Strategies for Maximizing Profit
Maximizing or even just achieving a desired profit margin when building a custom home can be analogous to conducting a symphony orchestra. At times, one instrument or section is louder than the others, but come concert night, they all have to sound right together. Custom Builder asked five builders how they effectively hit their margins and found their approaches varied, with solutions focused on financing, design, transparency, open book systems, and even meeting culture. But the common denominator was preplanning and assuming control over the home building phases that precede construction.
What About the Land?
What Stephen Adams lacked in experience swinging a hammer he made up for with financial know-how. After earning his MBA from Arizona State University, he worked as a finance manager for a Western regional builder. There he managed a $350 million asset portfolio and created financing deals with land sellers that maximized flexibility and reduced risk for the builder. In 2009, he cofounded Joseph Carl Homes during the downturn and grew the company’s valuation to $70 million before selling it to AV Homes in 2010. The next year he started Adams Craig Acquisitions, in Scottsdale, Ariz., building net zero eco-luxury custom homes and, eventually, communities in Paradise Valley. He then reacquired the Joseph Carl brand in 2017. This year, Adams Craig is building $1.8 million homes on two of eight lots slated for eco-luxury houses in the heart of Scottsdale, and Joseph Carl Homes sold out a 92-unit community of entry-level houses in Phoenix for $13.5 million in home sales.
More Reading about Maxing Profit:
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“Most home builders come from the operational side and have an advantage over me, as I have come from the financial side,” Adams says. “So I’ve had to put the finance pieces together to have some leeway against the operational advantages that a builder with a construction background has. I had to get on the finance side to stay competitive.”
His front-end strategy for securing financing and land is a key factor in determining profit on the back end of his home building operation. Land bankers in his market typically demand a 25 percent down payment and charge somewhere between 15 to 25 percent interest for financing the purchase. During his 17 years in the home building business, every one of Adams’ investors has realized the returns they were promised. Consequently, they’ll buy in for less than what a land lender seeks because they see less risk investing with Adams Craig.
“It’s a hefty banking proposition, so the first thing we tackle—and we tackle it well—is getting private equity investors to do the land at 12 percent,” Adams says. “That’s been a huge success for us—to get people who understand our business model to take a lower-risk profile with 12 percent return.”
Another land-buying alternative is forming a partnership with land sellers. In this scenario, rather than buy the lot in order to build, the builder starts groundbreaking and vertical construction, and the landowner holds the lot in exchange for getting paid a higher price for their dirt, which is paid when the house closes.This means Adams Craig avoids paying interest on a land loan during months of construction and is able to keep more cash in hand. Landowners are amenable to this arrangement because they’re going to collect more money compared with selling the land before groundbreaking. Here again, Adams’ business relationship and reputation instill confidence: Landowners are optimistic that they will see their payday, particularly since they see their properties being monetized as Adams Craig builds on them.
“It also comes down to track record and product,” Adams points out. “We have a track record for building net zero houses, so when you couple that with experience and reputation and landowners who want to see something fantastic done with their lots, that’s where the marriage is usually made.”
For vertical construction loans, this past summer Adams was able to get bankers to come in at 5.25 percent to 6 percent. Before benchmark interest rates increased last June, Adams Craig was able to secure construction loans at under 5 percent. The bank is comfortable financing the entire vertical because Adams is bringing land to the project free and clear as far as the lender is concerned.
“When you’re able to finance the sticks and bricks of a house at 5 to 6 percent and your land at 12 percent, the structured finance becomes a huge part of your profit,” Adams says. “You’re not wasting a lot in finance fees when you’re able to get money cheaper, and it has helped me a lot with my operating mistakes and malfunctions because I have a cushion that a lot of builders don’t have—just because of how their companies are financed.”
Controlling Design
Like finance, design is an early phase of home building, and how it’s managed will also affect schedule and margin in the end. Jim Schneider started as a framing contractor before going into spec building. After surviving a period of getting saddled with too much inventory, he changed his business model in 2005 to that of a design/build company. The owner of Schneider Custom Builders, in Norfolk, Va., once considered hiring an in-house architect and even interviewed candidates. But he then realized that, at four to six closings annually, he probably didn’t have enough volume to keep an architect busy. Plus he would lose referrals from the design community because they would see him as a competitor.
Instead, Schneider recruited a handful of architects into reciprocal agreements, similar to how he would hire a framer, plumber, or roofer. Having a regular team of designers enables him to pick the architect he thinks will mesh well with a client’s personality or select the firm whose work best matches the type of project, whether it be a beach house or historical renovation.
