Amid a softened housing market, builders must grasp their fixed expenses
Builders must avail themselves of rise-and-fall clauses if they intend to stay alive, a housing industry veteran said.
Mortgage Professional America recently interviewed Russ Stephens, co-founder of the Association of Professional Builders (APB) about the five key warning signs indicating a residential building company is headed to financial trouble. As head of a trade association for custom home builders in the US, Australia, New Zealand and Canada, Stephens has a unique perch from which to gauge the health of various countries’ housing industries.
Down under, for example, builders do not have the luxury of rise-and-fall clauses that US builders sometimes employ to temper rising building costs. The arrangement allows the cost differential to be shared with a client rather than a builder absorbing the entire cost.
“In Australia, we don’t have rise-and-fall clauses, so the situation has been even more extreme,” Stephens said. “In the US, where they do have rise-and-fall clauses, we’ve started to see a lot of builders struggle to implement those additional charges to the consumer, so it has affected them as well.”
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Stephens told MPA that at least 50% of US builders have lost money in the last 12 months, partially due to an aversion toward passing extra costs to the client. Rather than pass on higher costs to consumers, Stephens said, builders oftentimes will simply bear the brunt of increases.
But this is a slippery slope as the practice begins to erode on homebuilders’ equity: “This is where it gets really serious,” Stephens said. “When you lose money – all the equity and reserves that have been built up in the last few years – we’ve seen a lot of companies wipe those out just in the last 12 months alone which now puts them a bit of a knife’s edge [as] they’ve got to replenish those reserves.”
Simply being mindful of past mistakes and vowing not to repeat them may prevent many builders from losing money, Stephens said. “But we’re still seeing way too many building companies not react and still continue to lose money. Not all of them – mainly it’s been the large building companies and then it’s been the smaller building companies that simply don’t know their numbers.
“The guys that are not all across their KPIs [key performance indicators] are simply doing the work – they’re flat out, they’re not taking holidays and they’re working long hours. If they’d just take a step back and looked at the seriousness of the situation and realized they have to change direction, they’d be in a much better position.”
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What advice does Stephens have for builders intent on not losing money? “It does come back to the basics, really,” he said “You’ve got to trim your fixed expenses down to the bare minimum. You’ve got to look at every contract you’re signing to make sure the margins are correct. This is where most builders go wrong – at this stage they’re now chasing cash because they see their cash reserves are getting kind of borderline and they feel they’re in a situation where they need to feed the machine.”
Consumer attitudes also play a role in exacerbating builders’ woes: “Because the market is softening, consumers are now having second thoughts about proceeding with a contract or they’re playing one builder against another because they’ve got two desperate builders and builders will compete against each other on price and what that does is just make the situation even worse.
“Although it might appear they’re making a small profit on a contract, what most builders don’t realize is how much they’re fixed expenses are. In real terms, they’re losing money. What they do is compound the situation by chasing revenue.”
As far as fixed expenses that could be trimmed, he suggested wages – not for carpenters, but administrative – and building company owners’ salaries.
The Association of Professional Builders is a leading business coaching service for custom home builders in the United States of America, Australia, New Zealand, and Canada. It provides tested and proven systems for builders to scale and succeed, based on data, experience and results.