Is there a standard factor General Contractors use when calculating their fee to construct?
mooney231lv
| Posted in General Questions on
I am in discussion with a builder to construct my new home in zone 4B. We have engaged the services of an energy modeler to determine how to build the most efficient house within the budget. We are grossly over budget, at the moment. I noted that the GC has build a 16% fee into the budget to build the house. This is on top of all the subs and the contigency. Not wanting to negotiate something I have no background on, I’m wondering if this is a negotiated fee or is there some standard? I understand my builder needs to make a profit but I would love to get 16% return on my investments!
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Do you negotiate with the supermarket on their markup? As a general contractor, I have yet to find an alternative to making a living other than charging more for a product than it costs me to produce it. And it seems to me you have a pretty poor understanding of what you're trying to "negotiate" from your question. To take your points in order:
1) You are grossly over budget, I'm guessing, because you want more than you want to pay for. If you think your contractor is too expensive, get another price. Otherwise, the safest route to a lower cost is less work.
2) "On top of the subs and contingency." What do you think the GC's relationship to his/her subs is? He pays them. He can do that for free or charge you for the service he supplies. I don't know how the contingency is structured, but typically it's to cover unexpected costs that arise from things like finding ledge, bad weather, etc. It is meant to protect the client by making sure they have money in the budget for these things, rather than having to come to them later and tell them they need to find more money.
3) "Return on investment." How exactly do you think a GC earns money? First off, this isn't an investment; this is payment for what is typically a fabulous amount of work. Second, the line typically covers overhead and profit, meaning any office support, insurance, cost of buying or fixing tools, and many other things is in that line item.
You of course can approach your GC about negotiating the fee, but unless you use that approach with your doctor, dentist, mechanic, etc., I think you should be applauding your GC for opening his/her books this way instead of trying to punish them for honesty.
If you don't want to pay the GC's fee, you can always be your own GC and manage all the subs yourself. There's plenty of info on this available at http://www.byoh.com, but as you'll see, it's not exactly a small amount of work. :)
Dan,
I think there is bit better way to approach this, than take it personally and berate Scott. Clearly he is here to get educated on the issue. Schooling him is not a good approach.
BTW, I do negotiate with mechanics, dentists, and doctors. You supposed to do that, especially if you are paying cash.
Scott,
I have built two houses with my father over weekends, when I was a teen. So I have that side of experience. I also have to deal with GCs, when I am building out offices or my company. And I will be using GC for renovation work I will be doing on my house. Here is where I value services of the GC:
1. Dealing with trades, especially in a hot market with lots of demand, is a job. Members of certain trades are unreliable at best and it seems to be acceptable behavior. Your GC deals with that BS. There are also contentious relationships between say drywallers and electricians (because each side thinks they are gifts to mankind). Good GC keeps both sides in line.
2. You let contractors make decisions without educated supervision, you will learn what "grossly over budget" is. Contractors often have no interest to be on budget, let alone under. They know you have no choice but to pay. Good GC will put their foot down at the right time.
3. Inspectors. These people are drunk with power, yet often lacking education even in the code they are trying to enforce. GC will deal with these temper tantrums.
If I were in your shoes and I saw the cost of the house is over what I am comfortable with, I would step back and make some serious design/spec changes. I also would interview several GCs and check their references. Key is to ask question how these GCs deal with expensive issues. You will discover soon one who is worth the fee.
Agreed. No need to jump non the OP. 16% does seem high, but it's not like the GC makes all 16%. Advertising, gas/vehicles, web pages, insurance, continuing education, warranty callbacks, model homes, open houses, etc and last but not least, spending countless hours speaking with prospective customers to ultimately lose the job.
I'm a tradesman, but occasionally we've taken a job as a general contractor when a large portion of the work is in our industry. It's a lot of stress and a lot of phone calls to act as a general.
Getting back to the original question, in my area residential general contractors charge in the 11-15% range.
Apollo,
You gave some very sensible advice, but for some insight into what Dan is writing about let me describe "the look".
The look is something I get at least a couple of time a year. It happens when clients realize they can't afford everything they want. They sit, bereft of comfort, and stare across the table at you. Their gaze says that they have a dream, and their dream should be your dream. You should find away for them to get what they dream about. What they are hoping is that you will break down and say "Even though we hardly know each other, I realize your project is so important I'll call in some favours, reduce my income for the year and make sure it happens."