But the key to Schneider holding the reins of the design and budget phases is having the client and the architect who are working on the project sign a design agreement. “No design or schematics are released to the client until I put my eyes on them,” he says. “If I see something getting out of hand, the architect and I will work through that before it gets to the client.”
The parties determine a budget, hold a charette, exchange ideas about what kind of house the client wants, and then sketches are drawn. From that process, sketches are entered into a computer and preliminary pricing and budget work begins. Next come finalized drawings and budget updates before the builder and client enter into a construction contract.
“Architects are creators; that’s their skill set,” Schneider says. “But they’re not practical, they’re not budget people, and they don’t execute. What I’ve found is that creating a team with the homeowner, architect, and builder is much more successful than hiring an architect, doing a plan, and going out to find a builder to quote it because most often the architect and the owner get out of hand. The architect gets excited about the design, and budget isn’t as important to them.”
Systems for the One-of-a-Kind House
Tim Winter, president and CEO of Paradigm Building Group, in Fairfax, Va., finds that the more systematic his custom home building operation is, the more disciplined it becomes and the more he accomplishes. Paradigm closes eight to nine projects annually, of which 70 percent are custom-built homes. The remainder are remodeling jobs that typically involve major gutting and second-floor additions.
“We’re all competing for the same 24 hours in a day, so I look at what I can do to be more systematic in the same 24 hours to maximize my output,” says Winter, who worked for East Coast builder NVR before launching his own company in 2007. He took the management systems approach he’d learned at the national builder and applied it to his own company. He has systems for handling sales leads and marketing, production, and change orders, as well as preconstruction that, like Schneider, includes a design contract and production scheduling, as it also does for Schneider.
The scheduling document is nicknamed “The Autopilot.” It’s a resource in Paradigm’s BuildTools project management software that Winter and Brett Van Horn, VP of operations, created by compiling years’ worth of notes about details from previous projects that regularly get overlooked and lessons learned that can be applied to future builds. The checklist and process map don’t list obvious tasks, such as “summon framing crew after concrete is poured”; instead, they’re more nuanced items, such as “get engineer out to the tight infill lot to mark lines so concrete contractor doesn’t pour beyond property-line offsets.”
“It’s so good that I can give it to someone who doesn’t know how to build a house,” Winter says. “The quality may not be there, but they’ll hit the schedule. When I was at NVR, we had a document like this. It’s a little different when you’re in production and building the same home over and over again; you see the same hurdles and it just becomes memory. We never build the same product twice, so we constantly have to be on our A game. This is our tool to think ahead, so when there is a hiccup, we can turn it around faster. It helps us see the future and anticipate problems.”
Margin Transparency
Mike Freiburger of Newlook Construction, a remodeling and design/build company on Chicago’s North Shore, drives his projects forward with a cost-plus open book format so transparent that he divulges his margins to clients. As a result, his company always hits its margin target, and projects proceed with less hassle because the expectations of the client and builder are clarified during preconstruction.
The origin for the open book approach occurred a couple of years ago when a childhood friend asked Freiburger to build his house. But the two were wary that this business relationship could threaten their friendship if the project went bad. “I said the only way we could do this was to be completely transparent from start to finish,” Freiburger recalls.
First, the builder brought the client to see his previous builds. Next, he learned his client’s likes and dislikes and then presented numbers by line item for what the yet-to-be-designed house would cost. Both sides massaged the numbers to come up with a budget.
“It was our philosophy of making sure we’re always aligned with our goals and expectations and are truly sitting on their side of the table instead of it being an adverse relationship where I’m trying to protect my bottom line,” Freiburger says. “I said, ‘Look, this is what’s included in the cost and this is what our markup is going to be. We know the line items will go up or down, but we can manage it and get to our final number as long as you stay within the allowances."
The house was completed within budget in a year, as scheduled. Freiburger’s staff liked how easy it was to work that way with the client, and they wanted to use the format for every contract. However, the biggest challenge for achieving more transparency was all of the potential busy work that this approach could create.
An assist came from Newlook’s BuilderTrend project management software, which includes a robust portal that allows homeowners to see their allowances, selection deadlines linked to the production schedule, and what happens to the schedule if they miss those deadlines. They can also see a running tabulation of their spend and how change orders, which customers can approve via smartphone by signing the screen with their finger, affect the budget. Newlook is so confident about its process that Freiburger guarantees the schedule and the budget once both parties agree to those details after the initial meetings.
