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17 of the Biggest Mistakes Commercial Real Estate Investors Make When Negotiating Construction Contracts

Outline for MCLE Radio Presentation
April 13, 2002
CNET Radio

What Every Commercial Real Estate Investor Must Know About Construction Contracts

  1. Not realizing when you need a written construction agreement
    1. Not just for new construction
    2. Also for major (i.e., more than $50,000) remodels and tenant improvements
  2. Not realizing that most contractor forms are one-sided and much more protective of the contractor than the owner
    1. Many contractors try to use their own form
      1. Typically one-sided
      2. Does not address several issues of concern to the owner
  3. Not checking contractor’s references
    1. Do not take what contractor offers; rather, ask for the names and phone numbers of the last three jobs he did (story)
    2. Go look at each job to check quality and workmanship
    3. Talk to each reference and ask if there was anything they were not happy with; if they are reluctant to say anything bad, ask if there were any aspects of the experience that could have been improved, what would they be
    4. Most important questions:
      1. Did the contractor finish on time? If not, why not?
      2. Did the contractor finish within the budget? If not, why not?
  4. Not being sufficiently specific with scope of work
    1. Perhaps the most important provision
    2. Details, details, details
    3. Make sure scope is crystal clear about where the contractor’s work-which is usually the same as the “Landlord’s Work” in a commercial lease-leaves off and where the tenant’s work will begin
      1. Raw space vs. finished space
    4. Include as much detail as possible about function as well as specifications. For example:
      1. Blast cells example
      2. Level floor example
      3. Sufficient plumbing
        1. Different needs for office vs. medical office vs. restaurant
      4. Sound attenuation
      5. HVAC
        1. In addition to getting the specs right, include language that you want to make sure all spaces in the building can achieve your targets for heating (i.e., in the winter, the entire space can be heated to x degrees; in the summer the entire space can be cooled to x degrees)
        2. If you have spaces in the building that get direct afternoon sun, make sure the HVAC and design is adequate to cool those spaces
        3. Included language that all HVAC will be sufficiently adjustable so that you don’t have one space that’s hot and one space freezing at the same time
  5. Not understanding and evaluating all the choices for pricing
    1. Cost plus
    2. Stipulated sum
    3. Time and materials with a “not to exceed” maximum (generally the best)
  6. Not including a specific start and completion date
  7. Not including damages for delay and bonus for early completion clauses
  8. Not including a retention
  9. Not including the strongest and longest warranty possible
    1. Not realizing the difference between statute of limitation and statute of repose
  10. Not shifting as much of the risk as possible from the owner to the contractor
    1. Include provision that contractor has reviewed all plans and specifications and has determined:
      1. they are sufficiently detailed to build the improvements specified in the scope for the contract price
      2. they are in full compliance with all codes and laws
  11. Not including the broadest indemnification language possible
  12. Not providing under what circumstances owner has right to withhold payment
  13. Not providing under what circumstances owner has right to stop work
  14. If an architect is involved, not using him/her in a supervisory capacity
  15. If a lender is involved, not determining and including its requirements
  16. Not providing for mandatory alternative dispute resolution
    1. Mediation first
    2. If mediation not successful, then binding arbitration
      1. Generally cheaper and faster than court proceeding
      2. However, make sure owner understands that by arbitrating:
        1. Owner waives right to jury trial
        2. Rules of evidence not applied as rigorously
        3. There may be little or no discovery (depending on amount involved and the stipulation of the parties)
        4. No guarantee that process will be faster or cheaper than court
        5. Arbitrators not as likely to give 100% victory to either party
        6. Very difficult to appeal from binding arbitration
  17. Not establishing a phased budget and not tracking project to make sure you do not get ahead of the contractor
    1. Break down project into as many components/phases as possible
    2. Have contractor include target completion dates and values for each completed phase
    3. Track your payments on your own spreadsheet to make sure contractor is staying on time and on budget to minimize surprises at the end
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