If you’re considering building a new home, adding on, or renovating, cost is likely on your mind. This is totally understandable. Unless you’re fortunate enough to have limitless funds, you’re going into your project with one eye on your dream build and the other on the budget. Sticking to your budget is essential, and coming in under budget is a fantastic bonus, but doing so by choosing cheap home builders for your project can end up costing you greatly in the long run. The following true story sadly illustrates that point.
How Cheap Home builders Turned a Dream Home into a nightmare
One day Justin, a mortgage broker we know, told us about a couple he met who made some disastrous home-building decisions. The couple bought a lot and hired an architect to design their 3,235 square-foot dream home. Early in the design process, they told their designer they wanted to keep construction costs below $700,000.
The couple gathered bids from a dozen contractors. To their surprise, the bids ranged from $589,000 to $970,000. Eventually, they found a contractor who agreed to build their new home for the price they wanted to pay: $700,000. The couple liked the contractor and decided to hire him.
But there was a big red flag. The contractor’s price was only $216 a square foot. The prevailing cost at the time for a home of their desired quality was $285 a square foot ($922,000 for the project).
Because of the extremely low bid and the builder’s lack of experience, Justin’s bank declined to fund the project. However, the couple quickly found another bank that approved the contractor and funded their project. So, they started building.
About 18 months later, Justin drove by the project site. The house was still under construction! On closer inspection, it didn’t look like anyone was working on it. The exposed framing, roof, and exterior siding were grey and weathered from exposure.
Just as Justin’s bank feared, the contractor had run out of money, abandoned the project, and disappeared. The lender soon called in the loan and foreclosed on the home.
The hopeful homeowners’ credit was ruined, all their time and money were lost, and their dream home turned into a huge liability. They paid the same price that many people unfortunately pay when working with cheap home builders and their new-home dream became a nightmare.
“The contractor had run out of money, abandoned the project, and disappeared. The lender soon called in the loan and foreclosed on the home.”
5 risks of hiring cheap home builders
When cheap home builders bid a project below their actual costs, they will run out of money before they complete the job. As the funds dry up, the contractor will be forced into a variety of less-than-favorable tactics, including:
- Trying to make the owner cover the shortfall through change orders
- Cutting corners and delivering a low-quality, problem-plagued home
- Taking forever to finish (while interest accumulates and loan terms run out)
- Abandoning the project before it’s finished, thus triggering a slew of lawsuits
- Going out of business during or shortly after building the home
If you want to avoid disasters like these while building your home, make sure the bid price is high enough for your contractor to complete your project. If not, you may find yourself struggling to find a competent builder who’s willing to fix the first contractor’s mess.
when a cheap contractor underbids, you pay the price
The reality is that contractors don’t determine the costs to build a new home. In a free market, supply and demand determine the cost of all goods and services—not individuals.
That means regardless of bid price, the hard costs for skilled workers, quality materials, and building permits will be nearly the same for every contractor (even the “cheap” home builders). If they underbid, the contractor isn’t going to pour in their own many to make up the difference, so the owner will have to make up the shortfall, or risk a failed project.
The main thing that will determine the ultimate cost to the client is not the original bid price; it’s the contractor’s ability to minimize waste, manage resources efficiently, and stay on schedule.
“If they underbid, the contractor isn’t going to pour in their own many to make up the difference, so the owner will have to make up the shortfall, or risk a failed project.”
common causes of underbidding in construction
Contracting is the only industry where the price is set before the product is produced and the costs are known. Anyone who has done any construction knows how hard it is to accurately estimate time and material—even for small jobs. The more experience and historical cost records a contractor has, the more accurate their cost estimates will be.
This points to the two most common causes of severe underbidding:
- Lack of experience
- Inadequate cost estimating processes
It can easily take a contractor more than 40 hours to gather and consolidate the hundreds of line items they need to make an accurate bid. Since they don’t close every bid, they don’t want to spend too much time estimating them.
So, some contractors guestimate the costs instead of compiling accurate material lists and getting solid bids from their subcontractors and suppliers. Others write low bids to hook clients into signing then boost their profits during construction with extensive change orders. This is why seemingly cheap home builders can end up costing you more than a reputable contractor with a higher initial bid.
why a higher bid can save you in the long run
Cheap home builders don’t have lower bids because they somehow get discounts on building permits, materials, and labor. Their bids are low because the contractor hasn’t included all the costs required to complete the project correctly.
Quality contractors with higher bids are often less expensive in the long run because they know what it takes to do the job right the first time. They’re also less likely to run out of money because they estimate the job properly, which lowers your risk and increases predictability.
So, even though bids vary wildly, the cost to complete a new home to the same quality will essentially be the same for all contractors. The main differences in their bid prices will be their ability and willingness to spend the time compiling accurate construction costs.
