Retention
The withholding of funds owed in order to increase the probability that the project will be fully completed to the standards initially promised by the contractor/subcontractor. An example of this would be an owner retaining say 10% of the funds owed to the contractor until the project is complete. This minimizes the risk of the contractor moving on to another job by ensuring incentives are well-aligned.
Putting ‘Retention’ in Context
The Scenario
Lonestar Redevelopment Partners, a real estate development firm, is in the process of redeveloping The Vista Point Office Complex, a 150,000-square-foot suburban office building located in New Orleans, Louisiana. This property was originally constructed in 1985, and Lonestar Redevelopment Partners is executing a value-add strategy to modernize the property, which includes a full lobby renovation, the installation of energy-efficient HVAC systems, upgraded elevators, and a complete overhaul of the common areas.
The redevelopment is expected to cost $12 million, with approximately $3.5 million allocated to high-impact aesthetic improvements like the lobby and exterior facade, $4 million for mechanical, electrical, and plumbing (MEP) system upgrades, and the remaining $4.5 million for general interior and common area enhancements.
The Role of Retention
To ensure the project is completed to the high-quality standards expected, Lonestar Redevelopment Partners has included a retention clause in its general contractor agreement with Crescent Construction Co., a well-regarded commercial contractor in the region. The contract requires Lonestar to retain 10% of each progress payment made to Crescent Construction throughout the redevelopment period.
This retention clause is a risk-mitigation measure that ensures Crescent Construction has financial motivation to complete the project on schedule and to the agreed-upon standards. Here’s how the clause works:
- Monthly Progress Payments: Each month, Crescent Construction submits an invoice for the work completed. For example, if Crescent completes $2 million of work in Month 3, Lonestar only pays 90% of that amount, or $1.8 million. The remaining $200,000 is withheld as retention.
- Cumulative Retention: This process continues each month as progress payments are made. By the time the project is nearing completion, Lonestar may have retained several hundred thousand dollars. Assuming Crescent invoices a total of $10 million over the life of the project, Lonestar will have withheld 10%, or $1 million, in retention payments.
- Release of Retention: Once the project reaches substantial completion (i.e., the building is usable for its intended purpose), Crescent Construction is entitled to receive the retained funds, but only after the work is verified to meet the agreed-upon standards. This step ensures Lonestar has leverage to compel Crescent to address any punch-list items, like fixing minor defects or completing finishing touches, before final payment is released.
Financial Example of Retention
To see how the retention amount accumulates and is released, let’s look at a simplified calculation.
- Total Redevelopment Budget: $12,000,000
- Total Amount Paid to Crescent Construction: $10,000,000 (the remaining $2 million is allocated to design fees, permitting, and other non-construction expenses)
Monthly Payments and Retention
| Month | Work Completed ($) | Amount Paid (90%) ($) | Retention Withheld (10%) ($) | Cumulative Retention ($) |
|---|---|---|---|---|
| 1 | $1,000,000 | $900,000 | $100,000 | $100,000 |
| 2 | $2,000,000 | $1,800,000 | $200,000 | $300,000 |
| 3 | $2,000,000 | $1,800,000 | $200,000 | $500,000 |
| 4 | $2,000,000 | $1,800,000 | $200,000 | $700,000 |
| 5 | $2,000,000 | $1,800,000 | $200,000 | $900,000 |
| 6 | $1,000,000 | $900,000 | $100,000 | $1,000,000 |
At the end of the six-month redevelopment period, Crescent Construction has earned $10 million, but only $9 million has been disbursed. The final $1 million in retained funds is released only after the project passes inspection, and all outstanding punch-list items are addressed.
Conclusion
This retention mechanism ensures that Crescent Construction remains motivated to deliver high-quality work through the final stages of the project. By tying a portion of their compensation to the completion of the job, Lonestar Redevelopment Partners protects itself from “walkaway risk” — where a contractor might leave the project partially finished or cut corners at the end to move on to a new job.
This case illustrates how retention clauses are used as a safeguard in real estate development projects. They incentivize contractors to deliver a complete, high-quality product and provide the developer with leverage to ensure all aspects of the work are properly finished.
Frequently Asked Questions about Retention in Real Estate Development
What is retention in real estate development?
Retention is “the withholding of funds owed in order to increase the probability that the project will be fully completed to the standards initially promised by the contractor/subcontractor.” It acts as a financial incentive to ensure high-quality, complete work.
How does a retention clause work in practice?
A percentage (commonly 10%) is withheld from each progress payment to the contractor. The withheld amount is accumulated and only released once the project reaches substantial completion and passes final inspections.
Why is retention important in a redevelopment project?
Retention “minimizes the risk of the contractor moving on to another job by ensuring incentives are well-aligned.” It helps ensure that all punch-list items are addressed and the quality of work is maintained through completion.
What is an example of a retention clause in action?
In the redevelopment of The Vista Point Office Complex, Lonestar Redevelopment Partners retained 10% of each monthly payment to Crescent Construction. By project end, $1 million had been withheld until final completion and inspection.
How much retention was withheld in the Vista Point project?
From a total of $10 million paid to Crescent Construction, $1 million (10%) was withheld as retention. Monthly payments were reduced by 10% and accumulated over time until the project was substantially complete.
When is retention typically released to the contractor?
Retention is released “once the project reaches substantial completion” and “after the work is verified to meet the agreed-upon standards,” including the completion of all punch-list items.
How does retention help prevent “walkaway risk”?
By tying part of the contractor’s compensation to final completion, retention ensures they have “financial motivation to complete the project on schedule and to the agreed-upon standards,” thus reducing the risk they abandon or cut corners at the end.
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