Now, having been through this enough times, i just sit there blankly, thinking about something like what to have for dinner, until they stop. Then we get on with planning something a bit more realistic.
Excellent answer by Dan Kolbert.
"I have built two houses with my father over weekends, when I was a teen". Wow. What would be impressive is if you were building homes on contract, and making a profit doing it, year after year.
"16% does seem high" Why? Can you give us a breakdown of what the 16% pays for, how much is left for the GC as net profit, and how many hours he will expend earning that?
Don't count other people's money. If the product is worth the price charged, buy it. If not, don't. If you think builders charge too much for what they do, build it yourself.
Scott,
Several respondents feel that Dan Kolbert's answer was unnecessarily harsh. As a former builder, I side with Dan on this. But I'm going to give you the benefit of the doubt, and assume that you hadn't thought the issue through before you posted your question, and that you forgot to consider all of the work entailed in being a GC.
Clearly, the phrase that rankles most is "I would love to get 16% return on my investments." When you buy a government bond and receive 2% interest, you aren't doing any work. That's why the IRS calls your return "unearned income."
The 16% covers all of the GC's fixed expenses: truck, tools, office, garage, licensing fees, and insurance. In a slow year, 16% might not leave a penny for the contractor after these fixed expenses are paid. In a good year, of course, 16% works well.
Here is the work that a GC does -- and if you want to do the work yourself, my guess is that your builder and Dan Kolbert would have big fat smiles on their faces, and say "Go ahead! Be my guest": meeting with clients; reviewing plans; meeting with the architect to discuss all of the errors on the plans; developing a schedule; lining up subcontractors; verifying that the subcontractors have adequate insurance; reviewing bids from subcontractors; maintaining a budget; anticipating conflicts between contractors and using the GC's experience to anticipate problems that the architect knows nothing about; writing up requested change orders; dealing with unforeseen conditions; scrambling to come up with Plan B when some subcontractors don't show up; scheduling inspections required by the local building department; negotiating with inspectors who flag problems; supervising all work; inspecting the work; and cleaning up.
And, most important of all, the GC takes responsibility for the quality of the finished work, and answers the phone when the client calls back with a warranty issue. The GC has to fix anything that wasn't done perfectly, and the cost of that work usually comes out of the 16%.
And by the way, you can eliminate the contingency from your budget if you are feeling lucky. But when the backhoe digs an excavation hole, and discovers something unexpected, you'll have to call up Uncle Ralph for a loan, because your construction budget had no contingency.
Thanks all for your " educating answers" I'm the first to admit being new to this. I never implied that the GC doesn't do a tremendous amount of work...hence that is why I'm not being the GC! I'm simply wanting to know if this is a negotiable feature. I gather from most responses that it is not. Clearly, we are anticipating design changes to meet the budget. My question stems from the fact ( which I neglected to mention in the OP) that a previous GC came in much lower in cost however, his schedule prevented him from taking our project. Thanks for the answers as I will always appreciate the bark with the bite with no hard feelings!
The fee is negotiable, but if you approach a smart builder with the attitude that it is all gravy for him, he will probably be offended. Focusing on the percentage the builder uses as markup is a distraction in a lot of cases.
I could build you a house using a 10% markup. I would make sure to include absolutely everything "above the line" and would make sure the 10% was pure profit. Example, any custom home will have a lot of project management time. I would make sure you were paying for project management as a line item job cost, and would not include it in the 10%. If you didn't like that, I would move the project management below the line, pay for it out of my markup, but raise the markup to, say, 20%. You can't get something for nothing, unless you get a builder who doesn't know how to avoid giving stuff away.
If you are comparing builders, it is pointless to compare their percentage markups unless you get them to itemize in great detail *everything* that will be marked up and *everything* that is included in the percentage. Try getting two builders in line like this and you will see that it becomes very slippery very quickly. You might succeed if you put together a detailed solicitation using AIA documents or something like that, which almost no one does in residential.
In my opinion, you are wise to find a good builder by asking for referrals, interviewing people, and finding someone you like and who has a great reputation. Talk to friends, neighbors, your doctor and lawyer, the lumberyard owner, the various subs you know about, etc. Once you find a top candidate, ask them to lay out their fee schedule. Ask them how many items (if not all) can be made firm (i.e. by having detailed plans and getting sub/supplier bids). Get to a point of comfort, and hire them. The lowest price might not be the best value.
