[Updated 2022] Despite turbulent 2020 home builder profit margins rose

This article was originally published in February 2021 and has been updated to reflect the latest home builder profit margin data and trends impacting the residential construction industry.

Over the last two years a global pandemic greatly impacted the economy and small businesses. Independent residential construction companies faced significant headwinds: local restrictions shut down project work, disrupted supply chains for building materials, and created significant volatility in consumer confidence. Despite these challenges and the rapidly shifting landscape of residential construction, US and Canadian home builders still were able to increase their profit margins over the last two years.

We analyzed over 10,000 projects conducted on CoConstruct’s project management software in the United States and Canada between 2019 and 2021 to identify trends in the construction industry. In our analysis, we found that the average project profit margin for residential home builders rose from 14.4% in 2019 to 14.6% in 2020 and then 14.9% in 2021. The consistent and increasing 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 are growing

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 historic low in 2008 following the economic recession and housing crash.  

But how did builders overcome uncertainty and rising material prices the last two years 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 while this was happening, Americans and Canadians were subject to lockdown orders and sheltering in place. 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 created 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 starts for the majority of 2020. While the gap between permits and starts shrunk in 2021, both numbers stayed above pre-pandemic volumes, indicating steady demand over the last two years.  

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 2021 and have been incredibly volatile over the last two years. Yet these soaring lumber prices did not hamper the housing demand. The average $16,000 price increase in new single-family homes due to higher lumber costs has not slowed the market for single-family sales and starts.

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 2021 to prepare their business for 2022.

What’s in store for 2022

Despite low inventory fueling price increases, housing sales are still up to start 2022. Meanwhile, Canada continues to break housing sale records in back-to-back years. Across North America, however, low inventory, high prices, inflation, and supply chain issues continue to be an issue for home builders and buyers. While these issues have not slowed down the overall market’s appetite thus far, analysts remain concerned about their long-term effects on housing affordability especially with a potential interest rate increase coming this year.

If home builders can manage their building costs to take advantage of continued demand, they can set themselves up for another year of healthy profit margins. Construction professionals 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 construction contract.

The type of construction contract used

The type of construction contract a home builder uses has a significant impact on the project’s profit margin. The average profit margin for home builders in 2021 when builders use fixed price, or lump sum, contracts was 15.8% compared to 12.8% for builders using open book, or cost-plus, contracts. The average profit margin for fixed price projects has also risen faster over the past three years compared to open book projects. This gap between contract types is commonly due to open book contracts treating the entire project as an allowance and often utilizing a higher degree of customization compared to fixed price projects.

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. Home builders in the US saw consistent growth from 2019 to 2021 while Canadian home builders saw a 3% year-over-year decrease in 2020 before a strong rebound in 2021.  

Regionally all US builders saw higher average profit margins than Canadian builders but the Northeast had the highest average profit margin 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 over the past three years.

Regional differences in the United States

Across the United States, the three-year trends for average profit margin for home builders varied by region.  Home builders in the West saw year-over-year growth while builders in the Midwest saw year-over-year declines. The average profit margins in the Northeast and South both dipped in 2020 before recovering in 2021. The higher profit margins 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.

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.