Custom Builders Shouldn't Set Margins on Hard Costs Alone

At the Custom Builder Symposium last October, I spoke with several successful custom builders about how they set their margins. The discussion usually revolved around the percentage of markup applied to the cost of the project or, alternatively, the percentage of gross margin that the builder expected to make on the eventual selling price. What would they have to make on their projected volume to cover overhead and provide a net profit for themselves? 12 percent? 15 percent? 20 percent?

The fallacy with this approach, I believe, is that we get too caught up in percentages based on hard costs and lose sight of the other important factors that should be considered when determining our selling prices. I think builders should consider a more flexible pricing policy.

First, we need to acknowledge that most of us really are selling a service and not a product. Because we act more as facilitators and expediters than builders, our time and expertise is what needs to be priced, not just the cost of the sticks and bricks that go into the home.

To effectively gauge the value of your services, you need to consider the following factors:

What type of contract or agreement are you entering into? If you're providing the home site, taking out the construction loan, guaranteeing the price and providing a warranty on the project, the price for your services (i.e. your margin) needs to be substantially higher than if you're building on the client's home site, with the client's funds (borrowed or cash) and with a construction management or cost-plus arrangement. In other words, if the builder's risk and exposure are lower, the customer deserves to pay less.

What is the size of the project? Applying the same percentage markup or margin to different size projects makes no sense to me. Does a $1 million home take twice the effort as two $500,000 homes? In my book, no way. Two smaller projects — even though each is likely to be less complex and demanding than one large one — still require two permits, two selection processes, two warranties and two of everything. The management and administrative time required will most likely be substantially higher for two smaller projects as opposed to one larger one.

I would much rather build four $1 million homes per year than eight $500,000 homes per year. For that reason, a lower percentage margin may be appropriate for larger projects.

How complex is the project? Is it a relatively straightforward, conventional home or a cut-up, complicated, supervision-intensive design? What about features and finishes? Obviously, the more time you and your staff have to spend on the project to work through issues, the more you need to charge.

The location and government jurisdiction may also present some pricing considerations. Is it a long drive from your office and normal areas of operation? Will the local government or homeowners association give you fits before, during and after the construction process? If so, using a higher margin on this project makes sense.

What is your perception of the client? Will they be easy to work with or potential "clients from hell"? Are their budget expectations realistic, or do they have champagne tastes on a beer budget? Don't ignore your gut feeling. When faced with a client that you know will require lots of hand-holding, it is imperative to charge appropriately for the additional time and aggravation.

Tom Stephani, tom@custombuilding.com, www.custombuilding.com