Most of us are keenly aware of the sharp rise in the housing market over the past few years. Most industry experts credit basic economics and poor logistics for the sharp rise in lumber prices, and consequently, home prices.
Along with the rise in the value of the housing market was a rise in custom home builders’ average profit margins. Profit margins have risen steadily for the last three years and remain on pace to continue increasing.
To be clear, these profit margins are averages, and not category specific. Some custom home builders saw higher than average profits while others experienced a down trend. Housing markets tend to be local, so some builders benefit more than others.
A profit margin is the percentage of total amount charged that a home builder will receive after overhead and constructions costs are paid
According to the National Association of Home Builder’s Cost of Doing Business Study, the net profits for the average builder in 2020 fell to about 7%. Although gross profits were closer to 18%, operating expenses consumed over 11% of the profit. The authors also note that the 2020 results were not normal and were greatly influenced by the pandemic.
Combined with never-before-seen logistical complications, the building industry has seen its share of turmoil, but higher profits as well, as often follows periods of unrest.
Keep reading to explore some common stages of the normal construction process and which stages tend to be profit centers for residential home builders.
We can assign credit for home builder’s increasing profit margins on simple economics. The housing market is much like the textiles industry and the food business. Everyone on the planet needs food, clothing, and shelter, so when the supply is low, the demand is high. As a result, in 2021, some lumber prices at Home Depot were higher in the afternoon than in the morning.
Few need a reminder of the pandemic and the disaster it caused for the economies of many countries. At some point, the decision was made to assign special status to certain industries vital to our existence, like home builders. Obviously, these companies needed to provide essential services and follow special COVID-19 safety protocols to qualify, and many did.
The end result was that just like grocery stores and other businesses providing vital services, construction companies were allowed to continue operating, helping to prop up shaky economies. Once most of the safety protocols were lifted, these companies continued to benefit until manufacturing and logistics problems caused a lack of building materials.
Once the supply of materials began to trickle back in, what materials were available became very valuable. Some prices doubled in a matter of days and quadrupled in a matter of weeks. In turn, this allowed those home builders willing to pay more for the materials to continue to build, but of course, these home builders increased their prices to recoup their unusually large investment in materials.
Even so, the demand for residential housing far outpaced the supply available, so every step in the profit chain from lumber harvesters to floor polishers found themselves in a position to negotiate for a higher price. Of course, this led to runaway inflation, requiring the Federal Reserve of the United States to raise interest rates in an effort to slow borrowing.
In the construction world, the best home builders can make money regardless of the state of the building industry. For example, when demand is low, like just after the financial crisis of 2008, home prices fell steeply, so custom home builders just did more remodeling. When clients can’t afford a new home, they often turn to upgrading the home they already live in.
As a result, residential remodels increased, so builders took advantage of the demand. Because labor was more plentiful, these builders could profit from the additional revenue provided by lower wages and lower lumber prices simultaneously. As often happens, some developers invested heavily in raw land, allowing home builders to provide a steady stream of housing to the rising demand.
The most successful of those home builders took full advantage of the emerging construction technology explosion, which saved them both time and money. Efficiency is key to home builder profits, especially when business is booming. Tracking shipments, lumber prices, and personnel can be a nightmare unless some form of construction management software is used.
Pro Tip: BuildBook has quickly become a favorite amongst custom home builders for its clean design and simple, quick, and easy to use features. Unlike other construction software, BuildBook only focuses on the features that are most important to home builders and provides a free trial to eliminate the financial risk of evaluating the software.
Potential clients can have misconceptions about builder profits, especially when they see a developer driving a $100,000 truck. The reality is that builder profits are as variable as the locations they build in. To increase profits in a sustainable way, the builder must maximize every opportunity in their market.
The most successful developers, general contractors, and owner/builders understand that small profits are as important as large ones. For example, material management, change orders, and superior workmanship are among the highest profit centers for these builders. Because some home building projects can have significant size budgets, a small increase in profit can make a big difference in overall profitability..
