Mindset: Home as Multiple Investments

Before getting to the details of money, let’s set the stage. Your home is not a single investment, but multiple.

1) Real Estate

Primarily, you are investing in real estate and for most, the hope is that the value of your house will grow over time, even counting for inflation.

2) Quality of Life

The second, less obvious investment, is in your quality of life. Living in a new home, built to your specifications, is a luxury. It’s not easy to quantify, but you’ll see and feel the investment every day. I think of it like kitchen tools. If you use a knife or a skillet every day, get the best quality for your purpose. It may be expensive, but using a quality product will pay for itself in experience alone. Your experience and lifestyle in a new home is not to be discounted.

3) Sustainability and Self-Reliance

The third investment is both practical and philosophical. You have an opportunity to invest in self-reliance and reduce your use of non-renewable resources. The obvious example is using solar panels and batteries for electricity. Improvements in heating technology and insulation, along with sound construction and design practices mean homes can now be extremely efficient.

For many, the monetary savings are great, but the real investment is in living more responsibly and owning a home that works in harmony with nature and its environment. Like quality of life, this is difficult to quantify, but it matters. The pride that comes with owning a home that is built for the future is not trivial. 

The bottom line is that a new custom home is more than a monetary investment. You are investing in a platform for the life you want to live.

Webinar Video: Budgets, Bills, and Bids

The video below is an excerpt from a webinar that focused on the subjects in this chapter.

Cost Per Square Foot

Before you know what the house will look like, and before a design and materials are set, it would be really helpful to know if you're on the right track in terms of cost. A rough estimate would help you understand if you can afford that many bedrooms or if a swimming pool should be a part of the plan.

If you want to have high-end materials, labor-intensive elements and fine finishes, the number can rise quickly. If you’re satisfied with more traditional and/or standard construction and materials, it may be more affordable. 

As you get more serious about the house, you’ll find out more about what "cost per square foot" to expect in your area. Without knowing the final design, this number can give you a ballpark idea of total project cost. Usually, cost per square foot is in the hundreds of dollars and depends heavily on your location and local market. A local builder will be able to tell you what to expect. 

The equation is simple:

• Expected square footage of the home: 2,500
• Cost per square foot: $300
• Then 2,500 X 300 = expected cost of $750,000 

Having this number in mind can also be helpful when exploring options for financing. 

Elements of the Cost Per Square Foot

You may be wondering: what goes into the cost per square foot and what impacts that number? It’s a good question. Cost estimates, measured per square foot, can vary widely in the same market due to the style of the home and level of quality in terms of materials and construction.

Builders often consider three levels of construction:

Spec House

A spec house is one that is built by a builder without a potential owner involved. These homes offer a builder a way to earn income by selling the home for more than it cost to build. For this reason, spec homes often use off-the-shelf plans and include limited custom features. This doesn't necessarily mean these are of low quality construction or that they only use cheap materials. Many spec home projects can be well-built and find efficiency in cost by building a number of houses with similar design and materials. A spec house is not likely to be considered unique or original.

Semi-Custom

A semi-custom home is often one that is not designed from scratch. In this scenario, the builder may work with a homeowner to select from a set of existing plans and then customize elements of those plans to account for the homeowner's needs. The challenge is finding the right plans that fit your region and building site, and ones that are close enough to what you want in design so changes are less expensive. Existing plans can give homeowners a head-start on design and a chance to find some cost savings.

Full Custom

A full custom home can be almost anything the owner wants. It's typically the most expensive option and might include a high level of design, finish, detail, and craft. Here, the team works together on every detail of the design and the home reflects the owner's specifications throughout. Custom homes are often one of a kind.

Geography

Cost per square foot usually differs by location. For context, there are homes in some locations that are built for $100/sqft and in other locations, it might be $1500/sqft. The number reflects factors like:

• Cost of labor/specialists
• Cost of materials
• Cost of transportation
• Local construction market
• Design elements of the home
• Challenges in access or the building site
• Seasonal limitations

Your needs as the homeowner have an impact on the cost per square foot. If you want to have high-end materials, labor-intensive elements and fine finishes, the number can rise quickly. If you’re satisfied with more traditional and/or standard construction and materials, it may be more affordable.

How to Find the Number

One of the first steps in working through what is possible with your budget is to learn the going rate at your location, per square foot, for homes like the one you want to build. Contractors and realtors track the going rate per square foot and will be able to give you ranges for your area.

