A home builder, also called a residential contractor, constructs new homes and takes on major remodeling jobs. A home builder is more or less the owner of a residential construction company. Setting up any company is not a big deal but running it efficiently and profitably in the long run is. These days there is huge competition in the home building field because it offers exciting opportunities.
With government planning and focusing on low-cost affordable housing and housing for all, this sector holds tremendous growth potential. According to industry reports, profit margins for US home builders have continued to increase, reaching their highest point since 2006.
On average, builders generated US$16.4 million in revenue for the fiscal year 2017, of which $13.3 million, or 81 percent, was spent on the cost of sales and another US$1.9 million, or 11 percent, on operating expenses. Owing to that, the industry average gross profit margin for 2017 was 19 percent, while the average net profit margin reached 7.6 percent.
This statistic explicitly exhibits 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.
However, the overall gross margin for the professional home builder of 15-20 percent is typically normal in the United States. Have it in mind that single family scattered home builders can earn an average of $10,000 gross profit per house after all direct costs. Notably, these builders have to subtract the indirect costs for insurance, licenses, fees, taxes, and general overhead. This usually leaves one to two percent.
Meanwhile, for the sake of clarity, combination builders, who build on their customers’ lands as well as their own land, generate more – 7.6 percent per house, on average – which works out to $27,071 in pure profit on the typical house.
Indeed this can be quite 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. 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.
Note that the general contractor more or less generates 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.
Some fortunate builders and home contractors have enough free cash at 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.
4 Smart Ways Home Builders Make Money
Builders and home contractors are in business to make money. They have employees, tools, vehicles, insurance, and advertising to pay for, and also, they are expected to support their families. A new car in the United States probably has a 50-100 percent mark up over the cost to make it.
Indeed, most of the products you purchase have a similar mark up cost. But for some reason, people prefer not to pay builders and home contractors those margins for a new home. There are different ways a professional home builder makes money and generate profit, and they include;
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Base House Cost
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 of building the basic home before the client starts adding personal touches. A typical builder gross margin for this is 15 percent. When you think about the risk, cost, and time involved in most projects, this is actually a fair deal.
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Standard Options
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 choose prior to pulling a permit.
The mark up on these typically range from 30-50 percent. If a recessed can light costs the builder $60 for the electrician to supply and install, the cost charged by the builder will be somewhere between $75 and $85.
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Customers Changes
Builders and home contractors also make money on what is 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 to 100 percent mark up.
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Late Changes
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.
True cost of this type of change can be ascertained by breaking down the overhead cost of delays, the additional management time to implement, communicate and supervise the change, and the additional labor and material to do the actual work.
Conclusion
Home builders must have the ability to create a business that impresses residential shoppers. However, it can be surprising 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 typically for larger houses. This is because 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.