Ethics, Starting a Business and Marketing

Home inspection ethics

Ethics are the standards or rules governing how a person, or the members of a profession, conduct themselves. The term is easy to define. Defining what the standards should be, and putting them into practice, is not easy at all. Individuals, professional associations, and states hold different opinions on ethical behavior in home inspection. The perspective in this lesson is common but not universal.

Home inspectors must be an honest information source on the inspected property's condition, and must be perceived as one. This is needed for success, both for the individual and for the profession. Three areas require ethical action, and in them the home inspector must:

1. avoid conflicts of interest, both actual and perceived
2. report the inspected property's condition accurately, completely, and fairly
3. run the business without fraud, deceit, or misleading activity, actual or perceived

Conflicts of interest

Financial interest in the property

No home inspector should inspect a property where he or she holds a financial interest, or may hold one. The rule does not prevent a home inspector from inspecting his or her own home. Many still hire another home inspector, so that no conflict of interest appears.

Financial interest in the sale

A home inspector should not work on a contingent basis, under which compensation may depend on what the inspection finds. Nor should a home inspector inspect where compensation may depend on whether the property sells.

For example, this rule could preclude a home inspector from inspecting a house when the home inspector's spouse is a real estate agent involved in the transaction. The spouse's commission depends on the sale. The home inspector therefore holds a financial interest in it.

Pay to play

Pay to play is a demand by a real estate company or other referral source for compensation in return for a place on a preferred provider or recommended home inspector list. It also covers paying a referral source directly for referrals. Besides real estate companies, referral sources may include banks, mortgage companies, title insurance companies, and real estate attorneys.

Pay to play is a difficult ethical area. Gifts of nominal cost to a referral source are usually acceptable, and so is sponsoring a legitimate event the source holds. Whether advertising in a referral source's publication is acceptable is decided case by case. Some licensing jurisdictions have their own interpretations of what is acceptable and what is not in pay to play, paid to play, repair work, and report disclosure.

Paid to play

Paid to play is a home inspector taking compensation from a vendor for recommending that vendor, directly or indirectly. The term often covers payment for booking the free inspections offered with security systems and similar systems. It also covers payment for referring clients to a pest inspection company.

Payment for scheduling and billing pest inspections together with the home inspection may fall outside paid to play. In that case the home inspector performs a service for the pest company.

Repairing inspected property

For one year after an inspection, the home inspector may not perform construction or repair work for pay on the inspected property. A home inspector who appears to find problems, then charges the seller or the client to repair them, could damage the perception of honesty.

Repair work is also a difficult ethical area. The restriction is not part of every home inspector code of ethics. Where a relative of the home inspector, not the home inspector, owns the company doing the work, it may not apply.

Ethical reporting

Reporting within the scope of expertise

No home inspector, however experienced, knows every system and component that might be in a house. Experienced home inspectors know when to say "I do not know" and recommend that someone who does know inspect or evaluate it further. This is ethical behavior, and it is smart business.

Reporting only the facts

A deficiency comment can tempt a home inspector to understate or overstate two things: the actual condition of the component or system, and the deficiency's significance. Reporting only the facts, as understood by the home inspector, is ethical and, in the long run, smart business.

The more common temptation is understatement. Home inspectors whom real estate agents see as too picky or alarmist get labeled a deal killer. Such home inspectors may receive fewer agent referrals and earn less. The resulting temptation is to downplay a deficiency and keep an agent's referrals coming. Good agents understand that dealing with facts up front serves everyone's best interest, the agent's included, since it avoids litigation later. Agents who want friendly reports are avoided by good home inspectors, who prefer to work with good agents.

Overstatement is the other temptation. Defensive reporting is an unduly alarmist report, or one that recommends evaluation of nearly everything, written so the home inspector feels protected from litigation. It is unnecessary, and it serves no one's interest, not even the home inspector's.

Inspection result disclosure

Many parties usually want an inspection's results. Only the client has the right to know them. No one else should receive the results or the report unless the client gives written permission. That includes the seller, the client's own real estate agent, and the listing (seller's) agent.

Many sales contracts give the seller a right to see the report. The home inspector did not sign that contract and is not a party to it. Whether the report goes to agents and sellers is for the client to decide, and sending it is the client's responsibility.

Advertising and marketing

A home inspector's advertising and marketing should be accurate and truthful, in describing both services and qualifications. Neither qualifications that are not held nor memberships in organizations that the home inspector does not belong to should be advertised or promoted. A business license should not be promoted as a home inspection license.