“Without the software, I don’t think we would have been able to go this route because of the amount of paperwork we’d have to approve each time we go to the client,” Freiburger says. “That would have been too cumbersome. BuilderTrend makes everyone comfortable because they can see the process.”
Meeting Culture
Sebastian Construction Group is another builder confident about its preconstruction process. The Dallas builder pledges to eat the cost of that entire phase if clients believe the builder didn’t deliver the value the client was seeking. The Sebastian Guarantee has been around for almost four years and during that period the company has seen its margins improve and closings increase from five to seven houses per year to 11 to 14.
The company got there by clarifying the company’s organizational structure, thanks in part to adopting the Entrepreneurial Operating System. EOS is a strategic planning method based on Gino Wickman’s book Traction: Get a Grip on Your Business, which advocates making short- and long-term plans by identifying strengths, weaknesses, opportunities, and threats to your business.
“We were a pretty good builder, but we had trouble growing beyond a certain point, and we kept bumping up against that same ceiling,” says Matt Cain, president and integrator. “Our values and mission didn’t change because of doing EOS, but it gave us the structure that allowed us to scale, identify problems more quickly, and address those issues more systematically.”
Cain describes pre-EOS Sebastian as a company with many people performing multiple roles. The builder had people with titles such as estimator, project manager, superintendent, controller, human resources manager, and preconstruction manager, but everyone was doing a bit of everything. Even founder John Sebastian was de facto director of operations and business development, as well as estimator and chief problem-solver. Indeed, when the management team sat down and defined all of the functional roles within the company, they determined that John was sitting in 12 “functional seats,” as EOS calls them.
“It wasn’t so much because he didn’t think anybody else could do those things,” Cain says, “it was because we didn’t have any structure around what those roles were.”
The company restructured into three departments: New Product Development, which includes business development, marketing, and preconstruction; Operations, which is the construction team; and a Finance and Administration group. Employees were assigned to departments and given job descriptions with clearly defined responsibilities tied to expected performance outcomes.
Sebastian Construction also started using the EOS Weekly Meeting Pulse, which, EOS says, is used “to manage the heartbeat of the business.” Implementing a meeting structure that was previously lacking has helped company managers simultaneously work on short-term issues and long-term goals and boost accountability because managers and employees must own issues that need to be addressed.
Level 10 Meetings—another EOS device—follow a specific structure and have their effectiveness graded on a scale of 1–10. Meetings start and end on time on the same day every week. A session begins with 5 minutes of reporting personal or professional good news. The next three 5-minute agenda items are part of the reporting mode when participants run through company metrics on their scorecard, review quarterly goals, and then share employee and customer headlines, whether good or bad. Any item that warrants discussion gets covered during the issues processing portion of the meeting.
Next comes the To-Do List. Participants review the seven-day action items from the previous meeting and report whether those items have been completed. Ninety percent of the previous week’s to-dos should be dropping off the list. If they’re not, that could indicate a problem. The agenda then moves to the Issues List, whereby the leadership team has 60 minutes to identify, discuss, and solve the company’s biggest issues in order of priority.
“When we get to this point,” Cain says, “everyone can weigh in, and if the owner of that issue gets what they need out of the group, then he or she presents a decision about what to do to move forward on the issue. We record that as a to-do item, and the owner of that issue will report to us the following week.”
For each meeting, the team chooses three issues to resolve for the betterment of the company or a project. In some meetings, participants may only be able to work on one issue; in others, they may address several. No matter the progress, the meeting always ends on time with the last 5 minutes spent recapping the To-Do List and rating the effectiveness of the meeting from 1–10.
Level 10 meetings ensure that employees have regular opportunities to talk about their issues and take active steps to resolve them, which serves to minimize distractions from email and phone calls to coworkers about these challenges, helping staff be more focused and productive.
“We didn’t change the kind of work we’re going after or the target buyer group,” Cain says. “We just changed the way we go about it. Our meeting structure was a large part of that. It was a significant departure from how people thought we could be productive. We’ve gotten more organized around what happens prior to construction with clients, getting involved as soon as we can with lending, selections meetings, and communication. That realm used to belong to the architect and the client together. We’re now getting much more done in a shorter period of time. The maturity of the company in its business practices, professionalism, and how we go about things has grown exponentially since we started doing EOS. Our knowledge about the right way to do that has gotten so much stronger.”