A global pandemic wrought havoc on the economy and small businesses this past year. Independent residential construction companies, in particular, faced significant headwinds: local restrictions shutting down project work, disrupted supply chains for building materials, and significant volatility in consumer confidence. Despite these challenges and the rapidly shifting landscape of residential construction last year, US and Canadian home builders still were able to increase their profit margins, compared to 2019.
We analyzed over 40,000 projects conducted on CoConstruct’s project management software in the United States and Canada between 2018 and 2020 to identify trends in the construction industry. In our analysis, we found that the average project profit margin for residential home builders rose from 16.9% in 2019 to 18.3% in 2020. The 8.5% year over year growth highlights, among other things, the resiliency of the residential construction industry.
Over the rest of this post, we will dig into the numbers and provide insight to explain the rise and fall of profit margins among residential home builders.
Why Home Builders’ Profit Margins Grew
The overall trend for builders’ profit margins has been on the rise over the past decade. According to the National Association of Home Builders (NAHB), single-family home builders’ gross profit margins have been trending upward since dropping to a low of 14.4% in 2008 following the economic recession and housing crash.
But how did builders overcome uncertainty and rising lumber prices in 2020 to protect their margins? They rebounded from a stall in the spring to meet historic demand.
Surge in demand
Across the United States and Canada, jobsites became empty as nonessential businesses were forced to close before the Department of Homeland Security designated single-family and multifamily construction as essential. For states like California and New York, this seven to nine day delay and its resulting whiplash created confusion for construction companies of all sizes. Additional PPE shortages and new OHSA guidelines created new challenges and changed how businesses operated on the jobsite and in the office.
But at the same time that this was happening, Americans and Canadians were subject to lockdown orders and sheltering in place. In an attempt to mitigate the effect of the coronavirus, the Federal Reserve slashed interest rates and purchased $200 billion of mortgage-backed securities In Canada, The Bank of Canada dropped the key lending rate from 1.8% to 0.3% and pumped $156 billion dollars worth of bonds into the market.
The human element of needing more space because of lockdowns combined with lower mortgage rates to create a dramatic rise in housing demand. According to seasonally adjusted Census measures of home construction, signed sales contracts for new builds dramatically outpaced new home construction by October of 2020. This along with the 69% year over year increase in home sales indicates strong demand in the residential construction market.
Sheltering in place made people spend more time examining their living space under new conditions. In need of more space to live and work these people sought new homes and slashed mortgage rates made their dreams of new homeownership possible. Buyers with better access to capital suddenly flooded the market creating a surge in demand for home builders to capitalize on.
Dealing with rising lumber costs
Surging demand exacerbated supply chain issues caused by coronavirus shutdowns. Lumber prices, most notably, reached record highs in September and had the most volatile year in pricing history since 2001. Yet the soaring lumber prices did not hamper the housing demand. The average $14,000 price increase in new single-family homes due to higher lumber costs has not slowed the market for single-family sales and starts.
Source: NAHB Eye On Housing
For home builders who could pass along the rising costs to buyers using cost-plus pricing contracts, the lumber price was not a deterrent. But to builders who use fixed-price contracts, they can’t afford to risk their profit margin on the volatile market. Regardless of a home builder’s preferred pricing model, all builders can take lessons from 2020 to prepare their business for 2021.
What’s in store for 2021
Home sales slowed to end the year but they still finished up over 16% versus the previous year in the United States. Meanwhile, Canada saw a record low housing supply by the end of 2020. All across North America, low mortgage rates remain an incentive to home buyers. That’s the good news, demand and availability remain high for home buyers. The bad news, however, is that most experts agree rising lumber costs are here to stay.
After a dip to start November, softwood lumber prices rose again to end 2020 and another year of price fluctuations is likely. But if home builders can manage their building costs to take advantage of the newfound demand, they can set themselves up for another year of healthy profit margins.
Home builders can deal with rising lumber costs a number of ways including using contingencies, escalation clauses, treating lumber as an allowance item, or switching to a cost-plus financial structure.
The United States vs. Canada
There is a noticeable difference between the United States and Canadian builder’s average profit margin per project over the past three years. For home builders in the United States, 2020 saw a 9.3% year over year increase while Canadian home builders saw a 2.2% year over year decrease. This Canadian decrease was consistent with a 3% decrease from 2018 to 2019.
All US regions saw year-over-year increases in average profit margins but the Northeast saw the most significant increase which could be attributed to the Northeast being the most highly urbanized area of the United States. Canada, on the other hand, is less urbanized than the US with 81.4% of its population living in settlements of 1,000 or more compared to 82.1% of the US population living in settlements of 2,500 or more. A less densely populated Canada could help explain the divergence in both North American countries’ profit margins for the year.
Regional Differences In The United States
Across the United States, home builders achieved better average profit margins per project in 2020 than the previous two years. However, the Northeast and South regions saw the most growth with 18.1% and 11.3% year over year change respectively.
The surge in the Northeast could be attributed to the Northeast being the most highly urbanized area of the United States and the socioeconomic factors of the pandemic leading to an increased urban flight. Conversely, the West is the least urbanized area of the United States and saw the smallest increase year over year. The Midwest region, notably, is the only region that grew faster from 2018-2019, 5.3%, than from 2019-2020, 5%.
Looking for more residential construction insights? Check out our latest post which found that projects using fixed price construction contracts had on average 28% higher average profit margins.
Where we got our numbers from
CoConstruct's construction management software helps over 100,000 building professionals manage clients and trade partners, schedule work, track financials, and more. Aggregating and analyzing the data builders input into the system, CoConstruct can identify trends and highlight emerging issues in the residential construction industry. By using and sharing this information CoConstruct is doing its part to eliminate the chaos of project management and help create rewarding experiences for both home builders and clients.