Making the move from residential to commercial contracting

Have you considered making a move from residential to commercial contracting? On this week’s episode, we’re sharing a few things you should consider before beginning to seek out commercial construction projects.

Topics we cover on this episode include:

• What changes with job costing when you move to commercial contracting
• Customer mindset and getting paid as a commercial contractor
• Commercial contracting and cash flow
• Why you should consider setting up a separate company for commercial construction

LINKS

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Rob Williams, Profit Strategist | IronGateESS.com
Wade Carpenter, CPA, CGMA | CarpenterCPAs.com
Stephen Brown, Bonding Expert | McWins.com

TRANSCRIPT

[00:00:00] Rob Williams: Welcome to the Contractor Success Forum today, we’re discussing what needs to change in your company financially when you move from residential to commercial contracting. Because here at the Contractor Success Forum, we discussed financial strategies for running a more profitable, successful construction business.

And we have in one corner, Wade Carpenter, Carpenter and Company, CPAs helping contractors nationwide become permanently profitable. And we have Stephen Brown with McDaniel-Whitley bonding and insurance agency. And we have Rob Williams with IronGate Entrepreneurial Support Systems. 

So guys, what needs to change when you move from residential to commercial contracting? Because I’ll tell you, I was so intimidated by doing this. And I didn’t do it for years because I didn’t know what needed to change, or I was wrong about what needed to change. 

What changes with job costing when you move to commercial contracting

[00:01:08] Rob Williams: My first thought was something that I don’t know why I was so worried about. It was how to track the job costs and stuff, and what changes. There’s actually the job cost of tracking the job, but then the reporting it. And that is a big difference. I guess we’ve had some shows on that. You know, Wade, do you want to start on that? 

[00:01:26] Wade Carpenter: Well, I mean if we’re talking about the tracking of a job cost, I mean, unless you’re a spec home builder and you’re trying to report to the bank how much you’ve completed, I mean, you’ve got a set way of doing things. A lot of times, if you’re not doing something like that, the residential guys tend to be a little more lax about job costing.

Commercial guys, you know, all of them really don’t sometimes recognize the need to do the job costing, but when they are trying to do like a phase code cost code type structure, there are some national standard, things like that. But typically, each contractor will create their own, or they’ll modify that. I mean, some of them use the standard, but it’s very different.

[00:02:07] Rob Williams: That’s a really great point because I was really intimidated by that because I grew up even from like junior high, doing takeoffs from like 13, 14 years old, I was in the takeoff room with our home builder’s chart of accounts and standardizing, and then going into these phases of construction really intimidated me. And I thought I had to have all this just right. And I don’t know who was going to be looking at it. I don’t know why I was so intimidated. And it’s funny to hear you say that some people don’t even use those, because I thought it was just this big thing that I had to do. And I was embarrassed that I didn’t know those. And really part of that is more as a general contractor. If you’re not a general contractor, you really might not need to do it. If you’re one of the subs, it’s probably not as important.

[00:02:53] Wade Carpenter: I mean the subs, I hear all the time that, I know how I’m doing by what’s in my bank account. And that’s the absolute wrong way to run a company, especially construction.

Customer mindset and getting paid as a commercial contractor

[00:03:04] Stephen Brown: The other thing, you know, the mindset of your customer base. You’re dealing with an individual when you’re a home builder, or individuals. In order to get paid, you’re dealing with a architect, engineering firm approving your work. So from an accounting system, what you’ve got to do is you’ve got to have a good accounting system. You’ve gotta be able to do e-commerce well, and you’ve got to be able to bill and accept funds electronically. That’s one thing.

[00:03:31] Rob Williams: You know, and I think in hearing those things and hearing the job costs, for somebody that wants to step out and go from residential to commercial, I think one of the most important things that I’ve just heard is that everybody in commercial is not doing all this stuff perfectly. If you’re making the effort, you can get there. You don’t have to do it all before you switch. Maybe I was over paranoid and maybe some other people aren’t as paranoid as I was, but I wouldn’t take the thing and I was intimidated by the bonding process. And I was intimidated by all these things that had to line up exactly right. 

