Jump to Navigation
  • NBC News
  • CBS News
  • Fox News Channel
  • North Bay | Business Journal | North San Francisco Bay Area
  • San Francisco Chronicle
  • AV | AV Preeminent | Martindale Hubbell Lawyer Ratings
  • Super Lawyers
  • Avvo Rating 10.0 Superb

Biggest Mistakes Commercial Real Estate Owners Make When Negotiating Construction Contracts

Business Journal

Construction Update

Avoid These Five Mistakes When Hiring a Contractor

http://www.northbaybusinessjournal.com
© 2003 North Bay Business Journal
(Reprinted with Permission)

BY JEFFREY LERMAN
NORTH BAY -- In all of real estate, there is perhaps no transaction that more frequently dissolves (or escalates) into litigation than the one between real estate owner and contractor. This fact has lead one judge to remark, with respect to home construction: "No reasonable homeowner can embark on a building project with certainty that the project will be completed to perfection. Indeed, errors are so likely to occur that few homeowners would be justified in resting their peace of mind on [its] timely or correct completion."

Yet it is astonishing how frequently real estate owners -- from homeowners to large commercial property landlords -- fail to minimize their construction risks by exercising some basic strategies when negotiating construction contracts.

Five mistakes to avoid

Following are five negotiating errors most frequently made by real estate owners even before the first nail is hammered.

  • Insufficient scope of work -- The single most important provision in construction contracts is the scope of work, where the parties describe precisely what will be done. In buying real estate, the mantra is "location, location, location;" in preparing the scope, it is "details, details, details." The owner must provide as much specific information as possible in communicating to the contractor precisely what is expected, what he is trying to accomplish, what the finished product should look like, and what it should do. Owners are often lulled into a false sense of security that if they simply give the contractor a set of plans, their task is complete. That is not so.

    Owners must be vigilant in their plan review, both with the architect and the contractor, to make sure they understand as much as possible in these often-technical drawings. Moreover, there are often accompanying specifications and working drawings that become part of the scope. The more plain the language included by the owner the better. For example, if the project is an office building, consider including language such as "the HVAC [heating, ventilation, and air conditioning] shall be sufficient to allow all offices on the west (sunny) side of the building to be cooled to a temperature of 72 degrees even during the hottest days of the year at the hottest times of the day." A good exercise for the owner is to sit down and list his or her most important objectives and concerns and then include that list as part of the scope.

  • Failure to consider lender requirements -- In most projects, a construction lender is involved, and, if so, it is critical to get the lender involved as early as possible. Ask the lender to recommend two or three contractors with whom it has had excellent experiences. By using a lender-recommended contractor, owners can leverage off that relationship to obtain assurance that the contractor will go the extra step to make it a positive experience.

    Also, ask the lender up front for its required inclusions in the construction contract. This avoids the necessity of having to negotiate the same contract twice (first for owner's concerns, then again for the lender's), and it enables the owner to use the "good cop, bad cop" negotiating strategy, keeping the working relationship with the contractor as positive as possible.

  • Not understanding and evaluating pricing options -- Many owners do not realize they have several pricing options. The three most common are cost plus, stipulated sum, and a hybrid: a cost plus with a guaranteed maximum (G-Max). Cost plus is the most favorable to the contractor, because it allows the contractor to be compensated for time and materials plus a percentage for overhead and profit. Stipulated sum is arguably the most even-handed, because it most closely reflects what both parties believe is a reasonable price for the agreed scope at a particular point in time.

    The most advantageous for the owner, however, is the hybrid. That is the only structure that gives him the benefit if a cost-efficient contractor completes the job for less than the G-Max, yet provides protection from the cost overruns frequently associated with construction projects.