Seeing the Sausage Get Made

Think for a moment about buying a new car. The car has a bottom line price and as a consumer, that price is a shortcut. It summarizes all the messiness that went into making the car a reality. We don’t have to consider the costs of the design, engineering, overhead, marketing, human resources, or materials. We don’t see all the dilemmas and problems that had to be solved. The car’s production doesn’t depend on our decisions or preferences. It’s all built into the vehicle that we drive off the lot. 

Houses are obviously very different, but the expected outcome is the same: a new home in perfect working order. Unlike a car’s production, homeowners are often intimately involved in all the phases of production. We see the incremental processes and expenses that are required, along with the dilemmas, mistakes, and unexpected problems. Because our money is fueling the project, we get a front-row seat to see it all come together. How else can we be sure the house reflects our needs and wants? 

The front row can be a disconcerting perspective. Because we are involved in the production, we can see the process changing and evolving. We can see our money being spent in ways we didn’t expect or plan for. Unlike a finely tuned assembly line, a new home depends on a wide array of variables that are unpredictable and out of our control. Labor and material prices can fluctuate over time. The estimate for your siding could be 20% more than the estimate. 

We have to accept that ambiguity is an inherent part of the process and in the end, we’ll have a home that we love. 

When you find yourself in that front-row seat, it’s important to understand how your money is being spent and why construction billing and finance operate the way they do. This will give you context for getting through the project with relationships intact.

The Business of General Contracting

General Contracting, like virtually any business, has overhead and expects to make a profit. Usually, the amount earned scales with the size of the project. This is typically based on the biggest costs of the project:

• Labor
• Materials
• Subcontractors

This comes in the form of contractor's fees and it's important to understand how they work.

Contractor's Fees

Along with the costs of the project, you'll pay for the GC's role in leading it. This is often referred to as a "contractor fee", and it is usually based on a percent of the project costs. Together, they make up the majority of the total project cost.

Two Types of Billing Agreements

This may take a number of forms, but you are likely to see one of two types of billing agreements:

1. Fixed Price
2. Cost Plus

Fixed Price

A fixed price agreement is a common and simple form of billing. The GC compiles a detailed estimate of the total project cost and then agrees to bill for that amount. This works well when most or all of the details and materials are specified and agreed upon. Only with a solid and detailed plan can a GC accurately estimate project costs. The brief (and silent) video below explains other considerations:

Cost Plus Agreements

Cost Plus agreements are common in custom builds, renovations and other large projects. The GC provides an estimate of the total cost of the project, but the total project cost is not fixed from the beginning. Instead, the GC bills based on actual costs throughout the project. This is a better choice when parts of the project are not fully developed or there are uncertainties of what might arise. For example, in a renovation, a GC takes apart a wall and finds the internal structure needs more work than originally thought. Or in digging for a foundation, the excavators hit dense rock that will take much more time to excavate than estimated. The brief (and silent) video below will make it clear:

The contractor's fee is often in the neighborhood of 15%, but depending on the region and current market, and what is included, it can easily be in the 10% - 25% range.

GC Fees and Subcontractors

The contractor's fees cover the time and work required to manage and coordinate all the subcontractors on the project. This includes:

• Hiring subcontractors
• Developing specifications for estimates
• Managing materials
• Scheduling the work
• Problem-solving
• Reviewing the work
• Billing

Other Costs on the Bill

Depending on your region, and how your GC manages their accounting and your contract, you might find other costs added to your invoice. These might include:

• Labor Benefits/Payroll Fee
• Insurance Fee or Share
• Taxes

If you don't see some of these on your invoices, don't celebrate just yet. They are most likely already rolled up in the Contractor Fee. You can always ask your GC or their business office for details.

Levels of Estimation

Until you have a completed detailed plan, no one can give you an accurate cost estimate. However, it certainly helps to have an idea of where you are cost-wise as you build out your plan, because cost estimates can guide you in realistic directions as you make decisions. GCs will tell you, some of the first questions they tend to be asked are about:

• How much it will cost
• How long it will take
• When they are available

As we've mentioned, the more information you can give them, the more accurate they can be in estimating. Here are a couple of levels of estimation that you may encounter.

Ballpark Estimate

This is where cost per square foot comes in. Before you can provide a plan on paper, you might be standing with the GC on the property, overlooking what you hope will be the building site and say you're planning on 3 bedrooms, 3 baths, 2500 sqft. They might be able to provide a ballpark estimate based on cost per square foot and maybe give you an idea of the ease or difficulty of the building site. Without knowing what the structure will look like, this about the best they can do.

