At the end of the day, one of the most important considerations you and contractors have to make when getting a new construction home built is that of the costs associated with it. You are looking to reduce the costs while constructors are looking to maximize their profits.
Whether you’re wondering how much room you have for negotiation or wondering how much you can earn if you become a contractor, it is important to know how much profit a builder makes on a new construction home.
The average profit on new construction homes varies every year. For example, the gross profit margin for custom home builders in 2018 was 19% to 20%, which rose to 21% to 23% in 2019. Because of the slow economy in 2020, this range dropped to 15%-18% during the year. 2021 started with a bang though as more and more people sought to get a home built, bringing the average back to 21%-23%. The net profit for contractors amounts to roughly 6-9%.
Cost of New Construction Homes & Profit Margins for Builders
Depending on the size and material used, it is common knowledge that the cost of your new construction home will vary. Usually, single family houses cost somewhere between $165,000 to millions of dollars. On average, builders earn $20,000 gross profit per house after all direct and indirect costs are deducted.
The costs involved include, but aren’t limited to:
- General overheads
- Subcontractors and more
At this point, it is important to mention that the profit margin for general contractors and subcontractors are almost similar, which is why there is usually just one contracting party involved in new construction homes and other small-scale projects.
Contractors usually earn a weekly income from the trade they perform, but for this they need to get payment from you as a draw down. If you have made a lump sum payment and will pay the rest after completion, contractors draw down the amount from banks, basically living on construction loans until you make the final payment. Any interest that comes along with this loan is also transferred to you.
It is very rare to see contractors with enough free cash (in hand) to fund the construction project and cover their living expenses as well. This usually happens if the contractor is a friend or you trust them enough to pay the full amount before completion.
If you fail to make the final payment, it is well within the contractors’ rights to sell the home to recover any costs they incurred.
A survey from NAHB suggested that in 2014, the builders’ averaged around $16.2 million in revenue for the year. $13.2 million from that revenue was spent on land, water, and construction costs, while the remaining (18.9%) $3.1 million was their gross profit margin. After paying all taxes, compensation costs, marketing, finances, and other ventures, they were left with $1 million per annum (6.4%) as their net profit.
Of course, the 6.4% represented a relatively slower construction market than the one we are seeing in 2021 and beyond. Now, the cost of new construction homes is higher with a net profit margin of 6% to 9%, which ultimately means more take-home money. These are the highest earnings ratio builders have had the luxury to enjoy since 2006.
Let’s do some math:
On average, a three bedroom new construction home (roughly a 2,800 sq. foot single family house) costs $498,700. This means a gross profit of $94,254 per house, netting $44,883 per house or $16 per square foot. These figures represent the profit margin on an average quality new construction home. Of course, for luxury houses, the initial costs increase and so does the profit earned. The margin remains the same, though.
Another very important factor that determines profitability for contractors is the proximity of the construction site to their office, material depots, labor houses, and more. Proximity has a direct bearing on transportation costs, which in turn, impact fixed costs, which in turn, impact profitability.
How the Cost of New Home Construction Is Determined by Contractors
If you push a contractor too much to learn about their profit margins, you will eventually find that they will actually be willing to let the contract slide if clients persist too much. Their point is, ”why does it matter what our profit margins are?” because in their opinion, clients should only negotiate for the cost of material.
This moves to show just how protective contactors are of their profit margins. If you were planning on using this information to get an edge over a contractor in terms of negotiation, keep this factor in mind as well.
A contractor friend of ours seconded this opinion. When asked the same question, he replied with another question; “would you care if airliners made $2 profit on a $100 ticket or $50? You should focus on the quality of service, not the profit margin. If you really want to negotiate, you should be willing to move from first-class to economy.”
When determining the cost of material that is going to be used, contractors always ‘pad’ their estimates. This is because of the constantly fluctuating raw material market. Contractors always maintain a 5%-7% margin when giving estimates, keeping inflation in mind.
Rise in raw material prices would be catered to by the margin they provided. However, if the prices go down, the amount homeowners will have to pay will still remain the same, effectively increasing their profit margins. The ‘padding’ helps them give relatively reliable estimates by accounting for uncertainty while guaranteeing a profit.
Some owners usually go with another option which is ultimately more cost-effective for them but reduces the contractor’s printability. This is when owners procure the material themselves. There is a lot of hassle involved in the process, which is basically what you would have been paying the contractor for if you let them procure the material.
When the cost of new construction houses is being determined, the first thing constructors will look to are the floor plans. Owners are at an advantage here if they find a floor plan that has already been implemented since it doesn’t give contractors as much wriggle room as a completely custom plan would. You, as the owner, will have a rough estimate on how much it costs. Based on the variations you make, your price may increase or decrease.
Next up is the material cost. Remember, if you give a contractor the chance to rip you off, they will do so without hesitation in most cases. This is where your DIY mindset will come into play. Since you don’t mind getting your hands dirty, survey the market a bit. Make some phone calls and ask for estimates before finalizing the costs. Compare the quotes you get from the quote your contractor gave you.
Next, based on the quotes you receive and the labor cost other contractors are giving you; determine the cost per square foot. Calculate how much material will be used and the cost that should be incurred. At this point, you don’t have “padding” or the contractor’s profit margin (basically what you pay them for their help). If your estimate stands at $400,000, add 6-9% net profit along with at least 5% padding. This should give you a pretty good idea on how much the new construction house will cost.
The extra you’ll be adding will also be the profit a builder makes on your new construction home. Think of this profit as a charge for their services along with the risk they are taking – the loan we mentioned above.
Well known contractors can maintain a much higher gross profit, ranging from 35% to 54%.