If multifamily lenders ran an ice cream shop, they probably would say plain vanilla is better priced and more easily available than ever, but they’re having problems serving up a newer, more exotic flavor.
The amount of money loaned to multifamily developers rose 19% in 2018 to a record $339.2 billion and has continued to its growth this year, the Mortgage Bankers Association reports. Given two key fundamentals that drive lending—moderate interest rates and continued consumer demand—the prospects are good for developers to be able to continue tapping the markets for funds in 2020.
However, that growth comes with a caveat: The system works when the object of the loan is familiar. It’s not working as well now for newer products, in particular loans for modular construction.
Modular (also called “volumetric”) buildings are constructed out of modules manufactured in whole or in part at off-site factories. Modular techniques make it possible to erect a structure up to 50% faster than conventional methods and cut building costs by 20%, the consulting group McKinsey estimates. It believes modular construction could claim $130 billion worth of the combined U.S. and European construction markets by 2030—and save builders $22 billion in costs by that year. Modular is particularly attractive to developers who care about speed to occupancy. That’s why hotels and apartment projects are among the most popular modular jobs today.
The problem is that lenders aren’t as hip to modular work, says Kyung Kim, senior vice president at AVANA Capital, a project financier in Glendale, Ariz. At a presentation Nov. 5 in Boston during the Industrialized Wood-Based Construction Conference (IWBC), Kim said both imaginary and practical problems have made lenders shy.
Fuzzy Memories
Some lenders regard modular as a new concept, Kim said, not knowing that the first example of a prebuilt house dates at least to the 1830s and that Sears sold more than 500,000 prefabricated homes a century ago. There’s also a belief that modular construction is about mobile homes. A bit of teaching can knock down those misconceptions, Kim said, but that still leaves real challenges that have to be overcome in order to make loans for modular projects.
The first is the front-loaded draw schedule. On a typical project, the amount of money borrowed for a project grows slowly and consistently over time. But with modular, the majority of the funds that need to be borrowed get drawn very early in the process, because the borrower will need funds to simultaneously pay for planning, site prep, the construction of the modules, and the purchases of the fittings that go inside those modules. A lot of companies building the modules will ask for as much as 50% of their payment upfront, though bigger firms are more likely to accept pay-as-you-go terms.
For a real-life example, take The Graphic, a mixed-use complex in Boston that combined adaptive reuse of an old graphic arts building with a new structure containing 125 modular-built units. This recently completed three-year project shaved three to six months off what would have been the traditional construction schedule, said Kendra Halliwell, the architect, and Owen Huisenga, a representative of the general contractor, in a September presentation at WoodWorks’ Mid-Atlantic Wood Design Symposium. But that speed of construction also accelerated payouts. Once work started, monthly draws typically were two to three times higher early in the process, and they remained higher through to completion.
Locating the Asset
Then there’s another challenge: collateral. According to Kim, a lender is used to lending based on a piece of dirt. But in modular, a good part of the collateral moves around. During the entire operation, the modular collateral can be at the factory, on a truck, swinging on an installation crane at the jobsite, or finally put in place.
Modular lending specialist Tom Coronato of Citizens Bank, who spoke with Kim at the same IWBC session, said how and when funds get assigned is critical—“It makes or breaks the entire experience.” Citizens’ solution is a comprehensive loan that goes from closing on the original lot to the completion of construction. The package provides seed money for the builder and manufacturers to begin construction on the lot and start production of the home. It funds the manufacturer when the module is delivered to the site. And it pays the builder throughout to complete the project after the module has been delivered.
That raises the question of disruption during construction. What happens, Kim said, if the modular factory goes out of business while the project is underway? You’ll need to transport the assets to another factory or to the jobsite. You also would have to get a new modular manufacturer to take over, and that’s a chore.
There also is the question of finding general contractors who are fluent in modular—or even want to be. After all, if you do most of the construction in the factory, general contractors don’t have to do much work in the field, so their scope of work is lower. They might not like that and, as a result, demand higher pay than would seem logical. On the other hand, some general contractors are looking into creating their own subunits that specialize in modular.
Coronato said the banking industry has only a handful of people like him who specialize in modular construction lending. As a result, banks get nervous about the terms and end up refusing to get involved. That ultimately either kills the project or forces the developer to switch to on-site construction. Until bankers get more accustomed to serving up this new product, you can expect challenges.
