For some custom home professionals, the skills needed to design and build their clients’ dream homes comes naturally. For others, it’s knowing how to make a profit that is programmed into their DNA. The key to success is the ability to master both skill sets at once.
It’s possible to be good at making profit while not knowing how to create high-quality homes, but even those who create the highest-quality homes will fail if they do not turn a profit. So how do successful, profitable custom home firms do it? Residential Design & Build talked to managers of a design firm and two custom builder businesses to find out.
A simple way to ensure profit is building it into a project’s budget, which is much easier said than done. But Chris Landis, owner/partner, Landis Construction in Washington, D.C., knows how to make it work. Landis’ contracts spell it all out for clients so everyone is on the same page.
“Clients understand they’re going to pay for my work,” Landis says. “We have it in the contract that as price goes up so does the design fee. I’m explicit about it. For example, as we go along, if suddenly the clients say they want a fireplace, or some other change or addition, this increases the project budget, the time it takes to design the changes as well as our fee and ultimately, the profit.”
Landis’ clients sign separate contracts for design and construction services. The design process is divided into three parts: schematic design, design development and construction documents. The design budget likewise is broken into three parts accounting for two-fifths, two-fifths and one-fifth respectively. Each portion comes with its own budget of hours which allows Landis to track hours spent against the total design budget and to update the owner(s) on how the budget is doing.
“Ultimately, the design fee is calculated based upon an hourly rate,” Landis says. “This rate is essentially an average loaded labor cost for our design department plus a markup which theoretically would get us to a 10 percent net profit at the end of the process. The loaded labor cost includes overhead as it relates to the budget set forth in the beginning of the year for the design department.
“We know from past projects that this number of hours typically backs into a rate of anywhere from 9 to 12 percent of the final design fee, depending upon a universe of variables during the design process including: how decisive the homeowners are with choices; how much they assist with finish selections; whether the project is large enough to have economies of scale in the design process; the complexity of the project; and again, the general level of personal assistance that a customer requires during the process,” he explains. “Design sometimes continues into construction to clarify details and to make finish selection changes. After construction is complete, we calculate our hours and credit back to the customer any hours or dollars not used in the design process.”
In addition to accounting for man-hours and budget increases, the umbrella expenses of running the corporation fall within Landis’ overhead which is not necessarily job-costed, he says. This number is arrived at as a percentage of Landis’ annual construction goal and is factored into the firm’s markup throughout the job. “These expenses include, but are not limited to, our office, office equipment and office personnel, insurance and workers’ comp insurance, marketing, employee events, training, 401k program, employee health insurance program, licenses and more. At the end of the day, our goal is to achieve a 10 percent net profit. To achieve this, since our overhead as a percentage of our total annual goal is more than this number alone, our markup is also somewhat more.”
None of this works unless the clients agree to the terms at the beginning of the entire process, Landis notes. “What happens is people might say they don’t remember something, so we make them sign off in case they forget. One caveat in design is that both decision makers must be at the table at the same time. The wife one day can’t agree to something then a few days later have the husband come back and say they’re not going to pay for it because he wasn’t with his wife when she agreed to spend the money. These things always happen but you can pre-empt them. We have it in our contracts that both parties must sign off on decisions and designs.”
A simple way to make profit is to use software that automatically builds it into the budget. But it’s not that simple, at least not at Windstar Homes in Tampa, Fla., which decided to design its own software program. The software’s formula for determining profit levels might differ from a firm like Landis Construction, but Windstar’s owners believe as Chris Landis does that the more money a client’s house costs, the more profit the company makes. Period.
“It is what it is. We don’t negotiate. We don’t waiver,” says David Lesser, co-owner of Windstar Homes. “I think you must have a mind-set of making profits. Don’t start putting budgets together without knowing how much you want to make. Plan for profitability. Have it in mind before you start. We charge 15 percent on top of labor, materials and overhead.
“We might tell clients their allowance covers this, this and this, but they might find they need more. We let the client decide how much they need. But we also know that amnesia runs rampant in this business. There’s not a builder in the nation that can have the level of plans we do. Detailed documents is the panacea for amnesia. It reminds people what they wanted, what they agreed to,” Lesser explains.
