Dec 1, 2021
Financial Discipline is the Only Way to Keep Projects Clean and Honest
As cashflow analysts, we charted a random sampling of fix and flip projects and graphed their cashflow comparing Total Spend (Y-axis) vs. Time (X-axis). A clear trend emerged with insights you will want to see before you start another fix and flip project; fix and flip project spend follows a clear S-Curve. We observed that these projects typically require less initial capital followed by a rapidly increasing capital demand, plateauing near completion.
Note: The length of the initial startup period, and the length of the completion plateau are directly dependent to the speed at which the project starts, and how long the owner takes to successfully close out the project.
Analysis of this trend found the source tied back to the typical order of construction with the first 3 Phases of Work (Demolition, Framing/Structure, and MEP Rough-Ins) being the initial scopes for most fix and flip projects. These initial 3 Phases can range in size and value given the overall scope of the project, with Phase 2 (Framing/Structure) and Phase 3 (MEP Rough-Ins) consistently taking longer than initially projected.
NOTE: Phase 3 (MEP Rough-Ins) is the first Phase where outside inspections from local municipalities can be required, and while failing an inspection is typical, it adds delays as call-backs and coordination are needed and will add days to the schedule.
The Fix and Flip Phases
Phase 1 // Demo
Phase 2 // Framing/Structure
Phase 3 // MEP Rough-Ins
Phase 4 // Façade
Phase 5 // Interior Finishes
Phase 6 // Finals
Phase 7 // Exterior
Over the Hump
After Phase 3 (MEP Rough-Ins) is complete and has passed the required municipal inspections (mechanical, electrical, plumbing, and framing), the rehab begins to pick up speed and rapidly enters Phase 4 (Façade) & Phase 5 (Interior Finishes). Phase 5 is by far the most expensive and fastest moving phase of a fix and flip project with weekly spend more than doubling when compared to previous phases.
Supply and installation of scopes such as wood floors, tile, cabinets, countertops, and final paint, etc., consume project funds at a rapid pace as those scopes are typically installed in a day or two with payment due upon completion.
The typical fix and flip owner does not have access to or take advantage of the same payment terms available to new construction or commercial projects where payments for goods and/or services can be deferred for 30, 45, or even 60 days. Payments for goods and/or services on fix and flip project scopes are typically due upon completion and most tradesmen and suppliers require a hefty deposit (up to 50%) prior to any work being done.
This “Pay-Now” industry puts increased pressure on project cashflow and demands a higher level of planning and monitoring to avoid issues and to ensure success.
Fix and flip projects also differ from new construction and commercial construction projects based on their S-Curve spend.
New construction/commercial projects are much more level and balanced with nearly the same amount of spend week-over-week (after the initial startup). Thus, it is also easier to determine an approximate schedule when forecasting these projects as there is a typical weekly amount that can successfully be managed and approved, and the total project cost divided by that amount, can provide a rough estimate to the number of weeks it will take to successfully complete the project.
RISK #1: Project Cashflow
Funding needs to keep pace with the material & labor demands of Phase 5 (Interior Finishes) to maintain a healthy project pace. It is common for owners/lenders to develop a “payment rhythm” in both timing and amount, established in the mind of the owner/lender based on the timing of previous phases and capital needs.
A sudden and sharp hike in cashflow will often catch people off-guard in their capital planning if they are unaware of the increased demand in Phase 5. Knowing that this increase is coming will allow for greater preparation and a smoother execution.
Risk #2: Fraud/Commingling
Overcapitalizing a project during the initial phases (1-3) or undercapitalizing that same project in the latter phases (4-6) will likely give rise to funding issues. When a project is undercapitalized during the 2nd half of the project (Phases 4-6) it places a strain on the person/persons responsible for construction management – either an external GC, or an internal Construction Manager.
The cause for this strain is due to work being completed and payment demands now exceeding the project’s available funds. The project is under stress and as time continues, the owners are demanding more progress as the project is nearing completion, and owners may even withhold funds until more work is completed. This creates a problem for the Construction Manager as they have contracted and released work to loyal Subs and material providers that do great work, and now they do not have the means necessary to pay them upon completion – as previously agreed. They risk losing good labor and suppliers that have done exactly what they were asked to do, and in today’s climate they are extremely hard to replace.
That is when most Construction Managers/GC’s start to “Rob Peter’s project to pay for Paul’s.” They will take from projects that have just started (Phases 1-3) when costs are low and deposits are high and use that deposit to cover cashflow shortages on later stage projects (phases 4-6) without the knowledge of either owner.
Opportunity and convenience are to blame for this situation, and both the owners and General Contractors have been found guilty of commingling project funds to satisfy short term cashflow needs to their long-term detriment. Once this cycle starts, it is hard to break!
Financial discipline is the only way to keep projects clean and honest. Owners must be able to “silo” and successfully separate each project’s cashflow to keep them safe and fully accountable. They also need to plan for the increased cashflow demands BEFORE they are needed (during the second half of the project), and make sure that the project’s cashflow is readily available for distribution to keep the project moving forward.
By knowing how capital moves through a project, anyone can out-plan problems before they arise. Open and honest communication around cashflow needs, issues, and constraints will keep a Project Team moving forward and on the right path toward successful project completion!