Home Builder Profitability Reached Highest Level on Record

Last year’s net profit average for builders reached the highest level since management consulting firm The Shinn Group began tracking net income data in 1994. The previous record was set in 2006, but 2020’s net profit average of 11.4% beat out 2006’s levels by just 0.25% and exceeded 2019 income by 1.8%. Further breaking down the gross profit, net profit, and operating expenses between the record years of 2020 and 2006, 2020’s operating expenses were lower than 2006 levels, net profit was higher, and gross profit was also lower, reports The Shinn Group. 

In 2006, the industry performed at a gross profit of 29.7 percent and operating expenses of 18.5 percent for a net profit of 11.2 percent.  In 2020, the gross profit percent was 25.9 with operating expenses at 14.5 for a net profit of 11.4 percent.  

Under most economic conditions, the profit ratio in 2006 is more sustainable since gross profit is less susceptible to small variations in volume.  Operating expenses are very susceptible to volume changes as they are mostly fixed in nature and changes in volume will not necessarily decrease or increase the dollar amount, but will affect the performance ratio.  Obviously, after 2006, we had a total collapse of the industry, creating price discounting to sustain volume at the expense of decreases in gross profit.  During 2020, we saw an increase in sales volume extending into 2021, together with large increases in materials and labor cost, thus requiring a balancing act between increasing the sales price of the homes and cost containment.  Present conditions have created a volatile market requiring fast reactions to be able to maintain the desirable level of profits.

The two components essential to achieving good profitability are the cost of the product, including the lot (cost of sales) and the cost of running and managing the company (operating expenses).  To maximize the return on the product, you need to start with good market research, land position, design, specifications, and negotiations (to name a few), with the objective of maximizing value and minimizing cost.  The second component is the management of resources to achieve efficiencies and effectiveness through systems, processes and procedures.

Read More