The primary goal of flipping houses is to make a profit. Investors seek out properties with the intent of making basic improvements and reselling them. An experienced flipper with a skilled crew can turn a distressed property into an attractive turn-key investment opportunity. However, there are several traps that await the investor/flipper. Even a technical violation of state contractor licensing requirements could expose the investor to substantial risk of serious financial consequences.
In addition, if the contractor you hired is not licensed, or does not have workers’ compensation insurance, the workers brought onto the job site might be classified as employees of the property owner! Check – and double-check – whether your contractor is currently licensed and has proof of workers’ compensation insurance!
Many states, such as California, require anyone who does any improvement work on real estate that requires a permit must declare they are licensed as a contractor, or demonstrate that they are exempt from the licensing requirement. Some investors seek to take advantage of the “Owner-Builder” exemption and bypass the need to hire a licensed general contractor, doing some of the work themselves and hiring subcontractors as necessary. For those investors with the required skills and know-how, this could result in significant cost reductions and boost the profit margins. For those whose experience is limited to watching a few episodes of “Flip this House,” it could result in a disaster.
Qualifying for the Owner-Builder exemption is not easy. The Contractors State License Board (CSLB) division of the California Department of Consumer Affairs provides a checklist for Owner-Builders in a brochure appropriately titled: “Owner-Builders Beware!” Among the requirements is that the Owner-Builder must register with both the State and Federal Government as an employer, and be responsible for complying with various payroll withholding requirements. Most importantly, the Owner-Builder must provide Workers’ Compensation insurance. The Owner-Builder is responsible for supervising the job, obtaining building permits and all inspections, and making sure that all workers and material suppliers are paid.
Moreover, in order to qualify for the exemption, the Owner-Builder must sign an affidavit, under penalty of perjury, affirming they have read, understood and agree to comply with the applicable provisions of State law. The declarant must affirm that the property is your personal residence that you have occupied for 12 months prior to completion of the work; that the work must be performed prior to the sale of the home; and the exemption can only be used twice in any three-year period. For those flippers who seek to turn properties more often, the exemption is not available.
When hiring a general contractor or subcontractor, investors, flippers and homeowners are cautioned to check and confirm that the contractor is licensed and in good standing before signing the contract, and should recheck to ensure that the contractor remains in compliance at all times for the duration of the work. This can be done by checking the CSLB website (www.CSLB.ca.gov) and checking the name and number provided by the contractor. It is very important to confirm that the name the contractor is using on the contract is the same, exact name registered with the CSLB. Also, check to confirm that the contractor has a workers’ compensation policy in full force and effect for the full duration of the contract.
If a contractor’s workers’ compensation policy expires and is not renewed, the contractor’s license is automatically suspended. Although this would prohibit the contractor from recovering any compensation under the contract, it may also expose the property owner to liability for any claims from any of the contractor’s workers or subcontractors! Private lenders involved with rehab projects should be aware that if a contractor’s license expires or is automatically terminated for technical reasons (i.e., expiration of a worker’s compensation policy; improper transfer to a different entity, etc.), the contractor may be required to disgorge all compensation received under the contract. (B&PC 7031)
Having an experienced contractor can make a big difference in the success of a rehab project. Taking a few minutes to confirm that your contractor or subcontractors are properly licensed and in compliance with state requirements can be the best investment in your investment project.