Experience-Based Estimate

Depending on how the GC works, they might be able to provide an estimate with a bit more accuracy. If you can provide a basic floorplan, even one without details, the GC might be able to provide a very broad estimate based on their experience. They've probably worked with their subcontracting teams a number of times in the past and might have a feel for the cost range for similar projects. This could include general estimates for each of the major line items.

Some GCs decline to provide this kind of estimate because it can be too broad and can give clients an inaccurate impression. Instead, many will wait for plans to be ready before working toward a detailed estimate.

Detailed Estimate

This is a big step. When your plans are ready, with details nailed down, you can ask your GC for a detailed estimate. This is when they take the plans and figure out what it should cost. Here's how it typically works:

• The GC reviews the plans and estimates what work their team will perform
• They contact suppliers about costs for materials like lumber, steel, and concrete
• They contact subcontractors about availability/interest
• They share building plans, or project calculations with the subcontractors
• The subcontractors submit estimates or quotes for the work

The GC then combines:

• The time required for their team to perform the work
• The costs of materials
• The estimates/quotes from all subcontractors
• All known costs for specific appliances, systems, etc.
• Allowances for unknown costs (when not enough detail is provided)
• Any applicable taxes, insurance, etc.
• The GC's fee

This creates a comprehensive look at the project and what you'll consider the bottom line. And be prepared - it might be more than you expect.

When you ask for a detailed estimate, understand that you're asking them to complete a complex, time-consuming task. Acknowledge the time and effort it takes to create it and take your time reviewing it.

When an estimate is provided, ask the GC to walk you through it. Take the time to understand the costs of different parts of the project. If the total cost is higher than you expected, ask what parts or changes they would consider to reduce the overall cost.

The Risks of Cost Overruns

Building professionals do their best to be accurate with estimates, but it is an inexact science and a difficult task to complete with confidence. There are a number of reasons why:

1. Unexpected Events and Issues - GCs have no way to make long-term predictions about the weather, the availability of workers, and materials.
2. Variability in Material Costs - The construction industry relies on materials that have fluctuating costs that can increase quickly and unpredictably.
3. Change Orders - It's common for homeowners to request changes during the project that impact the budget.
4. Design Mistakes - Problems with the design may not be apparent until the project is underway. Fixing the problems can require significant time and money.

Pad Your Budget

For these reasons and many more, it's helpful to assume that the project will cost more than you expect. One option is to communicate a budget that is less than your actual budget limit. This kind of padding can give you some wiggle room over and above the number the team is working toward.

Homeowner Jake:

Dealing with Ambiguity

You may encounter instances where you see an opportunity to add a feature to the home that wasn't in the original plan. This could be a special staircase design, a skylight, or a built-in. Your architect may develop a design for the feature and on paper, everything looks amazing.

When you ask your GC about the new feature and the potential costs, they can't give you a lot of feedback. In the middle of the project, it's difficult to know what will be required and how the architect's plans will translate into the finished product. This kind of ambiguity is common and moving forward means accepting that you will have to pay for the work, even if it's more than you ever imagined.

Contractor Drew Reed:

Managing Change Orders

Every project evolves during construction and that's expected. Sometimes you can't make a confident decision until parts of the house are built. How these changes are managed depends on your GC and the formality of the project.

Formal Projects

In a construction project that's more formal, the team may use change orders as a way to account for changes that were not specified in the design or the builder's estimate.

An example is adding a window, which adds material and labor costs to the bottom line. If the homeowner wants to add a window, a change order is a method for tracking the added costs of this addition and creating a shared understanding of the desired change.

It often works like this:

• The change order is discussed with the GC and homeowner
• If needed, the change is documented, including any sketches or specifications
• The GC provides an estimate for the change order
• If the owner accepts the estimate, work can begin
• The costs of the change order are added to the billing cycle

Change orders are often used in projects with very detailed budgets and fixed price agreements.

Informal Projects

Many home construction projects with cost plus agreements do not use formal change orders. While they can help with budgeting and billing, they require administrative time and work. Sometimes, changes are handled with a handshake-style agreement between the homeowner and GC. This is obviously a judgment call depending on the relationship trust with the GC. When in doubt, have change orders in writing.

Change orders can be helpful for bigger changes, like adding a room. Here, it's important to have an estimate for the additional work.

You are likely to face a number of situations where you want to make a change and are unsure of the cost. The GC may be able to give you some guidance ahead of time. As I've said too many times, it's often in your best interest to assume the cost will be more than you expect.

Relationships and Money

Your home may be your most expensive project and you're likely to be very focused on making it work. One factor that can help the project to proceed smoothly is clear and honest communication between you and the GC regarding finances. 

