Builders got a better handle on their operating expenses in 2010, as they scaled their businesses in line with current modest business conditions. That allowed more builders to be profitable last year, despite gross margins that have been declining since 2006.
Those were some of the key findings from The Shinn Group’s 18th annual Financial & Operations Study, which is based on responses from the Littleton, Colo.–based group’s builder clientele. (About 50 of Shinn’s 500-plus clients participated in its most recent study. Their profiles range from building a few houses a year to 750 units, priced from $150,000 to more than $2 million.)
Chuck Shinn, the group’s founder, who presented the results of the study last week, pointed out that while gross margin is builders’ “first line of defense” to protect net profit, it doesn’t always guarantee net growth if operating expenses are rising. And that’s exactly the scenario that undid many builders during the recession. Between 2006 and 2010, the gross margins of builders participating in the study went from 29.7% to 23.5%, while these builders’ operating expenses increased from 18.5% to 20.0% in the corresponding years.
“You’ve got to control costs to what the market is willing to pay,” said Shinn, especially at a time when the average sales volume for the builders in the study dropped by 46% from 2006 to 2010. And as costs kept soaring, these builders’ net profit predictably plummeted from 11.16% of revenue in 2006 to only 3.73% last year.
The good news is that these builders appear to have reined in their spending, and their net profit from their homebuilding operations in 2010 was actually up significantly from the 1.16% they reported aggregately in 2009. Shinn noted that two-thirds of the builders in the study were profitable last year and half had lowered their operating expenses to under 18.5% of sales.
Other highlights from the study included
•A noteworthy improvement in builders’ construction management. Their pre-construction cycle times fell to an average of 41 days in 2010, from 60 in 2006. And the days it took builders to complete a house shrank as well:
For builders of homes: 2006 2010
under 1,800 square feet 124 days 94 days
1,800–2,500 square feet 132 days 102 days
under 4,000 square feet 233 days 174 days
6,000-plus square feet 308 days 246 days
Shinn noted, too, that the number of homes delivered that were supervised by a superintendent returned to pre-recession levels in 2010.
•Only 37% of builders who responded to the study were supervising their warranty programs, compared to 64% in 2006. The portion of superintendents who supervised warranty work rose to 33% in 2010, from 18% four years earlier. Shinn thinks that builders will need to take more control of their warranty processes when business comes back again to avoid construction defects.
•The conversion rates for the study’s respondents stood at 12% in 2010, versus 6% in 2006. To get those sales, builders reported that their concessions off of their selling prices ranged from 1% to 11%, averaging 4% last year.
•Of the builders in the study, 93% said they offer their buyers custom options, compared to 76% in 2006. Among these builders 60% allow for customization even after construction starts, where only 46% did four years ago. Shinn is not a big fan of this trend, which he believes negatively impacts cycle time, construction quality, and communications with buyers. He’s convinced that post-start options will “disappear” when market conditions improve.
•As has been the case for the past several years, about two-thirds of the builders surveyed have design centers. However, the management of those centers is now evenly split between the builders’ sales and purchasing departments.
•Last year, the builders’ cancellation rates ran at 13% of contracts written. Nearly three fifths of those cancellations were due to the inability of the buyer to get financing, and 29% because of “contingencies,” such as not being able to sell their existing homes. Shinn noted, though, that there was evidence last year that lending was loosening up a bit for mortgages and construction financing.
•Lastly, builders are steadily embracing technology to run their businesses. The study found “big jumps,” said Shinn, in the percentages of builders whose supers use computers (93%), receive service requests via their websites (58%), and use their websites for customer selection (19%). Nearly half of the builders said they use vendor portals to share information and documentation with their trades and suppliers. Shinn predicted that would eventually shoot up to between 80% and 85%.
John Caulfield is senior editor for Builder magazine.