Diversify and Conquer
This two-part series on diversification is designed to provide remodelers with business and investment alternatives to their core business. Part II will review cash flow and funding issues, and discuss sources of capital that can be tapped for expansion.
The logic behind diversifying from one part of the housing sector to another is to provide other opportunities for cash flow, regardless of how the economy as a whole is performing. If, for example, a downturn dramatically reduces custom high-end remodeling, rental properties might provide sufficient income to cover fixed costs of the remodeling company.
Taking a remodeling company straight into tract building or land development is probably inappropriate unless the owner has certain talents from a previous career. Some businesses require a completely different business model. Insurance reconstruction, for instance, involves 24/7 response capability, detailed line-item job costing and the need for substantial working capital. Before you diversify, recognize the difficulty of refocusing your company on what constitutes a new business.
For 20 years, Scott and Greg Yonkman of Yonkman Construction Inc. have built their reputation on Whidbey Island, Wash., one project at a time. While they primarily build high-end custom homes, they have successfully expanded into remodeling as well as light commercial projects. About three years ago, they decided to try the restaurant business, even though they knew nothing about it. Two years later, after a significant loss of money, they managed to get out of it.
"If you’re going to diversify, it should be in a field closely related to what you already know," Scott says. "We could have used the money we lost to build commercial lease space and kept it."
Among the opportunities professional remodelers might consider:
Custom home building
Many remodelers mistakenly assume that the transition from remodeling to custom home construction is a natural progression. It’s anything but.
First, the financial ratios that apply to remodeling are different in custom home building. While the gross volume is higher - it typically costs more to build a house than to add a room - the gross profit percentages are substantially less. You can’t mark up new construction as much as remodeling and stay competitive. Most custom home builders probably have a 15% gross profit. A remodeling company generating $1 million in sales with a gross profit of $350,000 would have to generate substantially more in new home construction revenue to generate the same gross profit.
Second, remodelers who employ their own field staff probably will find that subcontracted labor fits best for new home construction because using all subs lets a builder fix construction costs and develop a final price with reasonable certainty. You can’t hold employees to fixed costs or time. For one thing, in remodeling they typically wind up doing a number of tasks in addition to, for example, the siding work. New construction, however, means no unexpected surprises when trying to tie old and new construction together. For another, if you hold them to their time estimates and tell them they’ll be paid for only four hours to install siding even though it took six, you probably will lose your workers. With a sub, there are no estimates, only fixed expenses.
After trying trade-intensive light commercial work, Deimler & Sons Construction in Harrisburg, Pa., started building new homes, finding those two fields compatible. Its first attempt at doing so proved costly, says vice president Craig Deimler. Used to remodeling, the company put too much into the new homes and didn’t turn a profit.
Bottom line: It’s difficult to transform a remodeling company built around employees who are trained to work around a family living on site into a company driven by piecework and volume. Many remodelers have failed in transforming their business from remodeling to new construction. Those who have succeeded usually paid considerable dues along the way.
Remodelers with good subcontractors should consider expanding into single-line trades such as window, siding and roof replacement. The financial success of these businesses depends on productivity: Craftspeople who specialize in one trade can produce more units per day than carpenters who are skilled in multiple areas. Single-line trades are more productive because of their nature; all they do is the same task day after day. The more productive the worker bees are, the more money the queen bee can harvest.
Depending on the number and competency of the installers, multiple projects can be completed within one week. A remodeling firm that previously completed 10 to 20 projects each year might need 150 customers for a window re-placement division.
To meet and close so many customers, remodelers used to handling their own sales probably would have to hire or contract salespeople. These individuals typically are paid commission on each sale, and because of the sheer volume of prospects who have to be seen, they should be taught to close a sale at the first meeting.
The need for more marketing and sales support means that budgeting for a single-line firm differs from budgeting for a full-service remodeling company. Sales and marketing for a single-line firm easily could cost 20% of sales generated and must be built into job costs. Margins on single-line jobs are smaller than on remodeling jobs, but volume makes up the difference. A job supervisor monitoring one or two large remodeling projects might be able to monitor four or five siding or window replacement jobs per day. Over two months, your company might be able to replace one remodeling project with 45 window replacement jobs or 10 siding jobs.
This is a logical path for a remodeler with the supervisory capacity to monitor the installations.
Understanding the local housing market is critical to spec remodeling, which requires identifying undervalued properties that cost little to refurbish. Property costs, carrying charges, remodeling expenses, Realtor fees and all other related expenditures must be loaded onto a spreadsheet to determine whether a prospective property is feasible. The spreadsheet then must address return on capital.
If, for example, you can earn 6% interest by buying a bond while a risky spec remodel will net you only a 7% return tops, why take the risk?
To be successful, a remodeler must rely on a team of Realtors and subcontractors so costs can be locked in before the project is tackled. Zoning issues can affect plans, and so can unexpected site work, as in the necessity for septic-field expansion when adding bedrooms to an existing dwelling. Certainly subcontractors can estimate costs for the necessary upgrades/repairs. The role of the honest Realtor is to determine whether a high-priced, enhanced property can sell in that particular neighborhood.
There are no rules of thumb when costing out a remodeling project that will be converted into a potential sale. Be sure to put some multiple, however, on projected expenses for such potential cost-draining issues as a delay in selling the property, unexpected remodeling surprises and professional fees.
