Financing of modular homes

With increasing house prices and the government's housing targets, is the future in modular construction? The Government may think so as it wants to reach a target of 100,000 new modular homes by 2020.

Impetus is also provided by the House of Lords' Science and Technology Select Committee in their report "Off-site manufacture for construction: Building for Change" published on 19 July 2018. This report suggests that off-site manufacturing could provide a solution to the need for housing and identified the positives of modular homes whilst recognising that to increase the take-up of off-site manufacturing the industry will need to become more integrated. While there is potential growth in this sector, is the development finance market ready to fund modular residential developments?

Background

There are many reported advantages to modular construction. It has a quicker build time than traditional construction and is mooted as being far more efficient and providing better cost control and productivity than traditional construction. In addition, modular construction is not so significantly affected by a possible shortage of construction workers post-Brexit. All are elements which could help to address the UK's housing crisis.

The key to modular construction is that a significant part of the construction process is completed off-site. Whilst this leads to shorter build times on-site and a consequent reduction of environmental impacts associated with on-site construction, the manufacturing assembling time still needs to be factored in to the overall build programme.

Student accommodation is seen as one of the main areas where modular construction has a big impact. Given the assembly line nature of modular construction, it is perceived to be better than traditional construction at meeting target dates. The build to let housing and hotels sectors have also seen take-up of modular construction as these sectors are geared towards standardised models and layouts. The development at Creekside Wharf in Greenwich, which is one of the first build to rent schemes utilising modular construction and which is to be one of the tallest modular buildings in the UK is a good example.

Modular construction challenges

Will modular construction take off in the housing sector? For developers the challenge of modular developments is that the design has to be completed at the outset and agreed before the units are manufactured. Once the manufacturing process begins there is little scope to value engineer or alter the designs. Additionally, there may be significant upfront costs such as the cost of building the manufacturing plant in the first place (not many contractors will be able to afford to purchase their own manufacturing plant, although some contractors are actively looking to invest in their own manufacturing plants), the purchase of materials and the cost of training staff in new skills. Developers should also not underestimate the cost of transporting the modular units to site (some of considerable size and therefore requiring road closures or overnight transporting).

Financing of modular housing developments

Despite the arguments in favour of modular construction, there are a number of issues specific to modular construction in respect of new housing which funders need to address. One of those is the fact that the funder is lending against elements of the development which are being built off-site and away from the property over which they have their security. It is natural for lenders to be cautious and given that in general terms, their project monitors do not have the same level of experience with modular construction (compared with traditional construction), there is a perceived lack of confidence.

Whilst the acquisition of the development site is no different for modular construction or traditional construction, the funding for a modular construction scheme can be challenging. Monies will need to be advanced to contractors to pay for works taking place off-site which raises title and risk questions. Usually a funder is providing monies to enhance and add value to a site over which they have a charge. For modular construction, advanced monies are used to pay for works off-site and which initially do not increase the value of the development. There will be a requirement for advanced payment bonds and vesting certificates which will try to mitigate these risks.

In addition, there is a question over whether enough mortgage lenders will provide finance to homebuyers purchasing a new build property constructed through modular construction method. A development funder needs to know that the homes for which they are providing funding will be eligible for a mortgage. All of this uncertainty makes development funders less willing to take on the risk and fund such developments.

Another issue for funders is the security and recourse being offered. The availability of building warranties for new off-site manufacturers is a developing area. A substantial proportion of the development's liability rests with one sub-contractor. This is addressed by procuring bonds, parent company guarantees, etc but this is costly. In addition, there is a question over whether carrying out works to the modular units once the building is complete will negate any warranty or guarantee provided. Would a substantial refurbishment of the development void any provided warranties?

Going forward, it is currently unclear whether modular built homes will hold their value in the long-term and whether this might impact upon the mortgagee's ability to sell their modular built property.

Summary

As mentioned above, modular construction does appear to work best for the buy-to-let market which is being funded by institutional lenders. One reason for this could be that these units can be made on a large scale, designs can therefore be repeated, there are quicker build times and importantly, rents come in sooner.

Hopefully with more sizeable residential schemes coming on line, and the more common this type of construction becomes, lenders will start to feel more confident about funding modular residential developments.

Once development funders become comfortable with the risks and issues in modular developments, the more likely we are to see such residential schemes move forward.