Reflections and Forecasts

As 2007 is on the horizon, now is a good time to reflect on your business and ask yourself: What went right this year? What went wrong? What do I want to accomplish next year? Can I anticipate the impact the local and national economy will have on my business in 2007? What is my plan for making the most of the opportunities that I will be seeking?

What went right? Here’s what I see from where I sit. As 2006 began, my building company had more finished spec homes in inventory than I was comfortable carrying. I had a strong sense of urgency to sell product but I also had a diminished pool of prospects. Fortunately, by year’s end I had reduced my land holdings and spec homes by more than 65 percent. Also, I focused on converting my business by year-end from building 75 percent specs and 25 percent customs to the opposite; 75 percent customs and 25 percent spec homes. This is due to the slow absorption rates of the current pool of spec homes and increasing lot costs.

Fortunately, I now have more presold custom projects than at any other time in my career, to which I attribute my commitment to selling custom projects via open-book construction management. In response to this market condition, I sold my first three remodel projects which totaled more than $1 million in open-book construction management remodel sales with a guaranteed gross margin of 25 percent.

What went wrong? Both the spec and land inventory I sold had greatly eroded margins, and in more than one sale, significant losses. It’s not easy accepting a loss on a spec home, but the sooner you move the product, the sooner you can repay debt and owners’ capital. In retrospect, I would have been better off buying T-bills than building the spec homes I built and sold in 2006. Nothing ventured, nothing gained.

2007 goals. Having presold custom work to produce is a new problem for my company, and a good problem to have. I will be focusing on assisting my management team with all phases of bidding, customer selections and production.

My corporate shift from building spec homes to building customs is a significant one in terms of managing cash flow and profitability. When my primary business was producing spec homes, my cash flow was managed by making draws from my lenders on construction lines of credit. When we sold a spec and achieved our targeted 20 percent margins, we were profitable and we could withstand peaks and valleys in our income and production. Now that our business is primarily custom work, we are relying on client funding for our monthly cash flow. The timing for requesting and receiving funding from a client, who typically is using a commercial lender, often takes several weeks as opposed to several days.

Further impact on corporate profitability is apparent on a month-by-month basis. To be profitable as a custom builder (without profits generated by spec home sales), it is imperative to have consistent production to cover ongoing overhead costs. The analogous situation is building a spec home quickly to reduce your construction loan interest expense. But when doing a custom project, you must control both the time frame as well as the client selection process so production does not grind to a halt while the overhead cost meter keeps spinning.

The local and national economy affects your business, and as an owner, you must understand and respond to market conditions. Having enjoyed the benefits of more than a decade of rising real estate values, it should not be a shock to take a loss on your standing inventory. Remember, time is money. Sell your inventory as fast as possible. Best of luck to you in the new year.

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