What Kind of Builder Are You?
You and I both know it -- there are as many different types of custom and small volume builders in the market as there are houses. I like to think there is a builder for every buyer, and some deserve each other more than others.
% $Ltd. General
% $Con. Mgmt.
% $$200K18.0%36.0K15.0%30.0K12.0%24.0K$300K17.5%52.5K14.5%43.5K11.5%34.5K$400K17.0%68.0K14.0%56.0K11.0%44.0K$500K16.5%82.5K13.5%67.5K10.5%52.5K$600K16.0%96.0K13.0%78.0K10.0%60.0K$700K15.5%108.5K12.5%87.5K9.5%66.5K$800K15.0%120.0K12.0%96.9K9.0%72.9K
The type of contract determines your responsibility and risk on every project. This table suggests profit margins on homes with various terms and prices.
Let’s take a look at just two different kinds of companies. We’ll call the first, "Whatever It Takes Builders." When meeting with a customer, WITB first determines the buyer’s budget for their new home. While this is always a good beginning, let’s take a closer look at how the negotiation and project actually proceed.
Buyer’s budget: $250,000
Cost of land: $50,000
Home cost: $175,000
Subtotal: $225,000
The balance, or the margin for the builder, is $25,000. A "whatever it takes builder" will design and spec a home to fit the owner’s requirement and will sacrifice his margin to do so.
Let’s take a look at the same customer shopping at "Bottom Line Builders."
Buyer’s budget: $250,000
Subtract margin: $37,500
Subtract land: $50,000
Balance left for
sticks and bricks: $162,500
A "bottom line builder" will design and spec the home to fit the dollars available without sacrificing his or her margin. That is the type of builder -- the type of business -- you want to become. Profit must come first if you are going to build a successful business. It can’t be what’s left over after the job is done. Plan for your profit in the same way you set sales goals and then work your plan. If you project sales to be $3 million, your planned profit should be $150,000. Overhead eats up another $300,000, leaving $2.55 million for materials.
The Real Deal
In order to plan for your profit, you must deal with real numbers. This can be especially hard to do with new clients. Determining a client’s true budget -- and your real profit potential -- is tricky and requires some detective work.Establishing a budget that you and the owner can agree to is the foundation for a successful and profitable project. The next -- and most critical step -- is determining the right type of contract for you and your client. A good contract answers these questions:
These are issues that affect your profitability and are best answered before work begins.There are three basic types of contracts used in home building today. Each has its own specific risks and responsibilities and understanding the differences is important for you, your business and your customer.Before exploring the different types of contracts, let’s lay a foundation by reviewing the basic responsibilities in new home construction. I’ve created two lists.
Some contracts share the responsibilities -- and the risks -- between the two parties better than others do. No one type of contract is perfectly right or absolutely wrong, but knowing where the risk and responsibility lie within each will help you negotiate the best terms for a successful and profitable job.
Client QuestionsToo often as builders, we fail to ask the right questions when attempting to determine the budget. The client will often tell us what they want to spend, but I believe we need to ask two more questions. "If you had to pull out all of the stops, what could you spend on your new home?""How much would you be willing to spend on this project in order to be able to get most of the features and finishes that you have described as important to you?"This number will usually fall somewhere between the want and could spend figures. When they answer this question honestly, you stand a better chance of bringing the project in closer to their true budget and minimize the chance that your margin will be squeezed.This question is designed to find out what their absolute maximum budget is. Care must be taken to assure them that you understand that they really don’t want to spend the maximum on the project. Explain that dream homes are almost never possible for the budget buyers envision. Here, you are attempting to create realistic budget expectations.
General contracts load nearly all the primary responsibility on the builder. The owner’s only responsibility is the extras. The same is true for secondary responsibilities where the builder and owner share liability for the design and design errors; all else rests solely with the builder. When we take on a full General Contract, our pricing reflects the risks that we are assuming.
A more popular type of contract with small volume and custom builders is what I refer to as a "Limited General Contract." Here, the risks and responsibilities are shared by the owner and the builder. The owner purchases the lot, obtains the construction loan, and assumes full responsibility for all extras. The builder manages the build-accuracy of bids, subcontractor selection, inspections, etc.
Some builders also offer a Construction Management arrangement for those clients who want more involvement in the building process. In a CM scenario, the builder becomes the management and supervision sub-contractor to the owner, and the owner assumes the risks and responsibilities of the General Contractor. While some builders find this loss of control too risky, I and others have found it to be an excellent way to satisfy those clients who want to build it themselves, but recognize the need for expert assistance.
No one contract is right or wrong -- though some are certainly more advantageous than others. The key is pricing projects to ensure that profit matches risk. (See chart on page 53.) Profit must be managed throughout a project if it is to be there at the end.