How to Become a More Profitable Home Builder

In a highly leveraged industry requiring an average of 22 independent subcontractors per home and an average build cycle of 120 days, it sometimes seems impossible for builders to increase their margins much. However, despite an industry average of 3% net profit, according to Ed Hauck, Senior Consultant with Shinn Consulting, it can be done. Many of their leading clients have achieved upwards of 20% net profit, some even more. How did they do it? Below are highlights from a recent webinar, "Drive Profit by Finding Cost Savings in Your Operations," in which Ed Hauck, Senior Consultant with Shinn Consulting, explored three main areas that builders can focus on to reduce cost and become more profitable.

1) Plan design process and efficiencies

First, you need to develop a realistic financial plan with a set net profit target and continuously strive to meet that target. It's important to make sure you price homes appropriately. Start with ensuring you have priced homes appropriately; determine the competitive sale price for houses in your market. As you evaluate where you want to build, look around. What price are homes selling for in your area? What are the quality and size of these homes? Establish a price and product that is competitive for the area in which you want to build. Don't just build a house, add up the costs, and then set a price. If you don't add up the costs, you may price yourself out of the market. Look at new construction, and review the resale market. Based on what you find, do you believe you can build a comparable home within the price range of the homes sold in the area? If so, start with this as your target sales price. Then, see if you can build a house to match.

After setting your target sale price, determine how much money you have left to build homes. Start by breaking out the costs into general buckets and set budget targets for each bucket based on a specific percentage of the sale price. Typically, direct construction costs should account for 50% of the sale price and, unless you are in a high-cost market, land for 20%, resulting in 70% of the total cost to build. If you can achieve these targets, this should leave you with a gross margin of 30%. So, you can aim to spend 18% on running your business, and, if you plan correctly, a net margin of 12%. Sounds simple, right?

Now the work begins.

Set a profit target

You are a builder because you want to make money. Therefore, make sure you account for profit when determining your budget for building a house. Don't ever sacrifice your earnings. Start with the home price, set a target for profit, and, finally, work backward to figure out what kind of house you can afford to build. Since land cost is not very negotiable, and operating expenses are fairly set, you must look at other areas to cut costs. While cutting operational expenditures can impact the bottom-line, a greater impact can be on construction costs.

Stick to the plan!

Once you make a plan, it's essential to keep to it! Specify the construction materials to use and amenities to include in your homes. The less specific you are, the more your profit margins will erode. So, provide definite design criteria for the architect to give them a starting point. You can adjust as needed, keeping profit targets in mind the whole time. You want to ensure you're building the top-selling plans with the best margins.

Don't skip steps

One of the issues that can lead to poor cost management is a sense of urgency—the need to have homes on the market by an arbitrary date. However, it is best if you make sure that everyone has time to do their job—create a timeline and don't skip steps. Not giving yourself enough time usually results in leaving money on the table.

All the above are part of deliberate planning and lets you stay focused on your target profit.

2) Purchasing processes and procedures

Another way to reduce your costs is to audit all direct construction costs—review cost code by cost code and evaluate how you're buying materials.

Take advantage of the fluctuations in raw material prices and use unitized pricing instead of bid management. You may find extra cost savings this way and greater transparency. By paying attention to these details, you can lock-in much better rates and avoid pricing spikes in the future.

As well, you want to look at trade costs. Do you have three bidders for your project tasks? Are you getting bids on the right items? Make sure they are doing the scope of work that you are paying them for. And you want to be the Builder of Choice so you can get the best trades in your market. Formalize your recruitment program for trades and bid when you have work for them.

It's also important to look at who your manufacturers and suppliers are and develop relationships with them. Evaluate your terms of purchasing—are you buying for the community or annually? Find out which areas are working and which aren't.

3) Negotiations

Negotiating is complicated, but you want to aim for a win-win situation. The result must be suitable for both parties, particularly if you have an on-going relationship. Go for an 80/20 rule—you don't want one trade to have 100% of your work. Giving away some of the work to a different group encourages your trades to" sharpen their pencils."

There is a tendency to see price as the only thing that matters, but the total cost is most important, including upfront costs and costs incurred over time.

Some of the areas you can focus your negotiations include:

• Price locks
• Terms and conditions
• Conversion fee
• Draw percentages
• Delivery arrangements
• Supply guarantees
• Model home program
• Design center displays
• Manufacturer rebates

By taking the time to pay attention to the details, do a proper audit on your construction costs, and find areas to negotiate (whether it's with trades, manufacturers, or suppliers), you can improve your margins and become a more profitable builder.

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Learn more about reducing costs and becoming a profitable builder—watch "Drive Profit by Finding Cost Savings in Your Operations" with Ed Hauck, Senior Consultant with Shinn Consulting.