QHow can a builder determine how much to pay him/herself
out of the company profits versus re-investing it in the company?
A: What a tough question! Most builders are set up with the tax structure of an S Corporation and the rule is that you need to pay yourself a “reasonable” salary. The definition of reasonable is subjective and that is DEFINETLY one to talk through with your tax advisor. When it comes to how much to invest back into the company versus taking it out, we are always fans of having a significant reserve in case an opportunity comes up. However, you need to also pay yourself and this can become a careful balance. Whenever we meet with our clients, we ask them what their pipeline looks like related to new home builds, specs and land purchases. Virtually every builder finances these types of investments with a loan. Because the banking industry normally requires both liquidity and the ability to service the debt, builders again find themselves in a careful balancing act. When you are investing your own money, you need to run the calculation on your return on your investment. For example, if you have invested $100,000 in a spec house with a $150,000 loan, the question needs to be asked how much can I sell it for? When will it sell? How much am I getting related to a return on my investment as a percentage? We’ve run these calculations multiple times for builders and what they think is a great deal, simply turns out to be a good deal once we run the numbers. The numbers don’t lie so every investment you do has to be an acceptable return on that investment. As your company grows, it is also important to take risk off the table and invest it in non-real estate activities. Being diversified always makes things less stressful during downturns in the economy.
QWhat advice would you give to small companies (one to
three full-time employees) to enhance their profitability and safeguard their assets?
A: Simple advice: Stay on top of your cash flow! We see a lot of small companies that have initial success and then want to double down and take out more loans than they can handle. Growth is a great thing but controlled and sustainable growth is a better long-term solution. Take advantage of advice from seasoned builders and make sure you know what is going on with all aspects of your company. If you can’t do it with a small staff, how can you expect to do it with a larger one?
QIs having employees versus using all subcontractors better
for a builder? If so, why? And, when using either, what must a builder keep track of for each?
A: Employees are your #1 asset but they can be expensive! With the FICA match, insurance requirements, and general overhead costs, one must be careful when deciding whether to hire people as independent contractors versus hiring employees. Make sure you understand which scenario will be saving you money. The Department of Labor has specific rules on what constitutes an independent contractor versus an employee. In the building industry, most labor related to projects is considered independent contractors with the exception of Supervisors, which are normally employees. Additionally, office staff are typically employees. It is critical that you have a rock solid tracking system on time and expenses and that your payroll is done by someone who knows what they are doing! We have seen time and time again builders that pay someone and then fail to send in the necessary paperwork to the government resulting in thousands of dollars in fines and penalties simply because they didn’t understand the reporting requirements. Have a good tracking system is a must for any builder.
QS Corp, C Corp, LLC -How do builders determine what is
the best classification for their business?
A: The vast majority of builders are S Corporations in which they take a reasonable salary and then take distributions out FICA tax-free. C Corporations are normally not a good business model for builders since it requires you to pay taxes on the dividends you pay out along with the taxes on your W-2 wages. LLC’s (i. e. Partnerships) are usually used when investing in land and for more passive activities.
QAnything else builders should keep in mind in terms of running a sustainable business?
A: As you are growing, make sure you are running the business with knowledge in all aspects of the business before you take steps toward significant growth. Your cash flow is vital and needs to be monitored on a weekly basis. When investing in any building project or capital expenditure, run the real numbers to make sure it is a good financial fit for your company. In addition, take advantage of the numerous classes provided by your local Home Builders Association and hire an advisor