If you believe in the traditional 20/60/20 model, where 20 percent of your sales price is the developed land cost, 60 percent is “sticks and bricks” costs, and the final 20 percent is everything else, maintaining margins in home building is a tough task. With material, labor and sales costs fluctuating, it’s even harder.
How can you possibly estimate your margins in home building projects? It’s not easy, but it is feasible. Here are nine smart strategies that can help.
1 – Know Your Total Land Cost
Land is the single most expensive aspect of any project. However, the cost to purchase it isn’t necessarily your total cost. If the land isn’t developed appropriately, you’ll be putting a lot more into it than the purchase price.
There are many factors to consider when purchasing your homesites: land condition, proper grading, moving dirt, landscaping costs. If these are overlooked and all of the focus is on the structure, it’s easy to get nicked as a result.
Engaging with real estate professionals such as zoning attorneys, engineers and surveyors will help you in truly understanding what it will take before you start. This is one of the best strategies for controlling land development costs for home builders.
2 – Perfect The Take-Off
Land may be the biggest single cost factor, but it’s by no means the only one. If “sticks and bricks” are 60 percent of your budget, there’s certainly plenty more to consider — like labor.
It’s crucial to have a reliable and precise estimating process to know exactly what the job requires before placing the footers. Knowing the physical resources your land requires, as well as understanding the cost structure at a base level, will help calculate how many houses you need to sell. Getting these calculations correct will put you on the right path for taking off.
3 – Build Fewer Home Designs
Unless you’re building homes for high-net-worth clients and can get away with a cost-plus pricing model, you’re going to need to find efficiencies. One of the best ways to do this is by building fewer home designs.
Production builders understand this strategy better than anyone — by offering three to five standard home designs in their developments, they are better able to manage construction. They may personalize each design slightly to meet the needs of a variety of buyers, but they’re generally well optimized for both the buyer and the builder.
4 – Limit Variables
Limiting home designs is not the only way to reduce uncertainty — limiting variables in finish selections is a great strategy to anticipate margins.
For example, if you are a fixed-price builder and custom cabinets are available for every home, you may have difficulty estimating the cost from home to home.
Flooring is another example that has seemingly limitless variables in material and labor costs. Many hours can be lost pricing out exotic tile materials and complicated installation patterns, only for the customer to try to negotiate on price later. A much better approach is a predefined and comprehensive list of personalization options in addition to consistency in home designs for vendor management. When you limit the variables, you see fewer change orders. The fewer the change orders, the more predictable the costs.
5 – Create Economies of Scale
When General Motors builds cars, they know the exact cost because they are built frequently and on a predictable schedule. While homes are not built as quickly as cars, you can apply the same principles when it comes to purchasing.
Planning in advance and knowing the amount of materials needed will create economies of scale that can lower your cost structure. By building a backlog of presales and evenly spacing starts throughout the year, you can get in the habit of issuing predictable streams of purchase orders for trade partners and suppliers lowering your cost structure even further.
6 – Facilitate the Trades
Economies of scale don’t just apply to pieces and parts — they’re just as valuable when it comes to trade partners.
If you consistently build a handful of home designs, it’s easy to determine standard pricing with your trades. When they know how many electrical outlets to install and that you will be specifying the same products on each job, they can be very precise with their estimates and purchasing.
This consistency also allows trade partners’ crews to be more efficient. They may be able to rough two homes a day instead of spending several days on a single custom home, optimizing costs for your home building business and turning yourself into a “builder of choice” for them.
7 – Use Peers to Benchmark
An area where production and Franchise Builders have a distinct advantage is pricing — with their large network of peers who are willing to share timely data, they can make useful comparisons and shrewd decisions.
With over 75 builders in the Epcon network, there are a lot of experienced people to call and valuable data shared monthly to sift through. With those benchmarks, you’ll quickly know if you’re in line or not. You’ll also have a powerful negotiating tool in your pocket when you go back to your vendors and partners.
8 – Keep a Tight Schedule
If you take the advice above and create consistency in floor plans and options, you’ll keep your vendors on track at a reasonable 100-120-day schedule. That will allow you to keep turning over your inventory.
9 – Continue Learning
There’s one more way to improve profitability, and it doesn’t take a lot of extra effort – just a few questions.
The army does what it calls an “after-action” following any engagement. They get their departments or disciplines together after a project and ask what went well, what didn’t and where they can improve. You can do this too.
Every quarter, get your team together and do a key performance indicator (KPI) review on your most recent closings. Find out how you did on costs, cycle time and customer satisfaction. If you missed targets, find out why and make a plan to improve. Learning is the key to continuous improvement.
If you don’t have the resources of a larger builder, you have two choices. You can either join one or apply the same fiscal disciplines they used to become one. Be prepared, be precise and be strategic. That’s the not-so-secret secret — and it’s as true today as it’s ever been.