Starting a home inspection business

Starting a home inspection business takes two steps. First, the legal requirements to start and operate the business must be met. They vary by the home inspector's place of residence and intended work area. Second, people must be convinced to use the service.

Of all the parts of running the business, marketing is probably the hardest and is often the most poorly done. New home inspectors and some experienced ones might consider hiring marketing help, to free time for inspecting and learning.

The content outline of the National Home Inspector Examination does not include business planning, ownership, licensing, accounting, fees, or marketing. Examination items based on this material are unlikely.

The business plan

Failure to plan is planning to fail. Establishing a viable home inspection business often takes at least five years, and many fail during those years. An often cited reason is a lack of financial resources to carry a home inspector through the first lean years. A home inspector who planned for this normal situation has budgeted the funds, or has income that does not rely only on the business. The real failure, it could be argued, is lack of planning.

A basic business plan starts with five elements. They may be developed in another order. Taken in this order, they may help the new home inspector decide whether starting the business is viable.

1. Market analysis: market size in the proposed service area, and whether the market is growing, stable, or shrinking; who the potential customers and referral sources are; customer income level; and what customers really want.
2. Competitor analysis: the number of home inspectors serving the market, and their strengths and weaknesses.
3. Self-analysis: the home inspector's own strengths and weaknesses, how to differentiate from the competition, how to provide better value, and goals for the home inspector and for the business. A home inspector should not compete on price.
4. Financial analysis: the startup cost of training, certifications, licenses, permits, tools, and insurance; realistic revenue and expense projections for the first 3 to 5 years; and how startup costs and living expenses will be funded during that period.
5. Marketing plan: how the value proposition will be communicated to target markets.

Types of business ownership

How the business is organized and owned can significantly affect the business and the owner's personal success or failure. Benefits, risks, and costs differ by location, so the home inspector should consult a local accountant or attorney before choosing. Practices described here are those of the United States.

Sole proprietorship

A sole proprietorship is the simplest form of ownership, with one owner who also runs the business. It may trade under the owner's name or under an assumed name (fictitious name). Government registration requirements are few. Management and taxes both require separate business accounting records. The owner reports and pays the taxes on an individual return (IRS Form 1040 Schedule C). Its primary advantage is low cost and simplicity, to form and to operate. A claim against the business puts the owner's personal assets at risk. That is the primary disadvantage.

Partnership

A partnership is a more complex form, and there are many types. At its simplest, the business has two or more owners who share its profits and losses. Usually one or more partners run it, and it usually trades under an assumed name. Some states require it to register. It must file the partnership tax return (IRS Form 1065) and, in some states, a state return. The partners report and pay the taxes as individuals.

A partnership agreement is strongly recommended, and separate accounting records are required. Compared with a corporation, a partnership is simpler and less costly to form. The primary disadvantages are two. A claim against the partnership puts each partner's personal assets at risk, and each partner bears responsibility for liabilities the other partners incur. Modern businesses seldom use it, especially where a state allows limited liability companies.

Limited liability company

The limited liability company (LLC) is a newer form available in most states. The LLC, a separate legal entity, has one or more owners, called members. It trades under a registered name that usually contains the letters LLC. Members file with the state to create it. The state usually requires annual forms, reports, and fees to keep it in existence. In a single member LLC or one owned by a married couple, the members usually report and pay the taxes personally (Form 1040 Schedule E). Other LLCs are usually taxed as a partnership, but this can vary.

Separate accounting records are needed to keep the LLC's separate legal status, including protection of the members' assets. The primary advantages are that a claim against the LLC may not put a member's own assets at risk, and that forming one is relatively easy and inexpensive. The primary disadvantage is the added fees and paperwork of forming and maintaining it. Many home inspectors form an LLC where their state allows it.

Corporation

The corporation is a traditional form, available in all states. It is a separate legal entity, and its one or more owners may be persons or entities. Mostly larger businesses use it, where a complex capital structure or many shareholders are needed. It trades under a registered name, usually followed by Inc. or Corp. Its owners are called shareholders. Shareholders create it by filing with the state, and the state requires annual forms, reports, and fees to keep it in existence. It files its own tax return (IRS Form 1120), and some states require a return too.

In an S corporation, which has few shareholders, the shareholders pay the taxes as individuals. In a C corporation, the corporation itself pays the taxes. As with an LLC, separate accounting records protect the separate legal status and the shareholders' assets. The primary advantage is that a claim against the corporation may not put a shareholder's own assets at risk. The primary disadvantages are a higher cost to form, since an attorney is usually involved; more fees and paperwork to maintain; and, for a C corporation, double taxation of corporate dividends.