Builders are not always the best communicators and in such a big project, some things can fall through the cracks. You are likely to encounter situations where a cost is higher than expected, or something was missed that has to be redone. To maintain a strong working relationship, you both need to deal with these issues in an open and honest manner. Don’t hesitate to ask questions or request clarifications. 

When considering GCs, ask about their project management processes and what to expect regarding ongoing communication about project costs. An organized GC may provide monthly updates on what work was completed, its cost, and how the cost compared to the estimate. If you have questions about the costs of a subcontractor's work, work with the GC to resolve the issue.

Remember that a house project has many moving parts and an overage in one project may be balanced by savings in another. For example, when framing is complete, the time and materials cost may be lower than the estimate. Concrete may be higher. These differences can be accounted for in a spreadsheet that keeps a running total of overall costs compared to expected costs.  

Here is a sample spreadsheet format to calculate ongoing costs.

Money Sources

I am not a financial advisor and I encourage you to work with someone who knows the facts about financing residential construction in your location or your financial advisor. There are too many sources of funds that could possibly be used for funding your project to name here, but I would like to cover one type of loan because it is specific to construction projects.

Construction Loans

Construction loans are a common way that owners finance homes and they can vary based on lender and location. Your local bank or credit union may be able to help you get started. It often works like this:

There are three primary members of the team: 

• Homeowner
• Contractor (GC)
• Bank (or Credit Union)

A construction loan is a loan that is paid out to the contractor, by the bank, as the project is completed. Before the loan can begin, the team works together to establish a few key expectations: 

• What the construction project is likely to cost
• The expected costs of each phase/step
• How much the owner can contribute
• How much the bank will provide to make up the difference

When you apply for a construction loan, the bank may want to review your project plans, costs, timeline, finances, etc. before offering you a loan. The agreement may include signatures from your GC so everyone has the same expectations.

Once the details are in place, the bank pays the GC over the course of the project. Usually, the GC submits invoices to the bank based on work that has been completed. The bank then sends an inspector to ensure that the invoice is accurate. Then, the funds are paid to the GC. Once the project is complete, the homeowner can apply to have the loan converted to a standard mortgage, or in some cases the conversion happens automatically. 

This brief video will help you understand the basics of construction loans.

Many construction loans are are set up so that during construction you will pay only interest on the loan. Then, once you move in and convert the loan, you may make regular payments of principal, interest, plus taxes and insurance, as in a conventional mortgage.

Note that many construction loans don’t necessarily start when the construction project begins. Most banks will begin a construction loan mid-project and will account for the work already completed in their calculations.

There are a number of considerations and potential complications, but the system can work well and is designed for homeowners who need help. Choosing a bank that understands the local building environment can be helpful.

Paying for a home can be one of the most stressful aspects of the construction process and one that requires attention and planning. Contractors will not work for free, so if the money stops flowing, the work stops, too. For this reason, be diligent about your access to resources and communicate expectations to the GC. Together, you can develop a plan for keeping the project moving.

Sweat Equity

Sweat Equity describes the work the homeowner puts into the construction. Often, the goal of sweat equity is to save money by completing projects that would otherwise be accomplished by the construction team. And it can work. Skilled homeowners can save money and become a part of the construction team. However, it’s not for everyone. Some things to consider:

Contractor Fees - Not every contractor welcomes sweat equity. Remember that part of the GC’s fees are based on the costs of the people they hire. As the owner, you are not an employee or subcontractor, so the fees don’t apply to the work you do.

For you, that’s awesome. But to your GC, who ends up spending time managing your work without fees, it may not be so awesome. Talk to your contractor about your skills, the potential savings, and how to make it work for both of you.

Your Skills - Construction work can be deceptive. What looks easy for a contractor can be difficult and time-consuming for a homeowner. There is a difference between getting a project done and doing it well. 

Be aware of and honest about your skills and experience before taking on a project. If you don’t want to take on a specific project, there can be other ways to help. One is to be the clean-up crew. If you live nearby, you can agree to visit the construction site on a regular basis to clean up. This means sweeping the floors, disposing of trash, and general tidying. This work has to be done by someone -- if your GC agrees, it might be you.  

Repairs and Redos - Remember that If you take on a project and your work needs to be repaired or redone by a contractor, it will cost you and potentially remove any sweat equity you’ve accumulated in the process.  

Timeline - Construction is often a chain of events. If your sweat equity slows the project or stands in the way of completion, it can become an issue. Work with your contractor to identify what will work for you.