With an average profit rate of 9.59%, 2019 has been the best performing year for builders since 2006, when all the critical measurements were aligned with targets and production volume. Although 2019 numbers were not at the level of performance of 2006, they show profitability headed in the right direction. We had great expectations for 2020. However, COVID-19 has created many unexpected challenges that will hinder this progress. Even though it currently appears that 2020 sales volume will meet projections, we believe closings will fall short of the targets, creating a considerable negative impact on profitability. There are two factors with direct impact on profitability: time and cost. We are seeing an increase in construction times due to delays in inspections, delays in material deliveries, and delays in labor performance due to new regulations on the number of people working on the houses. At the same time, we can predict increases in cost as a result of the shortage of labor created by extended time frames and the increase in competition for resources.
Low interest rates bring a bright spot as they create incentives for homebuyers to buy now and keep the interest expense within a reasonable level. However, we anticipate the extension of construction schedules will cause an increase in interest expense because the longer construction times increase the time the construction loans are outstanding.
An increase in gross profit, or conversely, a decrease in the cost of sales caused an improvement in profitability during 2019. Land is always an open question in the profitability equation. However, since 2006, land has been holding steady at 18% to 20% with very small variations in between years. In 2019, we found an increase of 1.36%, from 18.05% in 2018 to 19.41% in 2019. At the same time, operating expenses have stayed in balance with production volume. Operating expenses are at an all-time low due to increases in productivity in the field as well as with the office staff, and a 2% financing expenses subsidy due to low interest rates.
On the operations side, as seen before, when the industry begins to grow, the operational systems get tested and take a secondary position in the day-to-day operations, which leaves processes and procedures behind for the sake of expediency and time. This approach will eventually result in a breakdown and have a negative impact on profitability. As the industry moves into the growth predicted for this decade, it is important to look at reinforcing processes and procedures to ensure and maximize not only profitability but the efficiency of the operation.
During 2019, there was as slight improvement on cycle time for homes up to 4,000 sf. In larger homes, there was an improvement of up to 10 days. The soft cycle shows an average improvement of five days. We are expecting this trend to reverse in 2020, with the exception of the soft cycle. In 2021, conditions might change enough to be able to reverse the trend back to where it was in 2019.
Builders are paying more attention to construction efficiencies, decreasing structural changes particularly after the start of construction. There was also a decrease in the number of active floor plans offered for sale from 36 plans in 2018, to 26 plans in 2019. The productivity of the superintendents remains about the same as in 2018. Going hand in hand with relaxing the processes and procedures, the number of punch list items at all stages—internal walk, orientation walk with customer, and closing walk with customer—has increased from 2018.
In the sales and marketing area, the conversion rates are holding steady at 12%. Compensation of sales agents is showing a strong trend towards commission only, going from 60% in 2018 to 73% in 2019. Cancellations in 2019 are up 1% from 2018, with financing up 10% as the main cause and concessions remaining at an average of 1% of sales price. During 2019, the use of electronic media increased 5% to a total of 38% of the total advertising budget. The highest electronic media usage was 44% during 2016 and 2017.
In 2019, 82% of the participating builders reported the use of a Homeowner’s Manual. Formal meetings with buyers for color selection and orientation remains the same as last year. Other meetings, such as pre-construction, pre-drywall and after move-in, have decreased. Orientation meetings are conducted by superintendents 52% of the time, an increase of 8%, and by the warranty staff 18% of the time, a decrease of 4%. Customer satisfaction, which is measured by willingness to refer rate, remained at 87%.
Average interest rates showed a small increase of 0.33% in 2019. On the technology side, we have seen an increase in the use of cloud-based services, from 57% in 2015 to 82% in 2019. There were no significant changes in the utilization of technology in different applications. The paperless approval process, payment releases (ACH), design, purchase orders, and lead tracking were indicated as the primary focuses for improvement in 2020.
A concerning trend is the increase of both mold litigation (from 1% to 4%) and product liability (from 6.85% to 10.71%). The study also shows an increase in the use of third-party inspectors (from 32% in 2018 to 50% in 2019).
This year we introduced a new series of charts depicting the number of employees for a number of positions in relationship to the revenue of the company. We believe this will provide you with some direction and guidance as to how to staff your company as you continue to grow during this decade.
As we state each year, this is your study. Please let us know if this is the information you are interested in tracking and if there is other information of interest to you. Every year, we add pieces in response to suggestions from our participants and readers. We appreciate your support and participation and want to reassure you that the confidentially of your data is our priority.
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