Modular Is On The Rise, But Lenders Are Hesitant To Put The Pieces Together

Modular construction is having a moment, touted by many as a solution to the rising costs and yawning construction timelines that plague just about every development in the U.S., but it is not without its own considerations, including building credibility among lenders.

Prefabricated and modular construction are increasingly popular for affordable and below market-rate housing developers in the Bay Area, as rising construction costs make it difficult to build economically while maintaining profitability.

“We want to target the 'lost middle,'” oWOW Development President Andy Ball said during a panel discussion at Bisnow's Bay Area Prefab and Modular Construction Summit at the JW Marriott in San Francisco.

Ball's company is building a mass timber project at 1510 Webster St. in Oakland with 236 apartment units, 42 of which will be income-restricted.

However, the technology is relatively new, and in the eyes of some,  unproven, which can make it a challenge to secure funding.

“On the front end, you have the lending community wondering, 'What is this stuff?'” Ball said.

Some funding problems occur because parts of the lending community have misconceptions about construction alternatives like mass timber, often lumping it in with other types of lumber, Ball said.

Those misconceptions can often bleed into concerns about the product’s flammability, for example, leading to headaches with lenders, as well as in the permitting process with city officials, Ball said.

“The codes are not adequate to the type of product,” Ball said. “There’s a lot of education to be done.”

Tidewater Capital principal Ross Stackhouse echoed these frustrations in a separate panel at the event, on the subject of growing pains in the contracting and financing process.

“That was hard for us, early on,” Stackhouse said. “There was a lot of education and patience with lenders and equity partners.”   

Stackhouse said that one issue lenders have is with the different construction timelines common in modular builds, as the financing process for traditional construction financing allows for lenders to provide capital in smaller draw packages, adding more as the project progresses, which increases collateral.

For modular construction, much of the cost is required upfront.

“Proving you can deliver on an unproven market is essential, and it’s usually the lender’s first question,” Stackhouse said.

Regardless of its challenges, modular construction is on the rise.

A recent report from ResearchAndMarkets.com estimated that the global market for the segment is on track to hit nearly $154B by the 2026, growing 6.4% from today, as reported by Yahoo Finance.

Building affordable product also places limits on which lenders developers can turn to, Eden Housing Senior Vice President of Real Estate Development Andrea Osgood said.

Republic Urban Properties President and Managing Partner Michael Van Every took a dimmer view of modular construction, noting that cost challenges are one of the biggest hurdles in development, regardless of the construction type.

“If I can’t get people to hold pricing, it doesn’t matter what the technology is,” he said. “What is the commodity price? How can I lock it in?” 

“Signing change orders sucks.”