A plot line shows the difference between Census Bureau data on home sizes vs. NAHB survey respondents.
A plot line shows the difference between Census Bureau data on home sizes vs. NAHB survey respondents.

The most magical words in residential new development and construction? The right price in the right location.

"Right," meaning, priced both to move into a satisfied home buyer's possession and to profit the builder and his many partners. What's less apparent--and for most home builders as critically important--is that the meaning of the term "right" includes both a cost and value of time. The ability to get all of those meanings and measures of the word "right" to come together in one place, structure, and moment is the dark magic of home building right now, and pricing is one of every home building organization's biggest challenge for the coming year.

Let's explore this, first by looking at the latest batch of data from a bi-annual well of research from the National Association of Home Builders.

It cost $103 per square foot--all-in in expenses and gross profit--to build the average home in 2015, a jump of 8.4% since 2013, and almost a 30% increase from four years ago. This is according to the just-released NAHB Cost of Construction Survey, which shows that the average home was built on 20,129 square feet (about a half an acre) of land, had 2,802 square feet of finished space, and sold for an average of $468,318.

A partial view of the NAHB Cost of Constructing a Home chart.
A partial view of the NAHB Cost of Constructing a Home chart.

First of all, what more glaring evidence of a "mix" tilt toward higher-priced, first move-up and second-time move up homes do we need, where all-in the cost, including profit, to complete and deliver an average home this year is 17% more than the $399K all-in cost in 2013, and a stunning 50% increase since 2011? This data, directionally, matches that of another source on new home price trends:

According to the Census Bureau’s data on new residential construction, the sales price of new single-family homes has been steadily rising from $267,900 in 2011, to $345,800 in 2014.

NAHB Construction Cost Surveys 1998-2015
NAHB Construction Cost Surveys 1998-2015

This bias, and imbalance, won't hold. If the recovery proceeds as it needs to going into the next 12 to 18 months, the 2017 Cost of Construction Survey should reflect an actual decrease in the cost (including builder's profit) of delivering a new home, as the sale of homes to entry-level buyers at a lower price-tag tier kicks up to account for a greater share of the volume. But it's going to be a struggle.

That's partly because of the cost pressure on both materials and labor.

According to the NAHB's HMI survey from June and July of this year, builders report that on average, over the previous year, labor costs increased by 3.3%, material costs by 4.5%, and subcontractor costs by 5.0%.

What these numbers bake in that's hard to detect from the roll-up of direct and indirect expenses is the cost and the value of time. For two different companies, total construction costs in 2015 of $289,415 could tell massively different stories as to the viability of one company vs. another.

NAHB economics analyst Carmel Ford elaborates:

"Results ... show that 61.8 percent of the average home sale price consisted of construction costs, which is similar to the 2013 breakdown (61.7 percent). The finished lot cost was the second largest cost at 18.2 percent, and also similar to 2013 (18.6 percent). Average builder profit was 9.0 percent, compared to 9.3 percent in 2013. Overhead and general expenses in 2015 were slightly higher, at 5.6 percent of the average home sale price in comparison to 4.3 percent in 2013. The remainder of the average home sale price consisted of sales commission (3.2 percent), financing costs (1.3 percent), and marketing costs (0.8 percent). These percentages are similar to their 2013 breakdowns."

If you look at each line item on the NAHB chart, you might wonder of those "averages," is that the right price, or is it the wrong price? You might even look at the 9.0% profit line item, and fairly wonder, is that the right profit margin, or is it the wrong profit margin?

Why is it fair to ask whether a 9% profit on a unit of volume might be "wrong?"

In response, consider the cost and value of time. Time in the duration sense may mean that the duration of a task rules out doing other tasks, which has opportunity cost. It also may mean paying an expense for that duration at a rate that is efficient or not. Or, alternatively, it may mean that one builder's use of that duration is smarter and better in the value-of-time sense than another's.

We wrote yesterday about process because we're hearing that many home builders face a painful challenge to put better processes into play, particularly as regards the fragile moment of on-boarding some of the younger, recently hired associates into roles, focus, and responsibilities of productivity and purpose. And as is so often the case, it's true with this one that the moment one does finally recognize this need, it was actually a need 6 months or a year ago.

Our friend and associate Fletcher Groves notes his own deep and disciplined approach to designing a process map that's both real and effective. It starts with a candid and rigorous inventory of current workflow. Brutally, if you don't know or can't describe where you are now, it's going to be say where you want to go by designing a process map. Groves writes of the benefits:

"More work completed, at a lower cost, with fewer resources, with less waste, less redundancy, fewer errors, less rework, less paper, fewer approval levels, fewer decision-making layers, less frustration and cynicism.

You name it.

Process mapping involves far more than documenting the current workflow; it also includes redesigning workflows, which invariably reveals other issues. Because it is so foundational, it is impossible to overstate the importance of understanding and improving the way work is performed, before starting down the road on other improvement initiatives. "

Why are we so preoccupied with price and process right now? It comes back down to those magic words, the right price in the right location. We believe there are currently more home builders out there at the moment than there are units that will go for the "right price in the right location."

What that suggests is that builders who are better at process, and more nimble with price as a result, are going to have more opportunity to hit that jackpot of the right price in the right location. And builders who are not better ...