Scenario: Charlie C. builds six custom homes a year, priced from $600,000 to $1 million. He also builds two spec homes a year. While business is still good, Charlie has noticed a recent softening of demand. Buyers seem to be more price conscious, and there are fewer prospects knocking on his door. Since everyone knows that building spec homes is riskier than building custom homes, Charlie wonders if now might be a good time to stop building specs.
Solution: While building nothing but spec homes can be risky business, mixing spec homes with custom homes is actually a risk-reduction strategy. Spec homes provide several important advantages for custom builders. They tend to smooth the work flow and allow increased production efficiency. This spreads overhead over a greater number of houses thus reducing overhead per house. Since builders tend to build the same spec home over and over, there is less risk that there are unexpected costs buried in the plans.
Spec homes also serve as a marketing tool; they let prospective buyers see your work without having a model home. This generates additional custom work. In addition, spec homes appeal to a different type of buyer than custom homes. Spec people are unwilling to wait months while their custom home is built and want to avoid the time and hassle of making all the decisions and selections associated with building a home from scratch. For these buyers, buying a spec is also a risk-reduction strategy because the home is nearly complete when they buy it so they can easily visualize the final result. There is less risk that the completed home won’t meet their expectations. And finally, there is a smaller chance that there will be unexpected cost overruns or schedule delays.
If Charlie were to stop building specs, the risk would be that his per-unit overhead would increase, making his prices less competitive or reducing his profit margins. It could also mean fewer custom sales because prospective buyers were unable to see his work. And it would remove from his company the discipline of having to understand broader market trends and buyer expectations.
If Charlie wants to reduce his risk, rather than eliminate spec homes he should focus on the way he builds spec homes. This may not be the time to build a show stopper spec—an oversized, over-specified, over-priced product. Charlie may want to scale back a little, building fewer spec homes and pricing them to the middle of his range rather than the upper end. He might want to review his spec home plans to tweak them for greater market appeal and construction efficiency. He also may want to reduce his turnover time, so that he can produce homes faster rather than keep them in inventory.
He should also concentrate on eliminating waste and inefficiency within the company. The greatest danger in any downturn is to the inefficient producer who has been carried along by the flow of excess demand, but who is unable to become truly competitive when conditions change.
Risk is an inherent part of home building. While you can’t eliminate it, you can minimize it through careful planning and attention to good management.
Al Trellis, a co-founder of Home Builders Network, has more than 25 years of experience as a custom builder, speaker, and consultant.