“Quality contractors with higher bids are often less expensive in the long run because they know what it takes to do the job right the first time”
how to know if a home builder's bid is too cheap
With a bit of research and some simple math, you can gather enough information to closely estimate what it should cost to build your new home. That price will include a general contractor’s fee which ranges from 15% – 20% or more.
There are four steps to determining a reasonably accurate cost to build your custom home. Start by defining the style and size of the home you want to build, along with any extras. Then, do some internet research.
1. research existing home prices
Just as new cars cost more than used cars, new homes cost more than “used homes.” In the Gold Country of California, state and local building-codes and fees have driven up the cost of new construction every year. So, buying a lot and building a new home now costs somewhere between 20% – 35% more than a buying comparable existing home and lot.
Home-buying sites like Zillow can show you what well-maintained, existing homes of your preferred size and style are selling for in your desired neighborhood. Only consider custom homes in good to excellent condition since mass-produced, tract homes are in a lower price class (custom homes cost about 50%+ more to build). The more comparable your selected homes are to your desired home, the better.
Identify 5 to 10 homes for sale that are similar to the one you want. Average the asking price per square foot for existing homes. Your price per square foot to build a new home will be roughly similar to the price per square foot to buy a comparable older home plus 20% – 35% for the luxuries of building a custom home.
Let’s do the math:
Average price per square foot for existing homes in desired neighborhood = $285 per square foot
$285 per square foot x your ideal home size of 2,500 square feet = $712,500
$712,500 + $178,125 (25% for custom build) = $890,625
So, your estimated whole-project budget based on existing homes would be $890,625
2. interview local home builders
Identify reputable, local contractors who build high-quality homes like the one you want to build. You can find them by searching online and via referrals from local real estate agents, construction loan officers, and friends, or friends of friends who’ve had homes built.
20 important questions to ask prospective home builders:
- How many years have you been in business? How many homes have you built?
- Are you licensed and insured?
- What do you feel makes you different from other home builders?
- Can you provide me references from previous customers?
- Am I able to view a home you’ve built for another customer?
- Do you build only from home plans you supply? Or can I provide my own set of plans?
- Have you built a home of this size, style, and quality before?
- What are your current bid prices per square foot for a home of this size, style, and quality?
- What standard features do your pre-designed homes include? What options and upgrades can I select?
- Who will oversee the construction of my home? Who should I contact with any questions I may have?
- How will we communicate during the project?
- How and when will the final price for my home be determined?
- When would you be able to begin construction?
- How long will it take to build my home?
- How many projects do you work on simultaneously?
- What’s your inspection process at key points of construction, at final walk-through, and to address any matters that need to be corrected or finalized?
- Can we make changes to our home during the build?
- Do you include landscaping (and pool if desired) in your design and bid process?
- Are you certified with lenders? Which ones?
- What type of new home warranty do you offer?
Don’t worry if you don’t cover each question during your conversation, but be sure to ask all contractors the same questions to get a true apples-to-apples comparison. And never feel bad about calling a contractor back if you forgot to ask something, or if you have a follow-up question.
Once you’ve narrowed your list down to about 3-5 finalists, average their price per square foot to obtain an average local contractor cost estimate.
3. interview construction loan officers
Once you know where and what you want to build, and have a rough idea what it will cost, it’s time to speak with a construction lender.
Construction lenders only work with qualified contractors whose bids are neither too high nor too low. Therefore, local lending professionals know what the current market price is for building custom homes.
Ask a few lenders what the average construction price per square foot is for loans they’re currently funding. Be sure to provide them as much detail as possible on the type, size, and quality of home you want to build to get the most accurate price. Average the prices from the different lenders to get the average lender cost estimate.
“Construction lenders only work with qualified contractors whose bids are neither too high nor too low.”
4. average the 3 estimates
Once you’ve gotten your existing home cost estimate, local contractor cost estimate, and average lender cost estimate, average the three to get a reasonably accurate estimate of the cost to build your new home. When numbers don’t agree, give more weight to the higher estimates.
Here’s an example of how to do this:
Existing home cost estimate = $890,625
+ Average local contractor cost estimate = $895,000
+ Average lender cost estimate = $900,000
Total = $2,685,625
Divide total by 3 (number of estimates used to get total) = $895,208
Your estimated cost to build is $895,208
screen out unrealistically cheap home builders to select your finalists
With this information you can screen out cheap home builders with unrealistically low bids (10% or more below your estimated cost should raise a red flag). It will also allow you to identify the competent and honest contractors whose bids fall within your estimated cost range.
Then you can have in-depth conversations with the finalists and decide which one has the best construction-management team and process.
Discover a proven process that makes it easy to plan, budget, and build your dream project here.