The most profitable builders keep their material waste below 5%, encourage profitable change orders if they occur, and do excellent work. Clients are usually willing to pay for quality, so the builders that a client feels will produce the best work usually win the bid. In other words, the better the work, the more willing clients are with paying more to receive it.
Each stage of a new home construction project will have different profit margins, but on average, most home builders will earn between 10%-20% gross profit. Some stages will be physically larger, but less profitable, while others may seem unusually expensive. Generally, the more skill required to perform the work, the more the home builder will have to pay subcontractors to perform the job.
Want to see how much revenue you need to generate as a home builder to achieve a desired net profit? Use the calculator below to adjust the numbers and see the results.
Site preparation may be minimal on tracts and lots with utilities already installed. However, subcontractors with backhoes and bulldozers will still be needed to create the house seat, disturbing at least some ground. Most builders will add 20%-25% gross profit to smaller jobs, but larger projects may get a 5%-10% discount.
Site Preparation also often requires the services of a civil engineer or transit operator to establish boundaries, set corner pins, and provide temporary drainage. Home builders will often add 10% to whatever the professional charges as a supervisory fee, because if there is a problem, the home builder will have to get involved.
Footings involve the trenches needed to establish a solid foundation below the frost line. Backhoe operators are often tasked with this project. In the majority of cases, the backhoe operator will also pour the concrete footings if the structure requires them. Home builders will often add 10-15% to this stage of the project.
After the footings have been inspected and poured, a masonry company is often hired to install a block foundation. Most masonry companies do not work by the hour, nor the square foot, but rather the unit. Lightweight cement blocks, for example, are often priced by the block, while bricks are often priced by the thousand. Home builders usually add 10% to this stage, but many will add closer to 15% if they also provide the materials.
Builders can improve the net profits on masonry projects by using careful materials management and attention to detail. Masonry problems can be expensive to correct, so the most profitable masonry contractors waste little material, move quickly, and work efficiently.
In most residential construction projects, the same subcontractor will install the floor system, framing, and sheathing on the structure. Home builders commonly add 15% to the framing stage. However, some custom builders start out adding only 10% to the project, because they anticipate many change orders to which they may add 25%-30% profit margins. Most will also install the house wrap as part of their construction proposal.
Some home builders will also hire the framing subcontractor to install the windows and doors. Doors and windows provide better profit margins for home builders because they often are sold in quantity and can be quite elaborate. Projects requiring sophisticated skills to install, like windows and doors, tend to offer profit margins in the 25% range for the custom home builder.
Framing contractors can increase their profits with efficient framing techniques and materials, such as using trusses, manufactured I-beams, and laminated veneer lumber (LVL) wherever possible. Tools like pneumatic nailers often require air compressors and hoses, but the time they save overall is more than worth the investment.
Exteriors are a common profit center in residential construction. It might be surprising to learn that contractors can make as much profit margin installing vinyl siding as they can installing brick. For example, a typical vinyl siding project will reap about 25% in gross profit, while a brick project may only produce a 10%-15% profit margin.
In general, exterior facades that can be installed quickly are more profitable than those that require substantial labor and time. This is why you see more paint and siding companies than you do stucco and brick installers. When you add in vinyl soffit and aluminum fascia cap to a vinyl siding project, the profits can reach 30% or more.
Profit margins for exterior projects can be increased with excellent materials management and having the proper tools. As mentioned earlier, vinyl siding projects can be very profitable, yet made more so by employing tools designed for the job. Hand tools for making small adjustments, for example, can save material, avoid trips to the ground, and increase the speed of the project.
Roofs can be a good profit center for a home builder if the structure requires a sophisticated roof, like synthetic slate or synthetic wood shingles. However, most roofs are made from fiberglass/asphalt shingles. Due to the popularity of this style of roof, roofing installers abound, so competition can be fierce.
As a result, typical roofs are not a reliable profit center for home builders or remodelers, so most expect the standard 10% premium. As mentioned previously, some builders will aim for a 10%-15% base profit margin and hope change orders will increase the overall profit margin.
However, those roofing contractors willing to invest the time and money to receive specialized training can earn much larger profits. Most manufacturers of new products like synthetic slate tiles, or composite shingles offer specialized training to roofing contractors in an effort to create a service network of qualified installers.
