders use the most. Buy a good one. Fiberglass handles last a long time. The 16 oz. Hammer is probably the most popular. Most carpenters use the same hammer from the formwork to the roof. But some carpenters keep several types in their tool box.

In this chapter I have used a broad brush to outline the shape of the construction industry. I’ve included very little here that will help you make a better living in construction. But much of what follows assumes you know what was in this chapter.

The next two chapters cover the most basic concepts in construction, plan reading and specifications. If you have been working in construction for several years, only a quick skim of Chapters 2 and 3 will be needed. But be sure to understand plan reading and specifications before going onto Chapter 4.

Introduction | Table of Contents | Back Cover

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