Government licensing and registration

Almost every business, a sole proprietor included, faces some government licensing or registration requirement. The requirements here are common in most jurisdictions. Each home inspector should learn what applies in the state of residence and in the intended work area. A good first contact is the office of the Secretary of State where the home inspector lives. Work in more than one state may require a business license, a professional license, and business registration in each state. Some states require registration in several counties or cities.

Home inspection professional license

At the time of publication, almost two-thirds of states required some form of home inspector regulation. The name is licensing in some states and registration in others, with the same effect. A professional practice act, found in some states, is neither. It may only define the profession, and some include prohibited acts.

A home inspector who intends to inspect in a license state must comply with the licensing law of the state where the house is located, even for a home inspector who lives in, and is licensed by, another state. Reciprocity, an agreement under which states accept each other's licenses, is a possible exception. In many cases it only eases getting a license in the second state.

License requirements vary by state. They usually combine experience, classroom training, and a passing score on a state-designated exam or the National Home Inspector Exam. Experience can sometimes be gained by accompanying a licensed home inspector on a set number of inspections. A related license, such as an architect, contractor, or structural engineer license, can often substitute for inspection experience. In some states it may substitute for the home inspector license itself.

Renewal requirements vary by state, but every license state requires renewal, usually every one or two years. Continuing education is mandatory in most states.

Business license

A business license (privilege license) is a government's permission to do business in its jurisdiction. It is often required of every business, sole proprietors included. A business license is separate from a professional license, and is needed in addition to it. Requirements differ widely from state to state, and between jurisdictions inside one state. Some states require one only at the business's physical location. Others require one in each jurisdiction in which it operates.

Federal employer identification number

A federal employer identification number (EIN) serves a business the way a Social Security number serves a person. Every business with employees must have an EIN to file employment tax returns. So must any business with a tax return to file, such as a corporation or some partnerships and LLCs. A sole proprietor without employees usually does not need one. Neither, usually, does an LLC with no tax return to file. Such an LLC might still get one, since EINs, like Social Security numbers, are sometimes needed in conducting business. The IRS issues EINs online at no charge.

Sales tax registration

At the time of publication, home inspection services were seldom subject to sales tax. Sales taxes may apply to other products or services a home inspector offers. The requirements for another license or registration, a contractor's license for example, may include registration to collect sales tax.

Business name registration

Registering an assumed name (one that is not the owner's name) with a government department may be required. Sole proprietors and partnerships are the businesses it mostly applies to. Searching government records for the proposed name is wise whether or not registration is required, to avoid a name someone is already using. Otherwise, money may go into forming the business and printing marketing materials before another party is found to hold prior rights to the name. In many states the search can be done online.

Office in home registration

Many home inspectors run the business from home, and many local governments require home offices to be registered. Registration usually means a form and a small fee. Usually no problem arises when no employees other than family members work in the home, and when clients usually do not visit the home to conduct business, something they rarely do.

Accounting and financial management

Ending the year with more cash in the bank than at the start does not prove a profit. The business may be less profitable than it should be, or it could be losing money. Real profit and loss, and the way to set up a system that measures it, are not understood by some home inspectors, especially new ones. A good accounting system is needed for operating any business. A home inspector with a minimal accounting background should hire a bookkeeper to set up the system and to teach its use. The likely return over time is higher profit and fewer problems with government tax collectors.

Types of accounts

Businesses and individuals both have five types of accounts.

1. Assets: things owned, such as tools, vehicles, buildings, cash, and stocks.
2. Liabilities: amounts owed to others, such as credit card debt, loans, and mortgages (a type of loan).
3. Revenue: money received, such as payments for services, wages, interest, and dividends.
4. Expenses: money paid to others, such as professional association dues, vehicle expenses (gas, maintenance, insurance), continuing education, and government fees and taxes.
5. Equity: assets minus liabilities. Profit, which is revenue above expenses, increases it; a loss, expenses above revenue, decreases it.

Types of accounting statements

There are three types of accounting statements. A balance sheet gives assets, liabilities, and equity on one date. An income statement shows revenues and expenses over a period of time. A cash flow statement shows why cash rose or fell over a period. It starts from income statement net income and adjusts for non-cash expenses such as depreciation, and for changes in assets and liabilities. It is more useful for larger, more complex businesses, and is not needed by most home inspectors.

