Builders Can Grow Profits in a Down Market
Not only can buiders survive a dip in the housing cycle, they can grow their profits when the market is soft. Just don’t, in today’s market or any market, give up gross margin to grow top-line revenue.
In fact, the single biggest mistake any builder can make — you may already have learned this lesson the hard way — is to sell more homes than you can build.
“Can you really afford to sell a house today that you’re not going to deliver for 14 months? Just think of the mess that’s going to create,” says Bob Whitten, of SMA Consulting, which provides financial and operational management consulting services to the construction industry.
Whitten offered several tips on growing your company and profitability, even in a down market, at the 2007 International Builders’ Show in Orlando. They included:
Because one Detroit builder maintained a healthy gross profit margin, Whitten says, he was able to survive a decline in closings of two-thirds — from 180 to 60 — in the past three years. A builder’s net profit before taxes and after distributions to the builder/owner, in base salary and bonuses should be 10% to 15%.
- Maintain and Employ Detailed Operating Reports
Witten says builders at least should have detailed operating reports on warranties, job cost variances, gross profit analysis and customer satisfaction to keep track of their business.
- Use Referrals, Rather Than Spec Homes
In a down market, builders should use referrals to attract customers and control their commission payouts, rather than build more spec homes. Builders should have a 45-to-90-day backlog of presales, which, he says, can be achieved with a 35% to 40% referral rate.
- Advertise a Lower-Priced Home
Whitten advises that builders should sell their base model at a 23% margin and optional features at 35%.
- Maintain and Control Systems
Control systems should be in place for market research, financial operations, construction operations, sales and purchasing, Whitten says.
- Establish Benchmarks, Rewards and Sanctions
Benchmarks, rewards and sanctions should be tied to performance and monitored using reporting mechanisms that can flag variances, Whitten says. Builders can then hold regular accountability meetings to provide a “pat on the back” or a “kick in the pants,” as needed. Bonuses should be based on the reporting data.
Builders should also invest their time, energy and effort in areas where less-than-stellar performance is costing them the most, he adds.
The following are sample benchmarks:
- Superintendent costs — 1.5 % revenue
- Warranty expense — 0.6 % to 0.75 % of sales revenue
- Debt-to-equity ratio — between three- and four-to-one
- Model home expenses — less than 1% of sales revenue
- Productivity ratio — $1.25 million in revenue per employee
- Average time warranty requests are open — less than 14 days
NAHB Has More Than 300 Resources to Help You Run Your Business More Profitably
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