Spec remodeling is not for the faint of heart or anyone unable to put personal capital at substantial risk.
Understanding your local housing market is also key to owning properties (but don’t ever disregard the need to find good tenants).
Economies of scale should be analyzed before you purchase residential properties for rental. For example, a spreadsheet analysis might reveal that a single-family home will yield more income than a two-family home. But this can’t be done on ratios alone; variables such as the economy and local issues such as zoning factor into the equation as well. And as opposed to a 100% vacancy rate if a tenant leaves a single-family home, a 50% vacancy rate occurs if one tenant leaves a two-family home.
When considering whether to buy a property for rental, apply a standard different from what a client would apply to a custom remodeling project. Certain finishes might be less conducive to long-term wear than others (linoleum versus ceramic tile, for example, or carpet versus hardwood). And certain other selections (upgraded interior and exterior trim) might not yield a higher monthly rental and should not be included when the property is refurbished. Functional-ity, durability and economy are the operative terms when dealing with rental properties.
Like spec remodeling, becoming a landlord is not for the faint of heart.
Light commercial renovation
Office and retail space require retrofit every time a tenant vacates. And a property owner or site manager typically requires a general contractor to oversee the remodeling work.
Often, the key component to successful light commercial renovation is timing. A contractor who completes the retrofit without impeding the rental schedule probably will secure more business in the building.
Certain elements of the work differ radically from residential remodeling. Some jobs require extensive amounts of repetitive work best serviced by specialty subcontractors, while others entail unique finishing details to attract retail customers.
While the jump from residential to commercial isn’t for everyone, similarities - subcontractor overlap, building component overlap, working with customers while they are using the space - do allow for the transition. Provided the subcontractors understand commercial building code issues, light commercial renovation might be a more natural progression for remodelers than new home construction.
Deimler & Sons Construction found the crossover from residential to commercial to be difficult for its contractors. "Light commercial renovation cultivated a whole new set of subcontractors," says Craig Deimler. "The demanding time frame and size of the jobs was something our residential remodeling subcontractors were not used to." The 25-year-old firm now offers full-service remodeling and custom home building.
Light commercial work provides good opportunities for remodelers who can stick to schedules and work on short turnaround times, and even work weekends and nights as necessary.
Many full-service remodeling companies perform handyman services for existing customers. Some do follow-up for years on previously completed jobs. Others offer maintenance and small-jobs ser-vices as a way to market to customers "in between" larger remodeling projects.
A full-service remodeling company with carpenters on payroll might explore starting a separate handyman services division or company, as virtually every handyman task can be completed by a competent carpenter.
Handyman services and full-service remodeling have obvious differences. First is the need for continuous leads. Depending on the types of tasks, a qualified craftsperson might be able to visit multiple customers in one day, as op-posed to staying at a large remodeling project for weeks or months. Second, a fixed pricing system must be established so jobs can be quoted over the phone and collected in the field upon completion.
Markup for smaller jobs must be significantly higher than for larger projects. The overhead is brutal. The door can’t be delivered tomorrow; the carpenter has to go get it today. Or someone else has to bring the door, or the lock, or the 2x4. Jobs are smaller dollarwise, so there’s not only less room for error, but you’re working with fewer dollars be-cause of the nature of the work. It is not unusual for handyman jobs to be marked up 100% or more.
But the markup should not inspire a company to jump into this type of business. It is more difficult to manage. A lot goes on at a number of places. There is no one job site; multiple small tasks are done at assorted places during the same day. For each job, someone must prepare job tickets and directions and bills, schedule the job, follow up to make sure each customer was happy, etc.
In starting a handyman division, an established remodeling company probably has the benefit of a lengthy list of satisfied customers. Those customers can be marketed for handyman services, as can their neighbors, friends and relatives.
Just remember to take into account the startup costs of outfitting a panel truck with lumber, nails, ladders and other basic items that might come up on a "typical" handyman call.
Realizing the benefits
It takes 45 minutes to fly from Loomis, Calif., to Redwood City, Calif., which is how Erik Sundquist commutes to work.
Sundquist runs Sundquist Associates, a $6 million diversified construction company started by his father, George, in 1969. The reason Erik flies to work is similar to the logic he uses in the day-to-day management of his company.
With housing prices far lower in Loomis than in Redwood City, Erik figured he could buy a lot more house in Loomis. And because living in Loomis meant a three- to four-hour (one-way) drive to the office, Erik realized he also could satisfy his passion for flying. So move to Loomis he did.
Sundquist Associates started as a general contracting company that handled remodeling work and custom homes and that employed just his father and his uncle. Erik worked construction while completing his course work at the University of Southern California, and he took over management of the company in 1996. But he knew he didn’t want to work with his hands his whole career, and he wanted more money and flexibility in his job schedule. So he decided to grow the company. Immediately.
This winter, Sundquist Associates was building four custom homes, working on four big remodeling projects and building three spec homes. The company includes Erik and his dad plus two project managers, three or four job supervisors, two apprentice carpenters, one laborer and an office manager.
The diversification of remodeling, custom construction and spec building allows the company to adjust as the economy changes. The risk of branching into spec homes is partially rewarded by gross profit margins greater than on custom homes. A good staff allows Erik to be more flexible with his personal work schedule. And a profitable company helps pay for jet fuel.
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