The Truth About Why Prices Are Different Between Homebuilders

In the early stages of your homebuilding journey, you might wonder why prices are different between home builders. Wouldn’t it be nice if the cost to design and build a home was the same price with every builder? You could contact the builder you like best and move forward with the project.

The truth is, home building business is both a service and a product business. With custom or semi-custom homes, service becomes even more important to a home buyer. Each company has a different business model for how they provide their products and services.

There are 4 main factors that affect the price of a home. These factors contribute to why prices are different between home builders.

1. Profits
2. Services provided to you in the design, build, and warranty phases
3. Cost of overhead expenses to operate the company
4. The cost to construct the home

As a buyer, you DON’T want to select a builder that has the lowest costs in all 4 areas. This can be a recipe for disaster as you risk settling for less. You want to find a builder that has the right mix for what is important to you. We’ve put together some additional tips on how to choose a home builder in this article.

The image below shows a visual representation of what makes up the cost of a home. Note, services are technically part of overhead expenses. We have combined the two together in this image.

1. PROFITS

Let’s start with the “taboo” subject of profits. Profits are one reason prices differ between home builders. Many people have a negative reaction when they hear the word ‘profit’.

However, you want your builder to be making fair and reasonable profits.

Here are a few reasons:

• It ensures the company will be around long term to provide you with warranty and service on your home.
• A builder making reasonable profits can employ high-quality staff to handle your project.
• Fair profit gives the builder leeway to absorb some extra costs during the build if needed. If a builder is making razor thin profits, they will likely make you incur extra costs instead.
• If a builder budgets for minimal profits, they may be cutting corners everywhere to save money.

With all of these benefits of fair profits, you may be wondering why a builder might choose to factor in low profit levels. Here are some reasons:

• They don’t know any better: The unfortunate reality is that some builders aren’t educated or sophisticated on the financial side of the business. They know how to construct a home but they don’t understand the true costs of their business. Cash flow will often be a struggle for these builders and they likely won’t survive in the long term.
• Race to the bottom: Some builders feel the only reason someone would choose to work with them is if they have the lowest price. In some cases, they don’t offer much value in terms of service, quality, etc. Therefore, they cut their profits to be the lowest price option.
• Hard times: When a building company has fallen on hard times, desperation can set in. They might need to get that “next job” at all costs.

Generally, most successful building companies should have profit levels within a few % points of each other. However, the tricky part is that a builder likely won’t divulge their profit levels to you. There will be red flags that indicate if it is a professional operation or a questionably run business. If it sounds too good to be true, it might be.

2. SERVICES

The services offered are another reason why prices are different between home builders. Technically, services are a part of overhead expenses. They warrant their own section as they play a significant role in the design, construction, and warranty of a new home. Services provided in a new home building project have hard costs. These costs must be factored into what builders charge.

Design services: When you are involved in designing and building a home with a builder, there SHOULD BE design services provided! This involves design staff leading and assisting you throughout the project. If a builder expects you to figure out design details yourself or with trades/supplies only, you should be looking for a deep discount in the price of the build. Be ready for lots of work. Some of the additional costs that come along with design services include:

• Software for creating house plans
• 3D renderings to help you visualize the final product

Warranty services: Builders budget for warranty differently. Poor builders won’t budget for this at all. Some builders budget for repairs up to the warranty program deadline. Other builders budget for repairs for the long term – when it is justified.

Energy efficiency services: In some cases, this service is free and may be provided in-house based on the builder’s knowledge. Other times, there may be specialized services such as 3^rd party energy modelling/design or mechanical (heating/cooling) system design.

Determining what is important to you throughout the process is done by balancing your wants and needs in your new home – from the type of builder you choose, the services offered, location, and design. If services are important to you as part of the package, ensure your builder provides them. You’ll need to be prepared for these builders’ prices to be higher than builders that don’t provide them.

3. OVERHEADS

Overheads are another factor that contributes to why prices differ between home builders. There are the expenses required to run a business. However, they are not directly attributed to the construction costs of the home. Examples would be employee salaries/benefits, office costs, insurance, vehicles, equipment, marketing, loans, etc. It goes without saying that:

Large businesses = large overhead costs
Small businesses = small overhead costs

Large overheads aren’t necessarily a bad thing. It depends how they relate to the company’s revenue. Here are some examples:

Example 1

Company A: $10,000,000 Revenue with $1,000,000 Overheads = 10% Overheads

Company B: $1,000,000 Revenue with $150,000 Overheads = 15% Overheads

• In this example, the Company B would need to charge 5% more on homes to cover their extra overheads in order to make the same net profit as Company A.