So part of what I’m hearing is you can just go do this. Now, you do have to get the licenses and you have to get things and you may have to get the bonding and go through that procedure. But all these formalities, that I don’t know who convinced me that I had to be perfect about all this before I went and did all that, that I had to know these things. Maybe people weren’t wanting us to move to commercial either. You know, they were intimidating us by the process of how difficult they made it sound.

[00:04:40] Wade Carpenter: I mean, I think there is a perception of people that are in the residential that, you know, there’s bigger money to be made, there’s higher margins to be made. And that may or may not be true. I looked at some statistics before, and by and large just on the residential versus commercial – like people building buildings, that is typically true that the owners tend to take home more. The profit is slightly more, but it depends on what you do, and the niche you get into.

[00:05:07] Rob Williams: And the profits definitely can be bigger in there than the residential. One thing I did like about the bonding processes is that you weren’t competing against what we call the pickup truck builders. They’re just bidding the jobs at their labor without a profit on top of there. And there were tons of people in this middle area. You know, the small homes, they couldn’t compete because they couldn’t get the lots. You had to get something approved, and then they may not build the really big houses, but those middle houses were a nightmare to make a profit on because there were so many people building three a year just with their labor. So that was really tight. 

Commercial contracting and cash flow

[00:05:47] Rob Williams: So yeah, the margins can be better. But also they may not be. Some of the other things, if we’re talking about the builder, rather than the subcontractor, the money situation on receivables and payables was dramatically different. And now that really shocked me. When we were a home builder, all of our costs would be paid, our job costs, by the banks because we had construction loans. We didn’t have a cashflow report in home builders because unless we overspent our profits and just did something personally, the cashflow worked itself out.

We didn’t have accounts receivable things because we got paid on our jobs based on the completion. And different size builders are going to be different. If you’re a bigger builder, you’re going to have a monthly inspection probably from a bank that goes out. And you’re going to get this money, and we typically had more money in the loans than we had costs because our payables were 30 days, so we got our money in faster on the building of the house than we paid, because we had 30 day terms on a lot of stuff. Some of our subs, we were paying weekly. So the cash cycle was upside down on the subcontractors. But our big money was in the concrete and the shingles and the lumber, those kinds of things. And the windows were all on 30 day terms. When I started getting into the other side and I started having receivables that were way out, boy that’s shocked me. That’s when I learned what a cashflow report was. So when the commercial side and even the sub contracting side, instead of the general contracting side, man, there was a whole different world of cashflow reports. I didn’t know what a cashflow statement was!

[00:07:41] Stephen Brown: I know where you can find some excellent podcasts on cashflow.

[00:07:45] Wade Carpenter: Yeah.

[00:07:45] Rob Williams: You do?!

[00:07:46] Stephen Brown: Commercial construction. Yeah.

[00:07:48] Rob Williams: The Contractor Success Forum, right? 

[00:07:51] Stephen Brown: Yes.

[00:07:53] Rob Williams: But that was a big consideration. In the commercial contracting though, it did take more cash out of my pocket because a home builder, the banks financed just about everything. Now as a subcontractor, that may not be true, but the subcontractors for a residential builder are typically paid a lot faster. They’re paid weekly where if you’re a subcontractor for a contractor, this is where the big thing is. And this is what really floored me, is that you may not get paid until they get paid. And so your receivables may be a lot longer.

[00:08:31] Stephen Brown: Well, that’s what we talk so much about, how to finance a job until you get paid. Until you get your profit out of it. How do you use the project to finance it? How do you use your accounting system to finance it?

[00:08:43] Rob Williams: Yep. And how do you do that? Because you might keep up with it and save your money, and that was one of our strategies, but also there might be a line of credit or something, even, even the subcontractors often have a line of credit. Wade, do you see that a lot? 

