The Lion's Den

When I was a young investor, I did not fully appreciate why tradesmen from established companies were so expensive.   However, as we have been maturing as a firm and a investor, it is becoming clear why tradesmen and companies have to build in those cost.   I wanted to review what are the components that force professional firms in the various trades to have higher cost.

First, smaller tradesmen are often not insured with liability insurance.  If  they cause any kind of damage to person or property, then they cannot reimburse those cost if they exceed their readily available funds. This insurance is charged based on payroll and revenue, and for small firms, this can often equal a hefty fee for example. For a company that bills $180, 000 in labor cost, then this charge can equal at least $5000 or more. This is over 5% of their revenues. 

Second, larger firms often carry additional insurances like nonowned auto policies and workmen’s compensation that are often very expensive.  A nonowned auto policy covers the risk that a worker while driving to a project gets in a car accident while enroute to the location. Due to liability laws, the company can also be found liable in these types of accidents.  Another expensive insurance for professional firms is their workmen’s compensation policy.  This policy is designed to cover the risk that a employee is injured on a job site.  If a worker is injured at the job site, then they could seek to sue the owner of a property as well as their employer.   A workmen’s compensation policy aims to protect parties in these types of claims.   All of these additional insurances can be costly with quotes with thousands of dollars for each of these policies. You could be spending over 10 to 15% of your revenues in insurance claims.

Third,the smaller tradesmen usually cannot provide you a emailed estimates and strong accounting of funds. These smaller companies are often paying money as they are going.  There are issue when you are doing a project that involves several smaller projects. Owners who hire the less sophisticated contractors are hoping that they will remember what they were paying for, but these owners will forget what the funds were being applied to.  This requires firms to retain quality bookkeepers and staff to insure that invoicing, payables management, and other items are being handled in a appropriate manner. If a contractor fails to pay material providers, then those material providers can often seek recourse and put liens against homeowners or investment properties.  This could cost additional overhead cost that employers must recoup when they bill out their clients.  Even if you take a clerk position to cost just $15 a hour, then you could have additional $28,000 or so a year to your bottom line (not including payroll cost or benefits).

Fourth, payroll taxes that are charged to employers by both the state and federal government add approximately 12% to the cost of a employees base salary. 

Fifth, any kind of benefits offered to employees will often cost the employer even more money.  This means that offering health care benefits, retirement plan options, etc. would only drive up the cost of the employment.  As was noted in a recent article by Forbes, a $15 person really cost around $25 due to the cost of benefits and payroll taxes.
This is why many firms who provide professional services have to charge $45 to $55 a hour per guy to even create a profit margin that make it financially viable to run a top tier firm (note this could be on the lower end as skilled trades people will cost more then $15 a hour, as my example is based on).   If you add in additional cost for firms that have to provide licensed professional (the labor tends to be more expensive), then you can see how licensed trademen can cost even more then that per hour.  This is why plumbers, HVAC, and electricians are costly from larger, reputable firms. 

As a real estate owner, you must remember that there is a price for quality, but there is also a price for all the other elements of a reputable firm as well (insurance, overhead, and payroll taxes).   You may save money by using a smaller operation, but you are picking up exposure that you must be prepared to handle.  This is a concept that s insurance analyst call ”self insuring”  for all the risk that are noted above.  When you save money, you definitely feel like a winner; but when one of the risk noted occurs, you feel like you were 2nd place in a 2 person race.

(Jay Raman is a real estate investor, and he is the owner of a full service real estate property management firm, Ashoka Lion- www.AshokaLion.com. You can send emails to him through the “Contact Us” portion of the site)

This entry was posted on Thursday, April 8th, 2010 at 9:56 am and is filed under Buying Property, Economy, Houston Real Estate, Investors, Owning a home, Property Management, Real Estate General, Renting. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.