This is an interesting topic and one that I have some passing familiarity with.
As far as I can tell, the big builders actually have three profit centers in their process: when they convert the raw land into finished subdivision lots, after they build the basic home itself, and with the upgrades/options package.
Let’s say a builder buys a 50-acre parcel of raw land in San Diego County and the site is zoned for 7 units per acre. Let’s also assume the site is generally level, has sufficient access to public utilities, has sufficient paved access, doesn’t require a traffic signal installation. Depending on which of the city or county planning groups has jurisdiction over it, it could cost between $60,000 – $85,000 per lot to subdivide and “finish” the lots to make them ready for building.
After that is the construction of the basic house itself. Based on national averages, it costs 18% more in hard costs to build here in SD County.
Now the basic house in most of these subdivisions feature a basic level of finish on items like flooring, kitchen cabinetry, fixtures and appliances, and trim items. However, in its heyday, I never actually saw one of these basic bare bones homes. The builders would charge for each and every upgrade, and in the subdivisions in northen San Diego county the lowest upgrades/optios package I ever saw in one of those homes was $30,000.
So as an example, lets take a typical subdivision home that Lennar built in Bressi ranch here in Carlsbad. I know a lot about this subdivision because I reviewed a lot of the appraisals that were used by the buyers there.
When they started out, Lennar (reportedly) bought the raw land for ~$60,000/unit, and they would have spent $75,000/unit to finish the lots. That would have put them into the project at $135k/lot. BTW, on that scale (600+ units), the $75,000 would include adding the traffic signals and common area elements such as clubhouse and pool.
Then they built the homes. Typical homes on the low end were 2200 – 2700 SqFt and of very average construction. The national averages for hard costs for such a home in early 2005 were about $78/SqFt or so, but California costs were about $95. Add in another $15/SqFt for the increased fees/permits and we’re at $110/SqFt. so for a basic 2,200 SqFt house we’re at $242,000. Add in the 2-car garages @ ~$13,200 + $10,000 in wood fencing, concrete driveways/walks, porch and mini-slab patio and the construction costs with permits and fees was about $265,000 for the “basic” home at Bressi.
Add the $135k for the site + the $262k for the home and the “costs” came out to ~$400,000 or so. If we added in a 15% profit margin this basic home could sell at $450,000 and still net a “reasonable” profit.
And guess what? In 2002 you could have bought a new house of about that size and basic quality in Carlsbad at the retail price for between $400k – $450k.
Anyways, after the basic house is up there are the finishes. As I said, it was theoretically possible to buy a basic house, and it wouldn’t have been “stripped” by 1990s standards; but this was the New Millenium and developers were really into high end cosmetics ’cause the retail markups are massive. So a buyer could substitute the $30/yard flooring for $60/yd flooring and it would only cost them an extra $120/yd. Such a deal, right? Now bear in mind we aren’t taking about the builder re-doing the existing flooring and tossing it, we’re talking about substituting one for the other. They did the same thing with all the cabinets, fixtures, appliances, etc.
As I say, the lowest “upgrades” package I ever saw during that time period was for $30,000, and I saw some of those packages hit $75,000 and up in some of these “low end” homes.
Anyways, if we add everything up, we’re at $480,000. As I say, a coup[le years earlier you could buy this house – with these upgrades- in this zip for about the $450,000, so a $480k price would have made some sense if you think materials costs were really going up that fast.
So do you think any of these Bressi homes sold in the $500k range? No way. Because the market conditions had continued to improve, these homes were selling in the $700k ranges, and I don’t mean $701,000, either.
So yeah, at a $60k/unit raw land cost and after figuring in all the profit markups at each stage of development, including the materials and other hard costs, a developer might be able to “show” that their markup was only about 15%, but it was really far higher than that.
BTW, if the margins on the $750k home that was 2,200 SqFt were that high, the margins on the $1,350,000 home (@ 4,500 SqFt) that went on those same sized lots in Bressi in 2006 were much higher than that.
The site costs on the $1,350,000 home were only slightly higher, and that was only because instead of 7 units/acre they were doing 6 units/acre. It was the same infrastructure and fees, subdivision costs, etc. At most, you could call it $150k per lot in costs for the best lots in the Lennar projects.
Anyways, the site costs for the top-of-the-line home at Bressi were only slightly higher than their bottom end homes. The larger homes were double the size, but the expensive parts of the home (kitchen, primary baths, foundation, roof, permits, etc) were more or less the same. Except for adding a couple extra bathrooms, the majority of the difference between a 2,200 SqFt 3/2.5 home and a 4,500 SqFt 5/4 home is the lower cost “living areas”, meaning living rooms, family rooms and bedrooms. Compared to the core of the house – the kitchen and baths, these other areas are a lot cheaper to build. Plus, you get that different economy of scale. So instead of a $110/SqFt for the entire structure, the additional “living area” construction might only add $75/SqFt – if that, to the core costs that would have already been there. That means that in addition to the $262,000 for the 2,200 SqFt size, the 2,200 SqFt of extra “living area” that made up the larger home would have only added another $165,000, meaning the bones of the biggest homes at Bressi – before finishes – only cost about $400k to build.
The basic construction quality – foundation, framing, stucco, insulation, roofing, windows/doors, etc. are the same all through Bressi, regardless of what any realtor chick tells you. The only difference in quality is in the finishes.
Granted, the finishes were much better – $60/yd flooring vs $30/yd flooring in the lower end homes, wood moldings, good stock cabinetry, nicer counters, etc. But by the time Lennar got done with these buyers, they were spending between $75k – $150k in extras on the interior of the home, and that doesn’t even include any patios, landscaping or outside kitchens that some of these fools bought.
So in total, at the peak of the market, Lennar’s costs w/ the legitimate 15% profit for land ($150k), basic 4,500 SqFt home ($400k) plus upgraded finishes ($50k) brings up all the way up to $600k, plus the profit of $100k, and Lennar would have done okay selling these homes at $700,000. Please note that to be the retail price w/profit.
My point in all this is that at Bressi, Lennar could have sold their homes between $500k – $750k and still made a reasonable profit. In 2002 when they were buying the land there’s no way they could have possibly known the market increases would have continued, so I doubt they planned for those prices to turn out that way. They just got lucky with the extended bull run.
So when builders complain they can’t get by if they have to take 30% off peak pricing of homes I just laugh. I know what those exact same houses were selling for 50 miles away in French Valley ($500k – $700k) during the same time period, and I know that even if you tell me they got the Riverside land for free it could only justify – at most – a $75,000 spread between these two areas on a cost basis. They’re both located in the same economic zone, materials and labor cost were exactly the same, and the fees are only a touch lower in Riverside County than they are in San Diego County.
So I’ll worry about local builders working at a break even when 2,200 SqFt new construction in Carlsbad drops below $400,000. Until then, everyone in the chain is just going to have to revert to more reasonable profit margins.