[00:08:59] Wade Carpenter: Oh, I mean, absolutely. And you know, one distinction between what you were saying earlier: a home builder, too, there’s a distinction between somebody building a spec home versus a custom home. Custom home builder typically is running into the same problems as a commercial guy.

[00:09:17] Rob Williams: Great point.

[00:09:18] Wade Carpenter: When your bank is financing it and you can put some work in place and they will give you the money for it fairly quick, it’s one thing. But if you’re trying to get the money out of an owner, maybe you can get some higher margins, but sometimes they’ll beat you up on every little, the residential guys don’t, they want their home just right. And they want this and that, and they don’t understand some of the things in construction. There’s pros and cons to both.

[00:09:42] Rob Williams: Yeah, that’s true. I guess the remodelers and the custom home builders may not actually have as big of a hurdle, a jump crossing over it. It may be a lot more similar than the track builder or the spec builder or the guy that actually owns the property. That is one of the points. Actually, I don’t know if I had that on my list, but this gets into Stephen: when you’re a home builder, you actually own the job. 

[00:10:04] Wade Carpenter: You could own it. For a custom home builder, you wouldn’t. 

[00:10:07] Rob Williams: Yeah, the custom builder, you wouldn’t. And so when you’re, say, a contractor though, most of the homebuilders I know, they, they’re building the houses out there. But when they go into commercial and you’re building a job for somebody else, somebody else owns it. So it’s more like a custom home where somebody else owns that. 

There are a lot of big considerations in there and the insurance and different things on that. And I was thinking about you, Stephen, when I was thinking about the differences, because we had a lot of the insurance and safety because it was our property and our thing, and we were probably more liable cause we owned all that. And then we were liable when the economy turned, because all those houses that were “sold”, they weren’t really sold. We had a contract that was contingent upon them getting financing. 

And when the economy moved and nobody could close the loans to buy the houses, all these homebuilders were stuck with hundreds of homes that they couldn’t pay the notes on, you know, in the middle. So that was, that was a big risk.

Why you should consider setting up a separate company for commercial construction

[00:11:05] Stephen Brown: Well, Rob, that’s why, guys, I would always recommend if you’re going to get into commercial construction, that you set up a different company for it. It’s two different mindsets for insurance purposes. Commercial insurance carriers do not want any residential exposures at all. Why is that? They just consider it a certain caliber of risk that they’re not interested in taking. But then there’s residential insurance carriers that just love residential contractors. But either way you have two companies. 

My reason for recommending that is because you can learn about setting up the commercial business the way it needs to be set up. And you can also not have to worry about losing all your good will and reputation as a home builder when you’re getting into commercial and vice versa. Then eventually you can sell off the company that you’re not interested in anymore. Stay in residential or stay in commercial, but either way, you’re taking one hat off and putting on another one, so to speak. And it seems to be very healthy for the ones that do it.

And if you’re bonding a residential contractor, the bonding companies, they do not understand residential construction, like they do commercial. So it’s so much harder to get a bond. You know, no one ever bonds home construction projects. I remember I had one customer once who was a commercial contractor that was building a house for his best friend, “best friend”, see the double parentheses? Who happened to be a lawyer. He wanted a bond. The best friend wanted a bond for the home construction project. I said, I would rather give you a loaded gun to put in your mouth than give you a bond for attorney best– well, it turned out in retrospect, it was an absolute nightmare. That lawyer was not a “best friend”.

He was an ass. And he took advantage of him in every possible way. But, so anyway, I guess my point is, in the commercial construction world it’s night and day, I guess you guys can understand that.

[00:13:07] Rob Williams: I do. I forgot about that. That’s a great, that’s actually my favorite point in today’s show, I didn’t have that down and I forgot we did have different entities. And I wonder about some of my other friends that were doing them. I don’t know that they opened separate entities. Maybe they did. But that’s a great point. That’s probably one of the first steps is not delving into both with the same company. And I’m thinking also what happens, I think most of our listeners are probably subcontractors even, and so I don’t, I know that–

[00:13:40] Stephen Brown: Well, as a sub contractor, it may not matter as much.

