The cost of homes has climbed to new highs all over the country, and the average home price is now about 20% higher since last year. Building houses seems like a perfect way to make money, but that might not be true. So, how much money can you make building houses?
Building houses aren’t simple as it sounds. On average, builders usually make around 18 – 20 % gross profit per house. After deducting all the direct and indirect costs, the net profit is from 6 – 9%. Several factors such as location, duration, and proximity to resources could affect profitability.
Major expenses for builders include permits and regulations, construction materials, general overhead and taxes, and labor. Here, we discuss how much a builder can make on building houses and factors that affect profitability.
How Much Do Home Builders Make on a House
Homebuilding is a capital-intensive project, and the best way to determine how much home builders make on the house is to look at their annual profit. According to the National Association of Home Builders survey, builders had an average revenue of $16.2 million in 2014. Out of that amount, they spent $13.2 million on water, land, and construction costs. The remaining $3.1 million, 18.9%, was the gross profit margin. After removing taxes, marketing, financing, and compensation costs, what’s left is $1 million, which is 6.4% as the net profit. While 2014 is a much slower market than what we’re currently experiencing. However, the higher cost of houses means the profit margin has increased too, and the net profit now ranges from 6 to 9 %.
Factors that Affect Profitability
Several factors affect the profitability of a builder. They include
1. Location and Cost of Building
The average of building a house varies all over the country. This is evident in the variation in the cost of building a single-family home across regions. HomeAdvisor puts the national average at $283,900, while the US Census Bureau states that the average new home costs $496,900. The cost also varies according to region. In 2020, the US Bureau Census data put the average price of new single-family homes at
- $617,300 in the Northeast
- $343,800 in the South
- $472,700 in the West
- $346,900 in the Midwest
The cost of building a three-bedroom single-family home of about 2,800 square feet will be around $498,700. This puts the gross profit at $94,254 per house, but after removing all the extra costs, including taxes, the net profit is about $44,883 per house. The profit margins are usually the same, even for cheaper or more expensive homes. The average cost per square foot is $100 – $200.
The proximity of the construction site to raw materials and human resources could affect the cost of construction and profit margin as it’ll affect transportation. If the construction site is close to the material depot, office, and other places with resources, the cost of transportation will reduce, which means the fixed costs will reduce.
3. Time of Construction
The duration of construction will also affect profitability. The longer the construction takes, the more expensive it gets. This is why it’s easier for large-scale builders to make more profit since they use the most efficient practices to get the work done within the shortest period. However, the location could also influence the duration.
Costs Involved in Building a House
There are a lot of costs that go into home construction. The major expenses are:
1. Permits and Regulations
One of the significant construction costs is getting the necessary permits for the construction. Bureaucracy has made construction more costly than before; a 2021 NAHB study confirmed this. It established that in 2021, the cost of getting permits and meeting regulatory requirements would be about 23.8% of the final purchase price of a single-family home. This means that builders are spending significantly more to meet regulatory requirements and obtain the right permits. There are fees to be paid for developing the lot and more fees during the construction process. For example, multiple inspections will happen during the construction to ensure that the building is up to code, and each usually comes with fees.
2. General Overheads and Taxes
The builder also must include the general overhead costs of running the company during the construction process. These costs could increase in some cases during a particular construction due to the peculiar nature of the project. It’ll also include the cost of fees on insurance, financing, and more. This usually ranges between 2.5% to 5% of the cost of executing the whole project. There are also taxes that the builder will have to pay after construction on the sale of the property, which further reduces the gross profit.
3. Labor and Subcontractor
The cost of labor takes a large chunk of the overall construction cost. The builder usually works with several subcontractors who are professionals in various aspects of the construction. For example, roof installation alone will cost around $14,000 and could be a lot higher if the roof isn’t the traditional asphalt roof or you’re adding solar panels. Subcontractors such as architects, electricians, HVAC experts, and more are integral to construction.
4. Construction Materials
Due to several factors ranging from supply chain issues to inflation, the cost of building materials has reached new highs. This reflects how much builders have to spend to get the construction materials. The cost of land, which is the number one material for construction, is also there. The location and size usually determine this. It could range from a few thousand to hundreds of thousands. The finishes and fixtures on the house will also take a significant amount of the construction fee. Going for high-end options such as hardwood floors and granite countertops will generally cost more than the more basic options. Appliances and key house features are there to consider. The cost of materials for building and finishing the house usually accounts for the most cost in construction.
How to Negotiate with a Builder
If you’re trying to build a custom home, you’ll need a builder, which means negotiations are necessary. When negotiating, the primary thing to target is the cost of raw materials because this is where most builders usually exaggerate costs. The contractors usually exaggerate costs by 5 – 7% as the prices constantly fluctuate. This means that if the price of raw materials goes up, the margin will cover it. But if it goes down, the profit margin will reduce. This is why some owners instead opt to buy the materials themselves, effectively eliminating the profit margin.
Homebuilding isn’t as profitable as it sounds. It’s a capital-intensive project at the end of which a builder only makes about 6 -9% profit per house. But that’s significant when calculated on a large scale, with most builders constructing multiple houses per year.