  • Failing to include retention -- It is human nature to focus your attention where you have the possibility of the greatest pleasure (profit) or the greatest pain (loss). In the context of construction, there is a real risk that as one job draws to a close and a new job begins, the contractor will be more focused on the significant profit potential of the new job rather than the relatively minimal loss potential that may result from being inattentive to final punch list (loose-end and repair-item) details of the old job. To keep the contractor's attention at the end of the job, the owner should hold back some portion -- usually 10% -- from the contractor's compensation. That way, even on a relatively small $500,000 job, the owner is still holding $50,000 at the end -- enough to hold the attention of most contractors.
  • Not including an attorney's fees clause -- The most commonly used construction agreement form is published by the American Institute of Architects. Yet the form does not contain an attorney's fees clause. So, if you sue your contractor and win, you will not be entitled to collect your attorney's fees and costs, which could be significant. Accordingly, it is incumbent upon the owner to add this important clause to the contract.

    While the above list is by no means comprehensive, if the prudent owner addresses these issues at a minimum, he will have taken important steps toward achieving that elusive peace of mind when signing the dotted line.

Jeffrey Lerman, a partner at LERMAN & LERMAN law firm with offices in San Rafael, Los Angeles, and San Francisco, is hosting a seminar for commercial real estate investors on February 27 on how to increase profits, minimize risks, and avoid legal traps in real estate investment; www.lermanlaw.com, 415-492-4505, or jeff@lermanlaw.com.

San Rafael Real Estate Investor Lawyers Video

Past clients discuss their experiences with Lerman Law Partners (1.27)

GET STARTED

Help Me… Top Rated by Peers and Clients
AV LexisNexis Martindale-Hubbell Peer Review Rated For Ethical Standards and Legal Ability

AV® Preeminent™ (4.5-5.0) - An AV® certification mark is a significant rating accomplishment - a testament to the fact that a lawyer's peers rank him or her at the highest level of professional excellence. *

Super Lawyers

Jeffrey H. Lerman has been selected for inclusion in 2013 Super Lawyers. Only 5% of the lawyers in the state were so selected.

Michelle C. Lerman has been selected for inclusion in 2009 and 2010 Super Lawyers. Only 5% of the lawyers in the state were so selected.

* CV, BV, and AV are registered certification marks of Reed Elsevier Properties Inc., used in accordance with the Martindale-Hubbell certification procedures, standards, and policies. Martindale-Hubbell is the facilitator of a peer review rating process. Ratings reflect the confidential opinions of members of the Bar and the judiciary. Martindale-Hubbell ratings fall into two categories - legal ability and general ethical standards.

AVVO Rating 10.0 | Superb

Michelle C. Lerman voted #1 Favorite Attorney for Marin/Sonoma

“J. Weekly” Newsmagazine Readers’ Choice Award 2007

Lerman Law Partners News



See Michelle Lerman's upcoming live Estate Planning seminars:

Click here for more information.


Jeff Lerman Spoke At Investor Education Institute Series' Workshop:

The Ultimate Commercial Loan Workout Symposium:
For Distress to Success

**

Save your commercial property from foreclosure under the new rules for commercial loan workouts. Learn secrets to a successful distressed loan workout...even if your property is "Underwater."

8-Part Home Study Course Now Available!

Click here for more details and to purchase home study course online

"One of the best programs I have attended. Excellent array of speakers." -- Nachman Flatt, CPA, Calabasas, CA

"Great speakers...very informative...great investment of my time." -- Leon Katz


Jeff Lerman Spoke At Investor Education Institute Series' Workshop:

STRATEGIC DEFAULTS IN CALIFORNIA
What Every California Homeowner Must Know

**

Get the tools, checklists, formulas and information you need to make this important decision

4-Hour Home Study Course Now Available!

Click here for more details and to purchase home study course online

"Your webinar is the only guidance we have gotten that put all aspects and consequences into one package. Now, we believe we have the necessary tools to make a decision on our unique situation."          Scott and Kim R. of San Ramon

"Comprehensive, understandable, and usable content."                                                                 Jean-Marc Landau

 

Office Locations
  • San Rafael
  • Century City
  • Glendale
  • San Francisco
  • Santa Clara
  • San Mateo
  • Woodland Hills
  • Berkeley
  • San Bruno