Sunday, May 28, 2023
Originally posted April 24, 2023
In this post, I'll discuss one of the hottest and never-ending topics in the industry: pricing homebuild jobs. We'll take a look at the two most common methods and then numerous aspects that impact them both. As always, feel free to add to this via comments below, I'd like this to be a knowledge repository we can all contribute to.
To get started, far too often I see homebuilders price their bids based on what it will cost them and not what the client should be willing to pay. You are literally leaving money on the table in this scenario. I know, we want to close a certain number of jobs per year and we are excited to work hard, but you must consider the homeowner's other options. If they want a new home built in a $1+ million neighborhood, then they should expect to pay $1+ million for that neighborhood, even if you think true costs will be substantially lower. Always ask yourself what they will be able to sell that home for after your work is done and factor that into your price.
In this model, you as the homebuilder quote a price bid that is almost totally fixed for the homeowner. Usually, the allowance section is the only phase of construction where the homeowner is liable for their own budget overages.
Easier to get bank approval if the homeowner is financing the build.
More predictable cash flow because there are certain milestones at which you can expect to receive a draw payment.
Almost zero negotiation with the homeowner after contract acceptance.
Highly susceptible to inflation. If prices for fixed costs (framing lumber, gypsum board, roofing, etc.) increase after contract acceptance, guess who has to absorb those increases? Yes, you do and during Covid times we have seen these increases high enough to ruin job profitability.
You will likely still have to reconcile allowances at the end of the job.
In the Cost Plus model, you quote your fee to construct the homeowner's job and they are responsible for all the materials needed. You are essentially charging for your professional expertise, which is a huge value for them! Do not underestimate the value of your expertise. Even if you and your staff are incredibly efficient, there's a reason for that... it took you years to learn that efficiency. Could you imagine the homeowner trying to self contract? It would take them forever and they'd make a ton of mistakes, so do not underestimate the value of your efficiency and expertise.
Easier to predict profitability because your contracting fee is set and the homeowner pays for all materials, regardless of the cost when it's time to purchase them.
Easier for remodels as opposed to new construction, because oftentimes the homeowner is self-financing or using a Home Equity Line of Credit ("HELOC"). Side note to use with the homeowner: interest expense on a HELOC could be tax deductible the same way interest is deductible on their main mortgage, as long as all the proceeds were used to buy/build/improve their primary residence.
More difficult to get a bank to finance using a traditional mortgage because the unpredictability of costs makes bankers nervous.
The homeowner may try to negotiate you down on your fee, but do not budge. As mentioned, they would never be able to do what you do. With everything, it will usually take longer than you think, so you need to have a fair fee plus a buffer (more on the buffer below).
Challenges on Pricing and How to Overcome
The biggest challenges we are seeing right now is unpredictability on prices. Inflation is starting to level off, but you never know when things could buck the trend upward. Prices are currently sticky, meaning they spiked at the onset of the pandemic and true costs leveled off but those prices are still high because suppliers aren't eager to give up that margin. The official econ term for this is "sticky prices".
One thing is for sure, homebuilding gets more expensive every year and rightfully so. Especially if you are in the custom market, the chances of a homebuyer finding exactly what they want are slim to none. Every year an existing home stands, the chance of it being exactly what your client wants is less and less. Therefore, their market for finding exactly what they want is always diminishing.
If you are going to take the time to work with them on every little detail they want, the outcome is priceless for them. This is especially true if you take the time to give them a positive experience along the way. All too often, we see builders down to the wire and overstressed, which translates into a less-than-personal experience for the client. All of this comes down to pricing.
Clients not understanding that the contractor cannot simply absorb cost overages on fixed materials. Some homeowners must think the builder gets a super secret big massive discount on fixed materials. When presenting proposals, I am a big fan of transparency even if the client can calculate exactly what your margin is. If they question or try to negotiate on your margin, my gut reaction is to question their validity as a client rather than retreat into that dark mental space where you think you are overpricing. In order to overcome their objection, do not budge on your markup.
Instead, explain to them the huge value and efficiency you bring. For example, you have a team of X people who are dedicated to their project while they continue their daily lives with careers or whatever else they do. Plus, your team is going to work hard to deliver a good experience. It's more than just the outcome, your team is going to guide them along the way. From selections to managing their budget, think about how much time, stress, and expertise every job takes. Price accordingly, justify your value, and do not budge on your margin! If they client walks, then it wasn't meant to be and it's their loss. It's better to sit at home doing nothing than to complete a job at a loss.
Not accounting for overhead costs. This is a big one because many homebuilders make the mistake of only calculating their gross margin, which is total revenue from the client minus costs that are directly attributable to the job. But what about your office rent, your cell phone, your staff payroll, and most importantly.... *your time*. In most cases, we advocate homebuilders to become S-Corps because the owner deserves to earn a wage for their time plus a healthy profit for all the risk involved in starting and managing a business. All too often, we come across homebuilders who don't even build costs into the bid for their own time.
Also included in this overhead needs to be re-work and warranty expenses. Ultimately, each and every job you complete has to be profitable on its own. You should not be stealing profit from another job to satisfy another client. This means the client literally has to pay for everything on their job, including these two painful (but necessary) items. Obviously, you will do your best to minimize these expenses, but could you image how much more expensive the mistakes would cost the homeowner if they were self contracting? Even your mistakes along the way are a bargain to the homeowner.
Too low of a margin percentage goal: It used to be all too common that we would see a 10% markup and accept it, but now I'm pushing homebuilders to aim more for 20-25% markup and this is subject to change again. Remember, this has to include your overhead plus your buffer for any unexpected inflation (and warranty and re-work!). You cannot make up for low prices with high volume. You will kill yourself.
No matter how you calculate your fixed overhead costs, revisit this calculation often and thoroughly. We see some homebuilders apply this as a percent and others apply it as a dollar amount. I believe the percentage model is a little more accurate because bigger jobs will likely take more of your time.
Overall, when you are pricing your jobs make sure you are including enough of a margin to cover overhead, inflation, the cost of your own time, and those pain in the arse late night emails. If you finish a job and you feel resentful toward the homeowner, it means your price was too low.
How does BuilderTrend help with this process? We advocate for BuilderTrend because it establishes a set system for you to budget and bid jobs. When you start estimating a new job, one of the first things you should do is create a budget for BuilderTrend. This should force you to look through all of your current cost codes to make sure you're not forgetting any costs. It should also force you to evaluate if this job fits as an ideal project for you. If you find yourself needing to create tons of new cost codes that you've never used before, it might not be the best fit for your Company.
The system BuilderTrend forces you to adopt ensures consistency in the way you bid jobs. Bonus if you can find subs who also use BT and are willing to submit their bids through the system, which will speed up all of your analysis. Even if you think you are the best estimator in the world, you still need to go through the process. You might think you can guess what price a sub will quote, but guess what... they are human, too. They have inconsistencies and they run ever-changing businesses just like you. Therefore, you still need to check in with them for a bid before you can officially deliver a proposal to your prospective client.
Overall, I'm tired of seeing too many homebuilders underprice their jobs and they reach out to us too late when they are already in a loss position. Let's take a look at your bids together, before you present them to the client, so we can be sure the work will be worth it.
As always, please comment with your thoughts. I'm curious to know if I missed anything.
CEO Of Remote CPA
With over a decade of experience, Jon was the founding member of Remote CPA back in 2017 and has been working with BuilderTrend since 2018. Prior to that, he was employed in Corporate Financial Reporting after spending time in Big Four public accounting. His Accounting degree is from Krannert School of Management at Purdue West Lafayette.