Just like in every other business, builders and home contractors are in business to make money. These experts have employees, tools, vehicles, insurance, and advertising to pay for and on top of that, they must support their families. A new car in the United States probably has a 50-100% mark up over the cost to make it.
In fact, most of the products you purchase have a similar mark up over cost. But for some reason, people prefer not to pay builders and home contractors those margins for a new home.
How Do Professional Home Builders Make Money?
There are different ways a professional home builder generates profit. First, these builders make money on the basic cost to build the home; this is known as base house cost.
This is simply the cost for building the basic home before the client starts adding all their personal touches. A typical builders gross margin for this is 15%. When you think about the risk, cost, and time involved in most projects, this is actually a fair deal.
Another way builders or home contractors make money are on the items clients decide to change during the pre-planning stage. When a client wants a recessed can light or an additional hose bib, it doesn’t require anything special to price out and install as long as they are chosen prior to pulling a permit.
The mark up on these typically ranges from 30-50%. If a recessed can light costs the builder $60 for the electrician to supply and install, the cost charged by the builder will typically be somewhere between $75 and $85. Builders and home contractors also make money on what is rather known as non-standard options, or special options.
These are custom options that involve drawing a plan, estimating quantities, bidding, and sometimes include hard finding expensive products. All these changes can be very time consuming and can be difficult to estimate accurately, and they can involve products that may be hard to get and are easily damaged or stolen. These special custom options typically come with a 75-100% mark up.
In addition, builders and home contractors make money from late changes in home construction. This last type of change is the one no contractor wants to deal with. These are the late change orders that come after construction has begun.
These involve plan changes, bidding, permit changes, tear outs, on-site management, product order changes, and delays. Note that the true cost of this type of change can be ascertained by breaking down the overhead costs from delays, the additional management time to implement, communicate and supervise the change, and the additional labour and material to do the actual work.
The Profit Potential for Building Homes in USA
According to industry reports, profit margins for US home builders have continued to increase, reaching their highest point since 2006. On average, builders enjoyed US$16.4 million in revenue for fiscal year 2017, of which $13.3 million, or 81%, was spent on cost of sales and another US$1.9 million, or 11%, on operating expenses. As a result, the industry average gross profit margin for 2017 was 19%, while the average net profit margin reached 7.6%.
This statistics clearly shows that on average, builders’ balance sheets have shrunk since 2006. That year, builders announced an average of US$13 million in total assets. But by 2010, average assets had been cut in half, down to US$6.2 million. In 2012 and 2014, assets regained some lost ground, up to US$8.9 million and US$9.2 million, respectively, before falling slightly again in 2017, to US$8 million.
Nonetheless, the overall gross margin for the professional home builder of 15-20% is typically normal in the united states. Note that single family scattered home builders can earn an average of $10,000 gross profit per house after all direct costs. Remember, these builders have to subtract the indirect costs for insurance, licenses, fees, taxes, and general overhead. This usually leaves one to two percent.
Nonetheless, for the sake of clarity, combination builders, who build on their customers’ lands as well as their own land, rake in more – 7.6 percent per house, on average – which works out to $27,071 in pure profit on the typical house. This is encouraging, except that it sometimes takes years to obtain the necessary government approvals to build, and then 90 days or so more to actually construct the place.
On the other hand, speculative builders’ (builders with land cost) net profit averaged 5.9 percent. So if a client paid $356,200 for a new house – the average price for new homes in March, according to the latest figures from the Census Bureau – the builder will pocket about $21,016 on the deal, give or take. In addition, small-volume builders earn about 5 percent on average, while their larger colleagues, aka production builders, earn 6.8 percent.
Building Homes in the United States is a job that includes other professionals as subcontractors or helpers. According to reports, the general contractor earns about the same profit as the sub contractors, but is expected to bear all the risk, and usually has to wait until the house sells to get any income. This is the more reason why you see so little activity with one contractor building homes one or two at a time. This is pretty consistent over homes from $165,000 to $300,000.
The general contractor usually generate weekly income from trade work performed personally, or as a superintendent, however, to get this funding they have to get the payment by making a draw down on a construction loan, essentially borrowing money to live on and then paying interest on that money until the house sells.
In the construction industry, some fortunate builders and home contractors have enough free cash in hand to fund the construction of a spec home and avoid the cost of a construction loan. These fortunate experts usually partner with a material supplier that can wait until the house is sold to collect the material payment.
The contractor fronts the money for all labour and for electrical, plumbing, HVAC, landscaping, and usually the land and the water and sewer taps, permits and zoning fees. These builders depend on selling the spec house within 6 months of completion, or they begin to lose their cash to holding costs.
In summary, if a builder is a publicly traded company, buyers who know their way around annual reports are often overwhelmed to find out that the net profit on the sale of each house ranges from just 2 percent to 6 percent. Note that the higher net is typical for larger houses.
The reason is that larger houses are more expensive and administrative and sales and marketing costs per house are lower. In contrast, the 2 percent net profit likely relates to a lower-cost property such as a townhouse or condominium.