By David F. Seiders Last year was a dreadful year for the U.S. stock market and corporate earnings. However, earnings and stock valuations for publicly traded home builders performed quite well, reflecting some gains in market share as well as growth in net profit per house. Many smaller builders also posted increases in profit margins despite the recession.

Profit patterns

In January, the NAHB conducted a survey of about 400 single-family home builders to find out how profit margins (per house) had changed from 2000 to 2001. Nearly half said their margins had increased while one-third reported some erosions (only 5 percent characterized this erosion as "significant"). Nearly two-thirds of the large companies (producing at least 100 units per year) reported higher profit margins and only 1 percent talked about significant erosion.

At the other end of the size spectrum, 30 percent of small builders (producing less than 25 units per year) said their profit margins had increased in 2001, 30 percent reported no change, and 40 percent experienced some deterioration (8 percent "significantly"). While this latter pattern may not look impressive, it's worth remembering that, overall, profits in the business community were under strong downward pressure in 2001.

Profit drivers

More than three-fourths of builders reporting higher profit margins in 2001 cited higher home prices as a key reason, and 85 percent of the large companies cited this factor. Indeed, house prices increased smartly in most parts of the country during both 2000 and 2001, while inflation in prices of goods and services was held to a bare minimum in other sectors of the U.S. economy. Lower costs of construction financing were cited by 36 percent of builders with improved profitability in 2001, reflecting aggressive monetary ease by the Federal Reserve throughout the year. Lower costs of building materials were noted by 28 percent of the companies, largely reflecting price declines for wallboard and framing lumber.

As in past NAHB surveys, many home builders with improved profitability in 2001 cited things they had done, including advances in efficiency, design, quality, and location. Indeed, one-fourth of the more profitable companies said they had been able to lower their overhead and reduce cycle time.

Builders reporting falling profit margins in 2001 often cited problems associated with stringent land-use issues in their market areas, including delays in the development approval and permitting processes as well as hefty impact fees or development exactions. Furthermore, nearly one-third of the builders with eroding profitability were located in places where home prices had slipped to some degree. Many in this group also said that their profit per house had been held down by sales concession they had made to buyers.

Looking ahead

Profitability in home building should remain quite good in 2002, at least in areas that are not beset by local land-use policies designed to thwart home building. House prices should continue to rise in most places, the cost of construction financing should remain historically low, and upward pressures on the costs of labor and materials should not be great as the U.S. economy works its way out of recession. As usual, market research, planning, and execution will be critical to builders' bottom lines.