A lot of homeowners seem to go after the percentage markup as their criteria for hiring a builder, without looking at much else. I have had people tell me "so-and-so wants a 25% markup, can you do it for less?" to which I reply "yes" and then proceed to put more stuff above the line.
Well put, Dave. Markup is a very variable number. Some companies apply a standard markup on everything; others (mine included) use a different system for internal labor costs vs subs, materials, etc.
As Dave says, the best bet is to find a contractor you like and include them in the design process, so the construction process can favor the methods they've mastered (and are hopefully able to perform efficiently) and avoid the ones unfamiliar to them.
I wrote an article several years ago on a related topic - why I think competitive bidding doesn't serve anyone's interests. You can find it here - http://www.jlconline.com/jobcosting/business--still-bidding-after-all-these-years-.aspx
I do a lot of cost plus new home construction, in fact I have 7 houses currently we are building that are all cost plus. My fees range from 15%-25%, depending on the size of the project. Larger houses ($2,000,000 +) we charge 15%-17% plus 2% for General Conditions. Deals $1,500,000 and under we charge 17%-25%, although 1 million$ is the smallest we do. We are competitive with other local high quality, well established builders, so I know our fees are in line with other builders. We are not taking on any new homes until 2016. I've seen builders charge less, client usually gets an inferior product and poorly managed process. We spend several months planning and consulting with owners, then 14-18 months (or longer) of actual construction, then the warranty period. I think a 15%+ fee is a fair deal.
I'll get to your question about their gross margin, but first I want to share a couple of points in addition to the excellent ones that have already been posted.
Cost is the last thing I'd consider before selecting a builder.
Have you been in at least two or three homes they've recently completed to see if the design, quality of materials and craftsmanship are what you would be happy with. What you see is what you'll get.
Have you checked their references? I ask for at least three references from clients the builder has recently completed homes for. If you can get the six most recent customers, that would be better. Here are some good questions for you:
1. Would they use the builder again? If not, why?
2. Did the builder do what they said?
3. Did they finish when they said they would?
4. Did it cost what you expected? If not, why?
5. Were they any surprises? If yes, what were they?
6. Was the builder a good communicator and did they return calls in a reasonable time?
7. If there were allowances, were they adequate?
8. Were the original plans and specifications adequate for what you wanted, or were there changes orders to get what you expected or wanted?
9. Were there any charges that you did not know about in advance or approve in writing before he work was done?
If any of the other gentlemen who responded have other suggestions, please jump in.
Regarding the builders gross margin, it is nice that he shared that with you. How many people do you do business with who open their books to you?
Beware of the "low cost" builder. The original estimates may look appealing, but you could have a very bumpy ride to get to the finish line and pay a lot more than you expected.
Good builders have very detailed specifications on what will be included in your home. When they're not detailed and complete a builder can say, "Oh, that's not what I quoted on. If you want that, it is $X more and here's a change order." Or, worst case you have a verbal discussion about something once a job is under way and you get a bill for the change.
Allowances can be another area where you can easily go significantly over budget. Ideally there are no allowances in your contract. The plans and specifications are complete and everything is costed out for you. Some of the specifications may be place holders, so at least you know exactly what you'd get for the money. Allowances can be used to bring a home in "on budget," at least on paper. After the contract is signed, the builder has started work and you start making your selections, you realize they're not enough to get what you want or thought you would get.
Regarding the 15% fee or gross margin, the National Association of Homebuilders does a Cost of Doing Business Study on the financial performance of home builders. In the most recent survey I have the gross margin for small builders who build on land they develop or buy is 21.4% and their net profit was 5.1%. For small builders who build on their customers land, the average gross margin was 15.9% and their net profit was 3.1%. For the amount of work and the risk, these are low profit margins. Most small builders love their work and are good craftsman, but are not getting rich quick.
I appreciate all the great input. I will focus my energies on the recommendations. The current builder meets all of the criteria and has great references and we really like him. I believe he will build us a great, efficient home. Now I just have to start shaving down the project to hit the budget.
Adding an 18.9% markup, or "fee"onto the cost of the project will give you a gross margin of 15.9%. Markup and gross margin are not measuring the same thing!
The takeaway from the NAHB study is that, as Alex says, 3% is a pretty small profit for a lot of high stress work with an enormous number of variables, and most builders undercharge for their work.
A client whose focus is the builder's profit margin rather than the 84% of costs (in Scot's case) that he has control over should send a red flag to any builder so my first reaction is the same as Dan's. The option is to play with the numbers as David suggests which may satisfy the client but change nothing. I do not discuss my markup with clients or play number games; they can look at my work, talk to previous clients and compare other builders; if they find one they think is a better fit, it's probably a win-win for all of us.
