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Posted Feb 25th, 2020

Predicting Profit: How to Know Your Margin Before You Close

By Paul Hanson, President of Epcon Franchising

It’s no secret that the homebuilding business doesn’t have tremendous gross margins. If you believe in the traditional 20/60/20 model, where 20 percent of your cost is land, 60 percent is “sticks and bricks” and the final 20 is everything else, turning a profit is a tough task in any environment. With material, labor and sales costs fluctuating the way they are today, it’s even harder.

So how can you possibly predict your profit before you take on a project? And how do you keep as much of that last 20 percent in your pocket? 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 part of any project. But what it costs to purchase it isn’t necessarily your total cost. If the land isn’t prepared appropriately, you’ll be putting a lot more into it than the purchase price.

What kind of condition is it in? Are you going to need to take out or bring in dirt? Is it graded properly? What’s it going to cost to landscape it, including irrigation and all the typical exterior items? We tend to focus more on the structure and less on the lot, and it’s easy to get nicked as a result. Walking the land and truly understanding what it’s going to take before you start is one of the best ways to protect your profit.

2. Get the take-off right

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.

The point is, you need a very reliable and precise estimating process so you know exactly what the job requires before you sink the first shovel. You need to know the physical, human and other resources it’s going to take, and you need to understand that cost structure at a house level. With that number in hand, you can easily calculate how many houses you’ll need to sell to break even – or make a reasonable profit. That’s your take-off, and when you get it right, you’re good to go.

3. Build fewer floor plans

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 if you want to predict and realize a reasonable profit. One of the best ways to do that is by building fewer floor plans.

Production builders understand this strategy better than anyone. They generally have three to five standard floor plans in their developments and are able to manage their profitability fairly well. They may modify each plan slightly to meet the needs of a variety of buyers, but they’re generally well optimized for both the customer and the builder. That means optimal profit, too.

4. Have fewer variables

Floor plans aren’t the only things to limit if you want to reduce profit uncertainty. You also want to limit variables in finish selections as much as possible.

Cabinets are a good example. If custom cabinets are on the table for every home and you’re a fixed-price builder, you may have a hard time estimating what they’re going to cost from house to house. Flooring is another example that has seemingly limitless variables in material and labor costs. How many hours have you lost pricing out exotic tile materials and complicated install patterns?  And, when you’ve finished those estimates, how often has the customer tried to haggle the price after doing some “research” online? Not a recipe for efficiency or profitability.

A much better approach is a predefined and comprehensive list of personalization options. When you limit the variables, you see fewer change orders. The fewer the change orders, the more predictable the profit.

5. Create economies of scale

When General Motors builds cars, they know what they’re going to cost because they build thousands of them on a predictable schedule. And while you may not be building that many homes, you can apply the same principles when it comes to purchasing.

By planning in advance and knowing exactly how many 2x4s, beams, pieces and parts you’ll need, you create economies of scale that lower your cost structure. By building a backlog of presales and evenly spacing those starts through the year, you’ll create a predictable stream of work for your trade partners and lower that cost structure even further. Then, when you become the job site of choice among your market’s trade partners, you’ll create a little friendly competition among them, too, which is never bad for your bottom line.

6. Facilitate the trades

Economies of scale don’t just apply to pieces and parts. They’re just as valuable when it comes to your trade partners.

When you’re consistently building a handful of floor plans, it’s easy to set up standard pricing with your trades. They know how many electrical outlets they need to install and that you’ll be using the same tile, wall and faucet brands from job to job. It allows them to be very precise with their estimates and purchasing.

It also allows their teams to be far more efficient. If you’re self-developing a very consistent community, they’re able to send one crew out and work through multiple houses at once. And they might be able to rough two houses a day instead of spending several days on a single custom job. Everyone gets more done and makes more money. That’s economical.

7. Use peers to benchmark

Pricing is another area where production and franchise builders have a distinct advantage. Whether it’s parts or labor, they typically have a large network of peers who are happy to share timely data that can help them make useful comparisons and shrewd decisions.

With 40 or 50 builders in a system, there are a lot of experienced people to call and valuable data to sift through. With those benchmarks, you’ll know if you’re in line or not – and pretty quickly. And you’ll have a powerful negotiating tool in your pocket when you go back to your vendors and partners.

8. Keep a tight schedule

“Time is money” may be a cliché, but it’s also true. And when it comes to building, scheduling is a great place to save both.

If you decide to take the advice above and build fewer floor plans with a consistent set of options, you’ll be more likely to keep your vendors on track and keep to a reasonable 100-120-day schedule. That, in turn, will allow you to keep turning over your inventory and increase your returns.

9. Keep 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. Good companies do this, too. 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, 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 were off somewhere or missed targets, find out why. Then, make a plan to improve. Learning is the key to continuous improvement, and every little bit helps.

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 strategic, be precise, be fast and be smart. Because that’s the not-so-secret secret to profitability. And it’s as true today as it’s ever been.

Article originally posted on Professional Builder.