A retention tracks the actual cost of a defect found in diligence, so its size is a build-up, not a round number, and unused money goes back to the seller.
Size a retention as the surveyor's estimate plus professional fees, plus a contingency on both, inflated to the mid-point of the works. On an illustrative 400,000 roof replacement found in diligence, 12 per cent fees, a 15 per cent contingency and 4 per cent cost inflation over 1.5 years give a retention of 546,419, 1.37 times the works estimate and 1.82 per cent of a 30,000,000 price. The seller gets back whatever the works do not use, so the contingency costs it far less than its face value.
Worked in full in Real Estate Transaction Due Diligence by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
When building diligence finds a defect with a known remedy but an uncertain cost, the parties have three tools: a price reduction, a specific indemnity, or a retention, where part of the price is held in escrow and released once the works are done. The retention is the one that tracks the actual cost, which makes it the natural answer for capex that will be spent soon. Its size is a calculation, not a round number.
| Input | Value |
|---|---|
| Surveyor's estimate of works, today's prices | 400,000 |
| Professional fees, % of works | 12% |
| Contingency, % of works and fees | 15% |
| Build cost inflation a year | 4% |
| Time to the mid-point of the works | 1.5 years |
| Retention held until sign-off | 2.0 years |
| Seller's cost of money / interest earned in escrow | 5% / 3% |
Retention = works × (1 + fees) × (1 + contingency) × (1 + inflation)years to mid-point
= 400,000 × 1.12 × 1.15 × 1.041.5 = 546,419
In Excel: =400000*(1+12%)*(1+15%)*(1+4%)^1.5. Use the mid-point, not the end, because works are paid for as they progress.
Fees of 12 per cent add 48,000, a subtotal of 448,000. The contingency of 15 per cent on that subtotal adds 67,200, so the cost in today's prices is 515,200. Inflation at 4 per cent for 1.5 years is a factor of 1.0606, giving 546,419. Without the contingency, the best estimate in money of the day is 475,147.
The contingency belongs on fees as well as works because fees are a percentage of the final cost, not of the estimate. And the inflation step is not optional: a retention fixed in today's prices for works let next year is short by construction.
| Actual cost | Drawn by buyer | Released to seller | Buyer bears, retention | Buyer bears, price chip |
|---|---|---|---|---|
| 450,000 | 450,000 | 96,419 | 0 | -25,147 |
| 500,000 | 500,000 | 46,419 | 0 | 24,853 |
| 546,419 | 546,419 | 0 | 0 | 71,272 |
| 650,000 | 546,419 | 0 | 103,581 | 174,853 |
A negative figure means the buyer comes out ahead. With a price chip, the buyer keeps any saving and bears every overrun. With a retention, the seller keeps the saving and the buyer bears only what exceeds the retention.
Sellers resist retentions because the headline is large. The economic cost is smaller. Suppose the actual cost is 450,000 with 25 per cent probability, 500,000 with 50 per cent and 650,000 with 25 per cent: an expected 525,000. The expected release to the seller is 47,314, received in two years, and escrow earns 3 per cent against the seller's 5 per cent cost of money. The present cost to the seller is 546,419 less the discounted release, 500,890.
The buyer, under a retention, still bears the expected overrun beyond 546,419, which is 25,895. So a price chip of 499,105 would leave the buyer as well off on average as the retention does. The two indifference points are 1,785 apart: in expectation, the retention and a price chip of about 500,000 are the same deal. What differs is the tail. If the works cost 650,000, the buyer with the retention bears 103,581; with a 499,105 chip it bears 150,895.
That is the negotiating point. A seller who argues the contingency is excessive should be offered the price chip at the expected cost; most will prefer the retention once they see that unused money comes back. Even if every pound came back, holding 546,419 for two years would cost the seller only 20,618 in lost return; what it really gives up is the money the works consume.
| Contingency | 1.0 year | 1.5 years | 2.5 years |
|---|---|---|---|
| 10% | 512,512 | 522,662 | 543,568 |
| 15% | 535,808 | 546,419 | 568,276 |
| 25% | 582,400 | 593,934 | 617,691 |
The contingency moves the number more than the timing. Set it by the maturity of the estimate: a surveyor's budget figure from a walk-round deserves 25 per cent; a priced specification from a contractor, 10.
The common mistake is to retain the surveyor's figure as reported, 400,000. It omits fees, contingency and inflation, together 146,419 or 36.6 per cent of the works, and turns the retention into a cap on the seller's liability that the buyer will exceed. The second mistake is to leave out release mechanics: who certifies completion, by when, and what happens to interest in the account. Without a long-stop date the money can sit in escrow indefinitely. The same discipline applies to capex beyond the defect, priced in how to price survey capex into the purchase price.
Retention = works × (1 + fees) × (1 + contingency) × (1 + inflation)t: 546,419 on a 400,000 estimate here. Because unused money goes back to the seller, its true cost to the seller, 500,890 here, is close to the price chip that leaves the buyer equally well off, 499,105, and the argument is only about who bears the tail. The fees and contingency build-up is the same one used to price survey capex; the retention differs in sending the unused part back. The free workbook for this case sets each diligence finding against the instrument chosen for it, retention, indemnity, policy or price.
Part of the price held back, usually in escrow, until a defined issue is resolved, typically works to remedy a defect found in diligence. The buyer draws the actual cost and the balance goes to the seller. On a 400,000 roof estimate, a 546,419 retention leaves 96,419 for the seller if the works cost 450,000.
It protects against overruns up to its size, while a price chip leaves every overrun with the buyer. On illustrative outcomes a 546,419 retention is worth the same to the buyer on average as a price chip of 499,105, but at a 650,000 outturn the buyer bears 103,581 with the retention and 150,895 with the chip.
Set it by how mature the cost estimate is. A budget figure from a walk-round survey supports around 25 per cent, a priced contractor specification nearer 10. On a 400,000 estimate with fees and 1.5 years of inflation, that range moves the retention from 522,662 to 593,934.
This article is one calculation from Real Estate Transaction Due Diligence. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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