The balance sheet and the income statement connect at equity on the balance sheet, since profit raises equity and loss lowers it. Double-entry accounting therefore links all five account types.

Double-entry accounting

For hundreds of years, accounting systems have rested on double-entry accounting. Every transaction is entered as both a debit and a credit. With all entries properly recorded, net debits and net credits should be equal.

Assets and expenses increase with a debit and decrease with a credit. Liabilities, equity, and revenue increase with a credit and decrease with a debit. Three examples:

1. A $400 check from a client for an inspection: cash is debited $400 and revenue is credited $400, an increase to each.
2. Gas paid with $40 cash: vehicle expense is debited, an increase, and cash is credited, a decrease.
3. The same gas charged to a credit card: vehicle expense is debited, and credit card debt payable is credited, an increase in a liability.

Each entry balances, so each transaction is recorded properly.

Cash and accrual accounting

To learn whether a business is actually profitable, revenues must be matched with the expenses needed to generate them. Revenues and expenses can be accounted for in two ways.

Cash basis accounting is the easiest. It is used by many small businesses, home inspectors among them. Revenue counts when the cash arrives, and an expense counts when the cash is spent. For a small service business such as a home inspection company, it works reasonably well. Most home inspectors carry few receivables, payables, or inventory, which are what might distort its income statement. For management purposes, material (significant) distortions should still be adjusted out.

In cash basis accounting, depreciation can distort results. Depreciation attempts to match what a long life asset costs against the revenue it helps produce. Such assets include vehicles, computers, reporting software, and expensive tools. For example, a vehicle used only for business is bought for $30,000, and the plan is a trade-in after five years at an expected $10,000. Its net cost is $20,000. It helps generate revenue for five years, so its cost should be allocated over those years. $20,000 divided by 5 years equals $4,000 of depreciation expense per year.

If the vehicle is paid for with $30,000 cash, the first entry is a $30,000 debit to a vehicle asset account and a $30,000 credit to cash. Each year, a depreciation entry credits the vehicle asset account $4,000, reducing its value, and debits vehicle expense $4,000, increasing it.

Accrual accounting tries hard to match revenue with expense inside each reporting period. Suppose a home inspector carries the fee to closing, so no cash arrives until the house closes. Cash basis accounting waits for the cash before recognizing the revenue. Accrual accounting recognizes it on the inspection date, with a debit to accounts receivable and a credit to revenue. Cash received in the same reporting period leaves that period's income statement unaffected. Cash received in a different period makes the income statements for both periods inaccurate. Revenue for the inspection period is too low, and the later period's revenue is too high.

Depreciation is also accrual accounting, since spreading a long life asset's cost across its service life matches the expense to the revenue it helps generate.

Setting fees

Suppose a grocery store pays $0.50 for a can of peas, and all other store expenses (insurance, labor, utilities, and so on) are $0.45. For a 5% profit, the price must be $1.00. Pricing purchased goods is relatively easy. A service such as a home inspection is harder to price. This calculation is needed to run a successful, profitable home inspection business.

The market drives home inspection fees to a significant extent. What competitors charge is usually known to home inspectors, or can be found out, and fees are set competitively against it. Some home inspectors can charge above the market. They are usually experienced, with significant credentials and an established following. Some try to set fees below the market. That approach means, at best, more work and more risk for little profit, and at worst, eventual business failure. The best basis for a fee is knowing both the business's running expense and local market fees. Those two figures support a competitive fee with a fair profit.

Allocating part of the operating expense to each inspection is among the best ways to learn what the business costs to run. This requires knowing or estimating the total annual expense and the total number of inspections.

Fixed expenses keep the doors open. They change little or not at all as the number of inspections changes. They include insurance (general liability, errors and omissions, vehicle), utilities (phone, internet), government licenses and fees, professional association dues, continuing education (travel included), interest on money borrowed for startup or to buy assets, and long life asset depreciation.

Variable expenses rise or fall, at least somewhat, as the number of inspections changes. They include marketing, legal and accounting costs, vehicle expenses (gas, maintenance), office costs such as paper, postage, and software maintenance, and small expendable tools and inspection supplies such as screwdrivers and flashlights.

Five inspections a week for fifty weeks is 250 a year. If the sum of variable and fixed expenses at that volume is $25,000, the expense allocated to each inspection is $100 ($25,000/250). An average fee of $300 leaves $200 of profit per inspection before taxes ($300 - $100). Profit for the year is $50,000 ($200 x 250). That profit is what the home inspector's time returns. At 2,000 working hours a year (40 hours a week for 50 weeks), the home inspector earns $25 an hour ($50,000/2,000) for every hour of inspecting and running the business.