Example 2

Company C: $5,000,000 Revenue with $1,000,000 Overheads = 20% Overheads

Company D: $5,000,000 Revenue with $500,000 Overheads = 10% Overheads

• In this example, the Company C would need to charge 10% more on homes to cover their extra overheads in order to make the same net profit as Company D.

As a buyer, you can watch for warning signs of a major unbalance of overheads relative to the revenue of the company. For example, if a company seems to have too many staff members for the number of homes they build, it may indicate they are running with high overheads. On the other hand, really low overheads isn’t a great sign either. Furthermore, a two-person operation building 10 custom homes a year would indicate they are severely overworked or don’t provide great service.

4. CONSTRUCTION COSTS

Large Builders

If a large builder and a small builder built the same home with the same materials, the larger builder should be able to build the house at a lower cost. This is because they have more “buying power”. They are able to get materials and labour at a lower cost.

Wouldn’t it be nice if we ended this section with that simple analysis? Unfortunately, it’s not that simple though.

Why do big builders have this buying power? It’s because they build a LOT of houses. They need to continue to build a high volume of houses to maintain buying power and to cover their larger overheads.

Large builders need to build a lot of houses, so they typically move away from custom builds. It slows them down. That’s why there is no such thing as a fully custom builder in Saskatoon that builds in excess of 50+ houses per year.

Small to Medium Sized Builders

There may be some variance in buying power between small and medium size builders. However, it likely isn’t a large factor in the overall house price.

The construction cost difference for builders in these categories comes down to their business models. If we had to generalize business models into only 2 categories, this is how we would do it:

1. Low cost builders: The builder wants to provide lowest cost homes so they have the widest range of potential buyers that can afford to buy their homes.

2. High quality builders: The builder wants to provide homes with the highest quality and/or best designs and realizes they serve a limited market.

While there are builders in between two ends of the spectrum, it’s not that black and white. However, looking at 2 categories of builders helps us understand how they make financial decisions about the home construction.

Let’s look at the some of the key business model differences between low-cost builders and high-quality builders:

1. Low Cost Builders

• Hiring trades/suppliers:
  • Obtain quotes from many companies in order to find the lowest option for the specific build
  • Grind the trades/suppliers down on price

• Buying materials:
  • Look everywhere for sales/clearance items
  • Build to minimum building code
  • Use the lowest cost options whenever possible

• Providing services:
  • Provide the bare minimum of services as they cost more money

• Approach to profits:
  • Often willing to cut profits to be the lowest cost option

2. High Quality Builders

• Hiring trades/suppliers:
  • Typically work with the same companies so that the end result is predictable and high quality
  • Price check trades/suppliers to keep their pricing fair and occasionally try a new company

• Buying materials:
  • Quality and durability prevails over low cost
  • Upgrade items “behind the walls” as they feel it’s the right thing to do
  • Look for ways to increase comfort and energy efficiency

• Providing services:
  • Provide an array of services that their target market values

• Approach to profits:
  • Maintain profit margins so they can continue to provide services for the long term

SUMMARY

As you have seen, setting the price of a home build is a complex process as it involves a lot more than just figuring out the hard costs of construction. Here are some additional tips for you:

• Chose a builder that has the right mix of offerings that are important to you. Some examples might be lowest price, design services, long term warranty, high quality, great designs, energy efficiency, etc. Furthermore, you’ll want to be aware that the pricing of the home will differ based on which features are included in the project.

• Professional builders that offer a similar set of services are typically in the same price range. Their construction costs, overheads, services, and profits would be in a similar price range. When reviewing quotes, ensure each builder is quoting on the same level of finishes for your home. Prices will differ if one builder is giving you a $30K cabinet package and another is providing a $60K cabinet package. Compare apples to apples!

CAUTIONS

Some things to be aware of when you are looking at pricing from new home builders:

1. High quality and lowest price is a myth. You get what you pay for.
2. Too good to be true. If a price seems too good to be true, it probably is. If a price is really low, one of the input costs is really low, too.
3. Increasing profits during the project. Some builders entice clients with a lower price up front. This may indicate that their business model is to increase their profits via upgrades and changes orders requested by the client during the project.
4. Ensure taxes are included in pricing.
5. Look for detailed specifications. If you don’t get detailed specifications of what is included in your pricing, then it’s easier for a builder to say, “that’s not included” and will be an extra cost.

The more information you have, the better equipped you will be to make big decisions throughout your homebuilding journey. We hope that this has provided you with some valuable insights when it comes to why prices are different between home builders.