A scope of work (the “scope”) for a renovation project with a fix-and-flip objective has more purpose than the basis for a contractor’s bid. The scope will enable the investor to keep apprised of progress in real-time against the budget, keep the contractor on task, and meet the lender’s requirement for a complete and well-prepared project schedule.
This article will focus on the expectations of a lender and the resources available to the investor when preparing the scope.
Key Takeaways
- A complete scope will categorize the work plan and provide an illustration of the investor’s vision
- The home inspector and the Realtor are necessary resources
- The purpose of scope extends beyond the contractor’s bidding
- A well-prepared scope becomes the basis for drawing applications
Defined Terms
- After-Repair Value – the market value of a property after renovations are complete
- SOW – Scope of Work for renovation projects
- OH&P – the acronym for overhead and profit added by a general contractor to its bid price
The Importance of a Scope
A well-prepared and organized scope will categorize the work plan. Each category must have line items for each task with columns for materials, cost, and the responsible team member.
The scope allows for efficiencies in time and cost. Accurate recordkeeping will also serve as the basis for preparing the monthly draw requests to the lender.
The scope is not set in stone. It is a living document to organize any needed changes in the work, the availability of materials, and issues to consider as the work progresses.
The Purposes of a Scope
The purposes of a scope go beyond pricing the project. While a complete scope is necessary for budgeting and loan approval, the scope will also keep the project on track and the contractor aligned with the investor’s expectations.
The important purposes of a work scope are to:
- aid the private lender in estimating the after-repair value (ARV) used in its underwriting,
- support and illustrate the investor’s expectations to the contractor, lender, and any co-investor,
- keep the contractor on track and on budget,
- document and manage the progress, and
- serve as the main resource in preparing the draw packages for submission to the lender
The professional way the scope is prepared and managed will give credibility to the investor. The confidence in the investor by the contractor and the lender will be reflected in the quality of the work and the quoted loan terms.
The Resources for the Scope
An investor will not be expected to prepare a full scope without resources. The home inspector and the Realtor are important resources to use. The necessary information needed from these professionals is obtained during the contract’s due diligence period.
A wise investment during the due diligence period is the fee for a home inspection. The inspector can prepare a proposed schedule and budget for the patent and latent defects that must be addressed to meet the code, repair damage, and prevent future issues.
This information will enable the investor to prepare a preliminary budget and determine the investment’s overall cost. The pricing given by the home inspector should be confirmed by the contractor from the accepted bids.
Often, the Realtor refers the home inspector and a savvy investor will encourage this interaction.
The Realtor will prepare a market analysis to support the ARV when the property is offered for sale. This analysis will also qualify the loan application and the proforma. The ARV is an important metric used by private lenders in their underwriting.
The strategic use of a home inspector and a Realtor beyond the signed contract will enable the investor to measure the property’s value potential against the cost. A home inspector is needed for the scope and the proposed budget and the Realtor is needed for the projected market value.
The Importance of a Scope of Work in Financing
A scope delineating the professionals responsible for the work, the materials needed for each task, and the final costs will be the illustration of the investor’s vision. This thoroughness will give the lender confidence in the investor’s ability to complete the renovations and create the projected value.
It will be necessary for the investor to track the project’s progress accurately. The tracking is needed for the borrower’s draw submittals. Since the contents of the draw application will require the approval of the contractor and the investor, they must remain in sync during the construction phase.
The initial proceeds are released at the closing for the purchase of the subject property, and the requested construction draws will be subjected to the lender’s approval based on the status inspection result and the relevant SOW. Any draw shortfalls will need a cash injection by the investor or be timed as a future draw.
The scope will support the draw amounts should the lender question or disagree with the request. Shortfalls will be avoided if the contractor manages and supports the scope and all draw requests remain compliant with the loan agreement.
The Components of a Scope
A scope needs to be complete and thorough with the flexibility for changes in the work, budget, and timeline. The components of a complete scope are:
- overview of the project,
- construction team members,
- construction budget,
- project timeline, and
- sign-off
These components are explained below.
1. Overview of the Project
The organization of the scope is at the discretion of the investor. However, the scope must stand on its merit for clarity and accuracy. The deliverables, costs, and descriptions are essential inputs within the scope to advise the lender of the quality of the work and for comparison against the inspection report.
The rooms and the areas of the property subject to the scope need to be described and measured, and any conversions or redesigns need to be explained.
The scope is better organized if the work is divided into exterior, interior, systems, and landscape categories.
2. Construction Team Members
A lender will want to know the members of the construction team and the party responsible for each task. Each professional must be listed with their contact information and license number.
It should also be noted which team member will be responsible for permits or inspections.
3. Construction Budget
The organization of the line items and categories must follow the scope’s layout. It will be necessary for the costs within the budget to be cross-referenced to the proposed budget prepared by the home inspector. Any significant variations must be explained.
All budgets should include a line item for contingencies. This line item should state the percentage and the calculated amount. A contingency percentage is only applied to the costs of material and labor, not to the costs associated with project management or the contractor’s OH&P.
A lender will look for a contingency line item. If the budget does not provide for this, the lender will add one as part of the underwriting.
4. Project Timeline
Like the contingency line item, the schedule must allow for changes due to unknowns and delays. Time is money, and the budget and schedule must account for both.
The contractor will typically prepare the schedule to illustrate the order and the length of time for each task. Through its vendors, the contractor will know the lead times for the materials and will ensure the schedule can accommodate these timelines.
It is in the contractor’s best interest for the project to proceed timely and without interruption.
5. Sign-Off
This section must confirm the requirements for permitting, inspections, and the approval of the responsible party. These acceptances will be the basis for the draw package and for the investor to view the progress in real-time.
Conclusion
Investors must realize that their profit on a fix-and-flip project remains only a projection until the sale. The contractor, professional consultants, lender, and Realtor will receive the stated amount in their contract. These team members will be paid what they are owed.
The best an investor can do to protect their profit is to retain trusted professionals, hold the contractor and the professionals to task, and ensure the completed scope aligns with the market values and the sale price.
Any delays in the scope or increases to the budget will negatively affect only the investor’s return.