Well, let me put my neck on the line.
In our area, this is called a "cost plus" contract and I believe it only benefits the gc.
With this type of contract, they are under no incentive to keep costs down.
The more the project costs, the more they make.
What really bugged me was when they prepared a budget, they used the cheapest windows at about $6000. I wanted a much higher quality window, at $10,000. So with no extra work for them, I was going to pay an extra $600.
Also, here the gc's seem to charge an hourly fee for managing your project. And they were charging their 15% on top of their hourly fee.
They said they budgeted 3 hours per day at $75 per hour.
We interviewed so many general's but in the end, I decided to be my own gc.
The job is going a lot slower, is way more stressful but in the end, I am getting a higher quality product for less. However, I would not recommend this route for everyone as you should have some construction experience.
The issue of how contractors get compensated is the subject of endless discussion. In addition to cost plus, there is cost plus-fixed fee (where the client pays all hard costs plus a set fee for a given scope of work), cost-plus with a not-to-exceed cap, and some models negotiate a plan whereby any savings under a set amount are shared by the parties.
Any system needs to have enough transparency that the customer a) feels comfortable, b) knows what to expect and c) trusts the contractor not to profit in ways that harm the client's interests.
Here's a good pdf that Building Green just posted today. https://www2.buildinggreen.com/infographic/whos-invited-green-building-table?woo_campaign=BGB150316&woo_content=headline&mc_cid=bfa8d7fafc&mc_eid=32d0993830
I really like the idea of cost plus fixed fee. The other typical options seems to create strange incentives for the contractor. Even if it's rare for a contractor to abuse the structure and profit from those incentives against the client's interest, it can sow the seeds of doubt and reduce trust.
Cost plus fixed fee does not make for perfect incentives, so there's still a need for a lot of trust, but it seems like an improvement over the other options, and it seems simpler than the "integrated project delivery" linked in comment 17.
It does have appeal, but there's no guarantee on price like in fixed cost contracts.
As most contractors do, I wear two hats. I am a homeowner and I am a contractor. Anyway my whole life I have for some reason been the type of guy that gets in both sets of shoes when discussing say the building of a home. IMO every post including the question make sense to me if one "gets into the shoes" of the person posting.
Over the years I have tried most ways to do work including of late my hand shake deals are now actually a couple of text messages back and forth. For a custom home I now prefer a set fee plus for a set square footage after going over the plan set and I pass on all other costs at actual invoice including my insurance costs but not including my vehicle, cell phone etc. The insurance gets passed on because to me it is their insurance even though I have to purchase it. Same with warranty, now if you buy something of value at any store the warranty is an add on that is purchased for how much warranty is desired. I do discuss this as a way to save money with customers. In all my decades I have had so little warranty work that I could post all of it in a short sentence.
And as to one off builders working for too little, that is so true for me. I'll work till I drop someday but from day one I have never thought of work as work,. It is play time with fun tools for me and most of us that play with tools. Even computers and phones are finally working well enough to be fun toys.
aj builder NY
Scott, you are good sport with the feedback you got on contractor fees question.
The value of goods and services is worth what someone is willing to pay. Not what someone charges.
I enjoy negotiating prices in good spirit, particularly when both parties are happy with the final price. Yes, I negotiate with my dentist, mechanic, and plumber.. Ditto my broker on mortgage rate. Years ago I successfully negotiated the of a suit to go on my first job interview. Grocery store? Not so much. But were I to buy a few thousands dollars were of produce, you betcha.
General contractors? Absolutely.
Negotiation may not always be a dollar amount. Sometimes, the negotiation may be delivery date on a service, or an upgrade on a product. A service provider who is offended by negotiations raises a red flag for me. I am unlikely to do business with such a person..
At the same time, I am not offended in the least if someone declines to negotiate. If the price is fixed fine. Negotiation is part of the art of doing business.
Finally, I am not the least bit shy about paying more than an agreed upon price, a tip if you will, if I am happy with the service, particularly if I enjoy working with the vendor, contractor, or other service provider. I even enjoy "reporting" exemplary employees to their employer or business owner.
Negotiating is an art, is part of every day life, and is nothing a homeowner should be ashamed of entering into with a contractor. Have fun. Engage people in conversation. Enjoy the deal.