Real Estate Articles
Retention's Role in Construction
Written by Brent Pace for Gaebler Ventures
Retention is an important aspect of managing a construction project. This article teaches entrepreneurs what retention is and why it is useful as they construct their project.
What is retention?
Retention, sometimes called retainage, refers to the amount of payment withheld from a contractor's contract.
On a construction job, you will receive invoices each month from architects, engineers, and your general contractor. The contractor should show the amount completed, and then request payment for only 90-95% of that amount. The money held back is the retention, typically 5-10% of the total contract price.
There are often two levels of retention on a project. The owner, you, will withhold retention from the general contractor. The general contractor, in turn, withholds retention from each of his subcontractors.
In other words, retention is a tool that allows a project owner to withhold some payment to contractors until the entire project is complete and a certificate of completion or certificate of occupancy has been granted by the local authorities. Once this completion has been granted, the owner typically has 30 days to release retention. This requirement varies state by state.
Why hold retention?
Retention is invaluable to an owner because it helps to ensure project completion. Allow me to explain with an example. Let's say you are building an enormous office building. This office building has over 40 bathrooms in it and you have hired a plumber to complete all 40 of them. Let's say, just for argument's sake, that this contract is $10 million dollars, just for the plumbing work. You feel good about this price, since it represents a much better price than you could get for building just 1 or 2 bathrooms at a time. It's a volume discount.
Now imagine construction is going along and the plumber has completed 39 bathrooms. Completing 39 out of 40 bathrooms represents 97.5% of the contract. So the contractor has earned $9.75 million dollars. If you haven't held any retention, he may walk away from the last $250,000 worth of work if he has a new contract elsewhere for another $10 million. The last bit of the contract may not interest him at all.
If you hold retention, however, you would have only paid out $8.775 million to this contractor (assuming 10% retention), meaning he would have completed $975,000 worth of work that he has not been paid for. And what's the only way to get that retention? He has to complete the last $250,000 on the job and get it signed off for.
The other big benefit of retention deals with punch list items. When a contractor completes a project there are usually a few items that need fixing. These items are compiled into a list called a punch list. To get retention release, contractors have to complete their punch list as well. This means you can ensure not only project completion, but also enforce your quality standards as well.
Retention may not apply in some areas, most notable stored materials. A lumber provider who is just providing material will not allow for retention to be held on his bill. In addition, retention won't correct for problems due to contractors just being dishonest or disingenuous. So retention is no substitute for making sure you hire the right people on the job to begin with.
Brent Pace is currently an MBA candidate at University of California at Berkeley. Originally from Salt Lake City, Brent's experience is in commercial real estate development and management. Brent will have tips for small business owners as they negotiate their real estate needs.
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