Direct Construction Costs: Key Profit Variable

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While the land buy sets the stage for profit potential, direct construction costs are the major variable that actually determines what the profit will be.

September 01, 2003

 

Chuck Shinn, President, Lee Evans Group

cshinn@

leeevansgroup.com

 

While the land buy sets the stage for profit potential, direct construction costs are the major variable that actually determines what the profit will be.

Because they are variable, a reduction in direct costs of $1,000 for a 100-unit-a-year builder will increase profit by $100,000, while a reduction in an operating or fixed cost of $1,000 will increase profit by only $1,000. There is no multiplier.

To determine what direct costs should be, deduct from the market-set sales price the targeted (and sacred) profit, along with the land cost at builder retail, the operating expense allocation and historical cost slippage (variances). Right is an example.

 

Market-set sales price
$239,000
Targeted 10% profit
$23,900
Land cost
$47,800
Operating expense
$42,800
Historical slippage
$4,800
Direct construction
$119,700

Use this target to design and specify the product. Break it into individual cost components and value-engineer to reduce material, labor and waste. Then continually attack direct costs on all fronts.

Eliminate low-profit house plans. Conduct cost/benefit analysis before you put any standard feature into a house. Just because competitors offer a feature as standard does not mean customers put value on it. Keep direct costs in the range of 48% to 52% of sales price. And remember that discounting sales price effectively increases direct construction costs.

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