The modular challenge: A lender’s perspective
The benefits of modular construction are clear. The speed, quality of materials/finishes and non-reliance on availability of specific types of labor. This type of construction is already prevalent in some commercial sectors such as hotels and student accommodation. However, it is not readily fundable in the residential sector yet. It is also difficult to predict when this will change.
The lender’s challenge
- Development lenders traditionally fund construction works in arrears – from a lender’s point of view this makes sense as their increased financial commitment to the project runs concurrently with incremental increases in the value of the property. Conversely, modular construction relies on forward funding of off-site construction. Assessment of production facility viability is something development lenders may not embrace in the short term. This might be because some of these facilities are not based in the UK.
- To exit a development finance facility, funders need to be confident in a high street lender. They will need reassurance of a residential or buy to let mortgage to a purchaser. If the Council of Mortgage Lenders are going to be able to fully endorse this method of non-standard construction, they are likely at the minimum to want:
- An accreditation scheme to assess quality of construction (there is a Buildoffsite Property Assurance Scheme but this needs to be adopted across the industry)
- To be satisfied that the lifespan of the construction is equivalent to standard methods of construction and that maintenance is financially viable, so that lending criteria can use the same assumptions
- Latent warranty insurance providers such as NHBC to provide 10 year products as they do with properties developed using standard construction methods (Legal & General provide such a product for modular units produced at their own factory)
A short term solution is that development lender’s finance the modular construction, but the developer finances the acquisition of the land. The lender can therefore assess its exposure against the value of the land. This is even if issues arise with the off-site construction. This is more likely to work only in southern England where land values make up a significant proportion of overall development costs. Alternatively, the developer could source specific funding for advance payments from lender assessing working capital. This could include SME lenders or those that deal with VAT or invoicing finance. Once the modular construction is on-site, these costs could be funded by the senior lender in the usual way.
The longer-term solution is for development lenders to either assess as a working capital facility. Evidently, production facilities are opening in the UK and insurers are providing specific products to cover non-performance/delivery. Consequently, development lenders will feel more comfortable in pursuing this route.
Despite the ease of the actual construction, there are still a number of hurdles to tackle when securing modular funding. Avamore is always keen to innovate however will continue to take a prudent approach, assessing modular deals on a case by case basis and in the context of project-specific risks. In summary, success depends on pieces of the development jigsaw falling into place. Several of which, however, is outside of a lender’s control.