When Windstar receives a call from a client who already owns property and knows the firm, the Windstar team does a needs analysis, finds out what the clients want, the budgetary parameters, and in two weeks Windstar designs a world-class residence that would win design competitions, Lesser explains.
“In those two weeks, we formulate a specification report that’s about 24 pages. It lists everything that’s going into this home. At the same time we give the clients a price so they know how much their home is going to cost. We also let them see their home for the first time, in color, with a floor plan and elevations in color with full specs and a budget. It sets the tone that you must get money on the table at the beginning of the process,” Lesser continues.
Windstar’s price includes its margins, and the only way profits will go down is if the client takes things out of their house. “These people are wealthy. They have business formulas of their own. They understand profit. The key is having margins built into these three things: labor, materials and overhead. Nobody can complain about 15 percent. When you think about all we do, from design/build, interior design and procurement, it makes things easy for people. Remember, you have to plan for profit. Costs might go down but profit never should,” Lesser notes.
Costs might go up, however, for items such as materials. But because Windstar aligned itself with the best subs in its market, costs can be locked in after sending subs the preliminary plans. Windstar can lock in pricing for shower enclosures, shelving, cabinetry, for example. “Anything that comes on later in the process are allowance items but they’re based on real-world pricing. So if a client says, ‘I can’t believe your pricing,’ I can at least justify it.”
The locked-in prices apply only for so long, Lesser notes. If he knows he’ll come out of the ground within 150 days, he can lock in his pricing because of the relationships he has with his subs. Anything after 150 days he can’t lock in, but he can make allowances for issues that pop up later in the process. “And we set expectations right so we’re not crucified if prices go up.”
Design firm WKMC Architects in Dallas is structured internally as five studios loosely organized along lines of specialty: banks, education, government, a boutique practice that does large single-family homes and also upscale retail interiors. Each studio is responsible for its own budget and goals. Michael Malone, principal, views WKMC as a traditional design firm that must be profitable because, as he says, it’s impossible to earn a living and do beautiful work as a loss leader. “We’re not only profitable, we provide an elevated level of service,” Malone explains.
“This firm is well run from a business point of view, but that doesn’t mean we don’t take on projects we know may not be as profitable as others. We approach each job with a target percent of profit we expect to make. If we don’t make it, we feel we haven’t done our job,” he says.
Being profitable also means being honest and understanding that WKMC is not the right architecture firm for every client and will not get every deal. “Once you internalize that and realize you have certain standards for successful projects, it frees you from foolishly pursuing things you can’t succeed with. Budget is not tied to client expectations. It’s tied to what the market will bear, and cost per sq. ft., but it has nothing to do with meeting the expectations of a client,” Malone explains.
Once a project is secured, the next step is outlining fees in such a way the client has a vested interest in the outcome and a reason to be focused and quick to decide, Malone says. WKMC has figured out a way to bear the risk equally with the client — by charging hourly for design. “We have an hourly rate sheet. If they balk or act scared, at least they understand the time they put in. Once design is agreed to, we switch to a fixed rate for construction documents. And if they want to make a change such as enlarging a room at this point, you go back to an hourly rate to bring that room to the level of completeness they want,” he explains.
“That gives the client accountability. They must be efficient and it alerts them that if they go into the design phase casually, there’s a cost ramification to it,” he adds.
Clients aren’t the only people with a vested interest in being efficient. Bonuses are paid at WKMC on financial performance even at the intern level. Employees learn the connection between efficiency, quality of work and the related financial benefits.
WKMC employees also know material costs can be profit killers. “Every house we draw is the same volumetrically. Money gets attached to the finishes, quality of lighting, plumbing fixtures, carpet,” Malone explains. “With a reasonable client you can make those issues known up-front. With an unreasonable client who doesn’t want to take responsibility for material costs, there’s the issue of trying to value engineer to get within budget, which is hard to impossible to accomplish.”