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How Much Do Builders Really Make?

Written by Al Heavens on Wednesday, 12 September 2001 7:00 pm
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Have you ever wondered how a builder determines what he or she is going to charge for a new home?

What goes into a house is hardly a mystery -- lumber, labor, wires, etc. -- but if you're going to plunk down a few hundred thousand dollars for a place in the suburbs, you should know how the final price is determined.

Your cost is based on such factors as expenses for construction, land and improvements, and include the builder's marketing and administrative costs and net profit.

It's as simple as that.

Each builder has his or her own way of doing business, but some things are common to all.

Construction, which accounts for about 50 percent of the base price of a house, has several different cost components.

The first is "direct" costs, also called "house" costs, which are defined as "stick and bricks.'' House costs include all the materials that go into a home -- framing lumber, concrete for foundations, windows, roofing, tile, flooring, drywall and carpeting.

This work is performed primarily by subcontractors hired by the builder.

"Indirect" costs involve work usually performed by the builder's own employees. These can include the use of special tools needed for a unique job, supplies or the cost of preparing a house for settlement by correcting work that was not properly done by the subs -- such as re-caulking a bathtub or sanding and re-staining a length of baseboard.

Then there's construction labor, are costs associated with work performed by the builder's employees.

Next is construction interest. To finance the purchase of your lot and the cost of construction before you pay for the house, the builder has to take out a bank loan. The cost of the loan, including interest, is figured into the base price.

The cost of buying the lot and preparing it for construction accounts for 25 percent to up to 40 percent of the base price.

Purchase prices and prep work have been increasing as choice land becomes less plentiful and the owners of choice sites demand more dollars for their property. Costs of preparing the raw land also are growing more expensive.

Many building sites fail to make the cut during the long approval process demanded by municipalities and state and local governments. Some of the land the builder had planned for housing can go instead to satisfy open space requirements or falls into a protected category.

Often a builder has to raise the prices of the houses he is allowed to build to compensate for the loss of land he thought he could use. Depending on your location, municipal and state permit fees can often add several thousand dollars to the price of each lot.

Builders often borrow to buy the site, so interest and lender fees also are figured into the lot price. Land costs include off-site improvements, such as building water and sewer lines to existing service that could be up to a mile away and even an off-site pumping station.

On-site improvements include sewer and water hook-ups, street development, curbing and paving and driveways and sidewalks.

To encourage first-time buyers -- about 40 percent of the market -- especially in the condo and townhouse end of the market, a builder often will give a discount on the base price, paying for points on the mortgage at settlement. This ensures that buyers can get into the house. A lot of purchasers have high-paying jobs, but not much in savings, so the discount helps get them to settlement.

For a less-expensive unit purchased by a first-time buyer, construction costs typically account for 50 percent of the final price, the lot represents 30 percent, a discount might amount to 3 percent, leaving a 17-percent gross profit.

Out of the gross profit the builder must deduct administrative costs, sales and marketing costs and taxes.

Over and above the base price is the cost of options, which can run all over the place, often 10 percent to 30 percent above the base price.

So what does the builder get when the home is sold and all the numbers are added together? Probably a lot less than most buyers imagine.

If a builder is a publicly traded company, buyers who know their way around annual reports are often surprised to learn that the net profit on the sale of each house ranges from 2 percent to 6 percent.

The higher net is typically for larger houses. The reason is that larger houses are more expensive and administrative and sales and marketing costs per house are lower. In contrast, the 2 percent net profit likely relates to a lower-cost property such as a townhouse or condominium.

For more articles by Al Heavens, please press here .

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