Why Does It Costs So Much To Build A New Home? And if builders are adding tens of thousands of dollars in profit to every contract they sign, why are so many of them failing every year?
In this article you’ll learn the truth behind house prices and who is really making money in the construction industry… You’ll discover the truth behind house prices and why it costs so much to build a new home. And while it may seem like home builders get paid a lot of money and do very little, the truth is a little different.
In fact, the average building company makes little or no net profit, a fact that should alarm you if you are considering building a new home. It’s for this reason you really don’t want to be choosing the builder with the lowest price unless you are prepared to finish the job yourself when they go out of business! While most building companies make less than 1% profit on each contract, the government earns a whopping 10% in Australia just from the GST! That means, on a $500k contract $45,454 of your investment will go to the government in tax.
Next is the home warranty insurance. This is a compulsory insurance that has to be paid when building a new home. Your builder will take care of this for you and generally they will include it in the contract price, but it’s probably costing you around 1% of the build as a rough guide so there’s another $5,000 that disappears. Then there is the long service leave levy which is also collected by the government and that will cost you another half of a percent, which is around $2,500.
So in reality, out of the $500,000 that you are spending on a new home, only $447k is actually going towards building it. But that’s not the biggest expense. The biggest expense is the labour and materials to build the home, so how much should that be? This is where it gets really interesting because not many people know this! In fact, a lot of home builders don’t even know this which is why they end up signing cost plus contracts!
A cost plus contract is where the consumer… i.e. you… pay for everything associated with the build including materials, labour and supervision… i.e. the builder’s wages… and then pays the builder an additional margin of around 15% on top. But the problem with a cost plus contract is that you are effectively giving your builder an open cheque book… And with standard industry discounts available to home builders of between 20%-40%, how hard do you think they going to negotiate in order to get a better price for you?
So although paying a builder 15% on top of cost might seem like a good idea at the time, you’ll probably end up spending a lot more in the long run. But when you deal with a professional builder, one that knows their numbers you don’t have that problem. You agree a fixed price for a fixed outcome on a fixed date. If prices go up, the builder pays. If there are delays, the builder covers the costs (and may even have to pay you for each day the home is late).
To cover this risk, and extract a profit the builder that offers a fixed price contract has to negotiate discounts of around 30% across all labour and materials in order to operate the business at a profit. Typically, a building company will be offered significant trade discounts by their suppliers in return for ongoing business, sometimes as high as 40-45%. It’s the same with their subcontractors, in return for continued ongoing business, some trades will discount their labour by over 25% in order to receive regular work.
If you compare that to a cost plus contract where the builder has no incentive to negotiate any discounts at all because the more you pay the more they earn, you could end up paying tens of thousands of dollars more for the same home. It may seem like a minefield you’re stepping into, but with the right builder building a new home is an exciting experience that you will want to repeat.
The trick is, to make sure you choose the right builder…And that means you need to ask the right questions because better information leads to better decisions.