[00:13:43] Rob Williams: Yeah, I did both in the same hat, even though I had a license, but as the general contractor, that’s true. We didn’t. Well, no, we did. We did some small and light construction under the same licenses. But I don’t think we were bonded underneath them. We would do strip shopping centers, things like that underneath that license. But you know what, maybe that’s why, our big ones, we would actually partner and do another deal with, if it was a big job. Or even subcontract and work– well, we were the owners. So some of our bigger jobs that we built to keep for ourselves, we actually brought in a commercial contractor for that. And maybe that’s part of the reason. So yeah, I’m going to have to think back on our history.

[00:14:27] Stephen Brown: Well, there’s a lot of subs that do both all the time, residential and commercial. Or they might have separate divisions within their company. Wade, what do you say about all that?

[00:14:38] Wade Carpenter: My personal opinion is if you’re going to do residential, I mean, there’s a lot of residential guys that dabble in commercial stuff, but we talked about the sweet spot. Rob talks about the sweet spot all the time. You know, you’re not going to bounce between both and know what you’re best at. Pick what you’re good at, stick with one side, and do it well.

[00:14:59] Rob Williams: Yeah. but, but there is something about the transition. And I remember even talking to Mike Michalowicz about this, you know, the one that wrote about the sweet spot, and he’s like, well, yeah, you pick your spot, but there is a transition area where you kind of have to test the waters a little bit here, you know. But, but having that separate company, Stephen, that is a great, great point that I forgot about. So I’ll have to remember that when I’m talking to some of my clients that are looking at doing that.

[00:15:26] Stephen Brown: Well, I mean, Wade’s point is good about, stick to what you know, but you can always learn new things. And, you know, I’ve seen a lot of residential contractors start off their commercial business just doing service work for commercial businesses. That’s a logical first step. 

And then, look out there regularly, if you’re thinking about commercial, at the work that’s out for bid. Some of it’s just right up your alley, commercial or residential. It might be dirt work, concrete work, grading, but the core of a general contractor is the ability to do that site work first, and there’s a difference in the layout, maybe. There’s a difference in the construction methods, but that’s all something you can learn. It’s not something that you don’t do all the time.

[00:16:15] Rob Williams: We’re mainly talking about the financial part, but that is good point. There are little bit of physical differences in there. Usually it’s just that, does it have to have an engineer stamp? Or is there an engineer on the job? So the engineer may make you go, we were talking about the slabs. You probably have to tie the rebar off a lot more, you know, do you certain little things that the engineer’s gonna tell you about, but don’t be intimidated about that. There are specs, and there are a lot more jobs specs. They tell you how to do it in the commercial. The residential, I have literally done work for people that are building a house where there isn’t code enforcement off of an 8×10 piece of paper. You know, they’re building the whole house, like, oh my God, at the lake, I remember… Anyway. There, geez. They didn’t, there’s not a blueprint sometimes. So anyway, those are some of the differences.

But this was great. So the discussion on this, we just barely even touched the surface on this. So go to ContractorSuccessForum.Com or look for us on LinkedIn. Look for Contractor Success Forum on LinkedIn and ask us those questions. You guys that are wondering about this, ask us those questions. 

There’s so many different things. What did we not think about? So bring up that, start a discussion about that. Cause we know there are a lot of you guys that are thinking about this, that just, one, you’re embarrassed to ask about it because you know, it’s, it’s intimidating. That’s a open space. We can talk about it.

So, all right. Well, I enjoyed this. I don’t know that we gave all of our guys the answers on this one, but we started the conversation and there’s a lot of things to do, and we got some highlights out of this. So we hope that if you are one of the guys that had that on your mind, like I did for years and years and years, that this will just start your thinking process if you’re looking in getting into the commercial contracting. So we are the Contractor Success Forum with Stephen Brown, McDaniel-Whitley bonding and insurance agency, and then Wade Carpenter, Carpenter and Company, CPAs. And Rob Williams, IronGate Entrepreneurial Support Systems. And we are the Contractor Success Forum. See ya on the next one.