The Association of Professional Builders (APB) has announced new guidelines to maintain profitability for small home builders, given 75% operate on a net profit margin of 3% or less. As a leading business coaching service for custom home builders, these profit margin guidelines are even more important now, given the slowing housing market, difficult supply chain, and labor shortage issues. Additionally, APB’s State of the Residential Construction Industry (SORCI) report finds that smaller residential building companies are failing to charge the correct margin because they do not have the demand.
A 2022 report by New York University Stern School of Business revealed that the average builder’s margin amongst the larger building companies was almost 25%, which enabled those businesses to enjoy a net margin of 12.73%. However, while most residential building companies do not currently add 25% to their projects, those that do will still not get close to clearing a double-digit net profit margin.
“The reason the companies in the NYU Report are clearing double-digit net profit margins is simple; they’re adding a 25% builders margin to the cost of their labor and materials,” says Russ Stephens, co-founder of APB. “However, simply adding 25% to the cost of labor and materials does not equate to a 25% builders margin; it’s a builders markup and that will result in a 20% builders margin."
According to Stephens, a typical residential building company operates on a fixed expense ratio, which includes the operating costs such as rent, wages and administration, of around 15%. When builders make the "simple mistake" of adding a 25% markup instead of a 25% margin, it effectively cuts the builders' net profit margin in half.
"And when a building company trims their margin to win a job, they can quite easily end up with no net profit at all," he says.
HOMEBUILDER'S PROFIT MARGIN GUIDELINES
Some of the guidelines that APB recommends include:
- Understanding the difference between a builders net profit margin and a builder's markup.
- The importance of investing in marketing in order to increase margins.
- Creating a business plan
The Association of Professional Builders has identified that allocating 3% of a building company’s total revenue to marketing and advertising is what enables successful businesses to enjoy 10% net margin due to a fundamental law in business. “There is clear proof that margins are linked to marketing because of the fundamental law of supply and demand,” said Stephens. “When demand outstrips supply, prices rise and when prices rise, margins rise and businesses become more profitable.”
APB advises that building companies that use paid advertising to increase demand for their services are able to continually increase their markup until they reach the industry benchmark of 33.3% for new homes resting in a 10%-15% net profit margin. When it comes to profitability, it is imperative for builders to understand their financials and to document a repeatable sales process while generating more opportunities than they actually need.
PROFIT MARGINS: CONSUMER IMPACT
The current market is being compounded by rising mortgage rates and competitive pricing on homes which is more quickly weeding out buyers, especially where housing inventory levels are lower.
Additionally, according to the U.S. Census Bureau, the start of construction on new residential homes fell to 1.45 million in July, a 9.6% decline from the month before. As a result, homebuilders have an ever-important task ahead of ensuring they are pricing for profit by carefully calculating their net profit margins.
Therefore, it is important for consumers to understand that the only building companies that will be around to complete their home are the ones that are making a net profit. Choosing a builder with the lowest price will simply pair them with the building companies that are most likely to fail in the months ahead. APB advises that the time is still now if a homeowner is considering building a home. The company notes that the biggest factor to understand is that construction costs are not going to be reduced anytime soon. In fact, it’s more likely that they will continue to increase for another few years. Therefore, delaying a project now will only mean having to find more cash in the future.
APB also notes that homeowners must understand the actual pricing based on the quote at the time of receipt. If a homeowners’ project was quoted more than 30 days prior to the contract being signed, then be prepared for the builder to revise the contract price in line with weekly price increases that are occurring in the industry. If the builder does not reprice a quote that was provided more than three months prior to your contract signing, they could enter into a loss-making contract. The building companies that will still be operating in 2023 are the professional operators who are recalculating their costs every 30 days.
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About the Association of Professional Builders
The Association of Professional Builders is a leading business coaching service for custom home builders in the United States of America, Australia, New Zealand, and Canada. It provides tested and proven systems for builders to scale and succeed, based on data, experience, and results. To access APB’s resources, visit: https://associationofprofessionalbuilders.com/resources