It's been a great run for housing, and maybe it's not over but is simply moving sideways. However, with unemployment edging up, industrial production sluggish, consumer sentiment waning, and the events surrounding the Sept. 11 tragedies affecting the economy, it may not be long before we experience more price conscious consumers, weaker consumer spending, and faltering demand for real estate. The signs all point to slower growth ahead with the probability that recovery will be pushed until late next year.
Housing demand has held up much better than the industry expected during this exceptional decade of economic growth. However, the industry has been preoccupied with building houses and raising prices to cover cost increases at the expense of focusing on improving business processes to increase profitability. With business conditions now taking a turn for the worse, there is little room in industry margins to maintain current levels of profitability, making now a good time to take action in areas where you can improve productivity and profitability.
The housing industry as a whole has always left a great deal of money on the table because of the way it prices its products. Thousands of housing producers exist, and the products they produce vary in design, size, and specifications, which makes it appear that no general price matrixes apply. If the home building industry is ever going to get adequate returns, industry participants must develop a general pricing philosophy as a basis to improve the quality of profits. A good place to start is to study the first number that shows up on your income statement: revenue/pricing.
Reviewing the conventions you follow for pricing homes will give you an opportunity to methodically reevaluate significant pricing choices. To capture the upside in pricing new homes, work to break the pricing review into the segments that make up the housing product.
Price your product to market. Establishing what the market will bear at a particular time is not an easy task. It is essential to take the time to price your product to market, not to average markups, if margins are to be improved. If all your homes have the same margin, it's a dead giveaway that you are not pricing to market.
Review lot pricing. Is there anything special about the lot on which you are building? Does it have trees? Can it be used to produce a walk-out basement? Often the best lots in a subdivision sell first because they are improperly priced. Remember that it's easy to give up the premiums if a lot doesn't sell, but you can't recapture the premium once the lot is under contract.
Review sales price. Price increases should be done in percentages, not dollars. When the average new home went for $100,000 in the early 1990s, a $1,000 to $3,000 price increase was good. But today, with the average price of a home having increased to more than $225,000, raising home prices in $1,000 increments represents a smaller percentage price increase, and thus fewer dollars in builders' pockets. Historically, a 1 percent price increase is required every quarter just to keep up with increased building costs.
Review individual gross margins of home plans. Compare actual gross margins of the plans you are offering. Home plans in the same series should generally have the same approximate gross margins, with the smaller homes having slightly lower gross margins than the larger homes. If not, investigate. Check the frequency of plans sold. The best plans should have average- to above-average margins. Your customers are telling you that they like something about these plans, and they are willing to pay more for these homes.
Evaluate pricing on elevations. Home buyers expect different elevations to have different prices. Price your elevations to market, not to margins. If you are charging the same price for all your elevations, even if your cost is the same, you are missing a pricing opportunity.
Know your customers. Build homes for your customer, not for you or your architect. Review whether there is a reasonable relationship between standard features in the home you are selling and the price point at which it is being sold. There is a big difference between what buyers would like and what they are willing to pay for. This point has nothing to do with quality. It has everything to do with specifications. Architects like to fill up kitchen walls with cabinets. If the smallest home has more kitchen wall space than the larger homes in a series, odds are that the smaller home will have more cabinets than larger unless you address the issue.
Review pricing for options. Your structural options margins should be significantly higher than the base margin for the house. The base margin of the house includes a lot, which, most likely, the builder has bought at market price. Therefore, the actual markup for the labor and material included in the base house package is approximately 25 percent higher than the average base margin for the house and lot. Accordingly, structural option pricing must command at least this differential, but preferably a great deal more.
The hundreds of dollars picked up in base pricing, lot premiums, elevation charges, specification reductions, and increased prices for options can quickly add up to a meaningful margin improvement. As a bonus, taking these steps will help you be more competitive in a slowing housing market without losing money or producing less-desirable houses.
Isaac Heimbinder, former co-CEO of U.S. Home, is a housing industry consultant based in Houston.