Profit from self-employment carries no benefits. No one else pays health or disability insurance premiums, sick days, or vacation days. There is no employer sponsored retirement plan or pension. The self-employed person must also pay self-employment taxes covering the contribution an employer would otherwise make. Fees should therefore return a reasonable amount for the time and the risk of running the business.

Home inspection marketing

Home inspectors fall into two types where marketing is concerned. One, in business for many years, receives a regular stream of referred work from a network of clients, agents, and other contacts. Referrals may carry most of that home inspector's business, so little active marketing may be needed. That home inspector is an exception. Everyone else must market continually to survive, and market more to grow. Any home inspector unwilling to spend time planning and carrying out marketing should instead work for a home inspector willing to do it.

What marketing is

Marketing is a planned effort to communicate a message to a target market. For home inspection services, the target market includes owners of existing homes, resale home buyers and sellers, and buyers of homes under construction. The message is that the home inspector's services differ from, and are a better value than, a competitor's. The message should be constant, so it is remembered among competing messages, and consistent, so people are not confused by different versions.

Advertising and public relations make up marketing, and all marketing plans should include both. Advertising is message placement that is paid for, in media ranging from print to pay-per-click internet ads. Business cards, brochures, and advertising specialities (products such as pens printed with the company name) all count as advertising. Paying gives the home inspector more control over the message, but that control can be expensive.

Public relations is information about the company placed in various media without payment. It tells people who the home inspector is and amounts to the company's reputation in the community. An expert interview with the news media is among the best forms, though any positive story is good. Social media, blogging, and article marketing are newer forms that give the home inspector control over posted content. Not paying gives up considerable control, in return for reaching a larger audience at minimal out-of-pocket cost.

Marketing aims to move the target market to buy. Without that motivation, the marketing effort and budget are wasted. To craft a message that motivates people, the home inspector must understand what the target market needs and wants, seen from its perspective, not the home inspector's.

Inspections are usually needed on a tight timeframe, so cross marketing to allied professionals in the transaction is wise. Appraisers, lawyers, title agencies, pest control companies, and real estate agents have worked with the client up to this point and can refer the client to the company. Compensation for a referral should never be offered or accepted.

Marketing the intangible

Home inspection services are intangible, which makes them challenging to market. A tangible product is much easier to market. People can see it, and often touch it, before buying. Most products also have features and benefits a buyer can understand and set against a competing product's. Being able to see, touch, and compare a product makes buying it feel less risky.

A home inspection cannot be seen or touched before purchase. Its features and benefits are harder to compare because home inspectors are harder to compare. What the client buys is an intangible promise, trusting that the inspection will be done well. Buying something that cannot be seen, touched, or compared feels risky. That feeling of risk makes credibility very important to a home inspector, and credibility belongs in the marketing message.

Features and benefits

Features are the attributes of a service or a product. A feature matters only to the extent it benefits the buyer, and any feature, however fantastic, is worthless without a benefit. A guarantee offered with an inspection, for example, is a feature.

Benefits satisfy a need or a want. A buyer is mostly interested in how a product or service benefits him or her. An inspection guarantee, for example, lowers the buyer's sense of risk and makes the promise feel more tangible.

A marketing message should not lead with features. Nor should the home inspector expect the target market to get from a feature to its benefit unaided. Leading with benefits is better, with features supporting how they are delivered.

Elements of a marketing plan

A good marketing plan analyzes five elements:

1. Demand: how many inspections the service area could produce, and what the target market wants and needs.
2. Supply: competing home inspectors in the area, with an analysis of their strengths and weaknesses.
3. Differentiation: which features and benefits of the company's services will set it apart from other home inspectors.
4. Message: a message crafted to move people to buy.
5. Channels: the ways the message reaches the target market, chosen by deciding which to use, when and how, at what cost in money and time, and, perhaps most important, how each one's results are tracked and analyzed.

Marketing resources

Marketing is the subject of many books, and a few deal with home inspection marketing in particular. Community colleges often give marketing classes, and home inspector training events often give classes on marketing home inspections. Many home inspectors, possibly most, lack effective marketing training. Home inspectors, new ones especially, should attend more training and read books on marketing. Good resources exist, and not using them increases the chance that the business will fail.

Numbers and rules to memorize