John Burns: Cost Advantages Allow You to Pay More for Land

Lot and Home Values, Cost Advantages

By John Burns

I learn the most when others tell me I am wrong. At a recent roundtable I moderated for 20 Washington, DC regional home building and development executives, we were discussing the challenges private builders face competing with public builders for land. The following chart shows the difficulty of buying land at a price that supports profitable home building, as lot prices (in green) began rising before new home prices in 2010 and 2011 and shot up dramatically in 2013.

Finished-Lot-and-Home-Values_Feb2015I attributed the difference to a better cost of capital for publicly traded builders. The largest land owner in the room chimed in:

“I disagree. The biggest advantage is having lower construction costs. There are two builders in this room who continually pay me more for land, and it is because they have lower construction costs.”

Everyone agreed and knew which two builders he was referring to—– one was publicly traded, and one was privately held. While the public builders in the room agreed they had lower costs of capital, they pointed out that corporate charged them “private capital” rates for their land holdings, effectively holding them to the same land acquisition standards as private builders. While I had heard this many times before, I never really believed it because public builders often tend to be the highest bidders. That may be because public builders tend to have lower costs, but there are plenty of private builders who are large in their local market that have the same competitive advantages:

  • Low costs through local volume. Volume in the local market drives costs down. Builders with predictable volumes negotiate better rates with the trades (and often demand their best crews) and lower materials costs. Most agreed that national volume made little difference when it came to costs, especially considering the additional overhead associated with being national or publicly traded.
  • Low costs through repetition. While the luxury builders, architects, market research consultants (including us), and others continually harp on builders who leave money on the table by building the same floor plans over and over again, those who do build the same homes over and over again should be able to build them faster, cheaper, and with fewer mistakes (clearly not the case for those who are perhaps building them too fast or driving costs down too far).

I thank the builders and developers for setting me straight. While public builders have a cost of capital advantage, large builders in their local market (regardless of their source of capital) can compete effectively.

P.S. For the many in the industry who hate the low-cost, high-volume, repetitive business model, I did not say that your model cannot work either. It can. You just have to do your homework to know that the incremental revenue from your beautiful, unique homes will far exceed the additional costs.

West Coast Commercial Real Estate News