Banking & Finance

Financing Modular Construction of New Housing

Modular, or off-site, construction is a hot topic at the moment. There has been a constant stream of announcements of new projects, including significantly that Japan’s largest house builder, Sekisui House, has agreed a £90m deal with Urban Splash and Homes England to deliver new modular homes.
Of course modular construction techniques have been with us for many years, but there does seem to be an increasing seed change in attitude and recognition of the advantages in adopting this methodology.

The advantages include a quicker build time, greater cost efficiency (at least in principle) and cost/quality control, reduced carbon footprint and reduced risks associated with on-site construction, including delays due to weather and health and safety issues.

There are however of course a number of challenges including increased up-front costs associated with the build of manufacturing facilities (potentially alleviated through housing providers clubbing together to share such costs), lack of an appropriately skilled workforce, increased transport costs and reduced scope to address variations during the construction process. Design control will also be key.

The other big challenge is the availability of finance.

Funders face a number of challenges when looking to finance housing developments dependent on modular construction. These include:-

Transfer of risk: Under traditional procurement, a funder’s security over a development site will automatically catch housing build on the site as and when it is constructed. When however off-site construction methodology is used, title to the modular units will rest with the manufacturer until delivery and payment for the units. Funders/developers need to consider how to finance stage payments during the off-site construction period. Potentially this may need the use of advance payment bonds or similar.

Warranties and guarantees: In principle a home built in-doors in a modern factory should be finished to a higher standard than one constructed outside in the wind and rain applying traditional methods. Funders will however expect the quality to be underpinned with appropriate quality assurance standards and supported by warranties/guarantees underwritten by relevant levels of insurance. Am industry based accreditation scheme along the lines of NHBC would seem a natural progression.

Lifespan: Is the modular housing constructed to a standard that provides an adequate lifespan to support mortgage provision? Generally mortgage providers look for new housing to have a 100 year lifespan. However modular housing may be restricted to a shorter period potentially restricting the availability of mortgage finance. In turn, this may make modular based schemes unsuitable for private sale, and instead restrict their use to PRS or affordable housing provision.

Lack of familiarity of project monitors with modular based construction methodology, although this will naturally dissipate as such build methodology becomes increasingly common.

Reputation: There has been a traditional stigma associated with what is occasionally still maligned as ‘pre-fab’ construction methodology. This remains a hurdle but anyone making such a comparison is not comparing like with like and one would hope that given the design, quality and environmental benefits that can be delivered through modular construction this reticence can be demonstrated to be ill-founded.

There are therefore challenges to financing modular construction based projects. I would suggest however that there is no hurdle not capable of being overcome and that modular construction offers potentially a huge step-forward for housing supply.

Chris Dun, Partner, Brodies LLP 6 June 2019

Chris Dun

Partner at Brodies LLP
Chris Dun is a lawyer who specialises in real estate finance. He has a particular interest in housing finance, including build for sale, build for rent and social and affordable housing.
Chris Dun