These roofing contractors tend to work on upscale projects, which can earn profits of 25% or more. Complex roof lines and architectural concerns can also add to the complexity of using these materials, so the contractors with the most experience will often earn the highest profits.
Doors and windows are one of the top five profit centers for home builders. Normally, the more elaborate the door or window, the more profitable it is for the home builder. For example, a $150.00 steel door and $50.00 lockset are perfectly suitable for most door openings.
However, a very expensive mahogany door and lockset will fit the same opening, so why does one cost a fraction of the other to install?
In many cases, oversized, heavy doors will require special tools and knowledge to install, so the home builder can charge a premium for the expertise and equipment. Sophisticated locksets usually require special tools to install as well, in addition to specialized training from the manufacturer.
Door and window installers looking to augment their net profits will often commit to one or two brands and support them fully, as opposed to just shopping around. Door and window manufacturers are known to offer exclusive products and better pricing to those contractors committed to supporting the brand.
Much like the roof, most home builders don’t expect to make more than the standard supervisory 10% profit margin from electricians, HVAC contractors, and plumbers. Plumbers and electricians are licensed professionals, so there really isn’t much expertise a home builder will add to the project. However, home builders will add 10% to whatever those pros charge as a supervisory fee.
In general, home builders do not expect to add more than a 10% - 15% profit margin to insulation, drywall, and painting projects. There are exceptions of course, like projects using closed-cell spray insulation and designer paint schemes.
Insulation upgrades like closed cell spray foam can add an additional 30% beyond standard fiberglass batting, so builders are usually more than willing to add it to a project. Special paint techniques, like orange peel and knockdown can add another 25% gross profit to the custom home builder’s bottom line as well.
The most profitable insulation, drywall, and painting contractors will offer the latest in technology and explain the value. Most of these projects only get performed a few times over the life of the home, so it is important to get the best available at the time.
Floor coverings are a common profit center for home builders. Home buyers tend to upgrade their new homes, and after kitchen cabinets, floor coverings are often upgraded next. Basic floor coverings like vinyl sheet flooring and laminate flooring are common. Often these projects will only include the standard 10% home builder profit margin.
However, floor coverings can be something as simple as vinyl sheet flooring, or as unique as cork parquet. Again, the more luxurious the flooring, the higher the home builder’s profit margins will likely be.
Finished hardwood, engineered wood, cork, bamboo, and other flooring materials can provide the home builder with a profit margin of up to 20%. Tile, stamped concrete, and other flooring materials can also profit a home builder an additional 15% -20% profit margin.
Other systems within the home can provide unique features, like recirculation pumps, home automation, and security. These individual systems are usually provided by a licensed subcontractor, so the home builder expects a minimum markup of 10%.
Some builders opt to not take responsibility for these systems for the minimal profit they might receive. In these cases, the home builder often pre-wires for security and home automation and/or plumbs in a recirculation system during the framing stage.
Successful home builders and remodelers usually determine their prices based on their overall profit goals and the market price for the service. Generally, most contractors offering a similar service in a similar area will charge about the same price, assuming they pay the same price for the materials.
Profitable home builders and remodelers will take advantage of every profitable opportunity. They work at night, personally deliver materials, and make sure expensive mistakes are kept to a minimum. However, they will not price gouge, cut corners, or do sloppy work.
The most profitable home builders understand that construction services aren’t something most clients only need once. Advertising and marketing expenses are significantly reduced by positive word of mouth referrals, so those costs go down. The best home builders can also choose the most profitable jobs for their company, based on the way they do business.
It is usually in the interest of any client for their home builder to be profitable. Savvy homeowners are also investors, so they want home builders and remodelers to make a profit. Home warranties and good customer service are hallmarks of a great home builder, but only if they remain in business.
Some home builders have been in business for generations, navigating changes in financing, home designs, and recessions, and they keep turning out incredible work. These companies make a steady profit regardless of the market conditions by understanding where their profit comes from and maximizing it, while providing superior customer service to their clients.
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