CA considers an innovative idea to stimulate prefabricated housing

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In an effort to ease the state’s housing shortage, California is considering something unprecedented: getting into the construction insurance business.

Last week, Rep. Buffy Weeks, D-Oakland, and a bipartisan coalition of lawmakers introduced long awaited package of bills aimed at guiding real estate developers towards innovations that reduce construction costs, with a special focus on prefab construction.

Building homes in factories and then trucking them to where they are needed offers a wide range of potential benefits: faster construction, safer working conditions and lower overall costs, which should ultimately make housing more affordable.

But despite decades of hopes and expectations this promise never materialized on a large scale. Industry promoters point to regulatory and financial hurdles that prevent cost-effective mass production.

The six new bills aim to help the fledgling industry overcome these obstacles. Most would achieve this by standardizing or simplifying regulation. however Assembly Bill 2166 introduced by Weeks and Rep. Juan Carrillo, D-Palmdale, is different. Although details are still lacking, the bill aims to guarantee insurance compensation for entrepreneurs and lenders who are interested in building factories but still need guarantees to take the plunge.

Taking on the role of reinsurer—committing to a rescue at a particular critical point in the housing process—is a radical departure from almost anything the state has done before in its effort for years to reduce housing costs in California.

“This is the first time I’ve seen a state propose, draft and potentially implement something like this in terms of housing,” said Tyler Pullen, a researcher at UC Berkeley’s Center for Housing Innovation, which is providing technical assistance to Wicks and other lawmakers on the package of bills.

He added that while the bill was undoubtedly “the most open-ended and technically complex” of the legislative package, some version of the idea came up in nearly every interview he and his colleagues conducted with industry representatives as part of Turner’s recent report on industrialized construction.

“It may be one of the most impactful things, but it raises a lot of unknowns,” he said.

Avoid a vicious circle in construction

Construction is a risky business. Organizers are left without liquidity. Costs are skyrocketing. There are many lawsuits. Projects fail. A complex set of financial mechanisms exists to help everyone involved, from lenders and investors to the humblest subcontractor, minimize their exposure if things go wrong.

One of the most important levers is the bond, a financial agreement in which the insurer, in exchange for an upfront fee, agrees to pay if, for example, an electrical subcontractor defaults.

The bond-backed project is one that “brings peace of mind to both developers and lenders,” said Michael Merle, director of business development for Autovol, an Idaho-based homebuilder. “If any part of the project fails, they won’t have to take the losses.”

Depending on the nature of the project and the contract, a bond can cost a factory between three-quarters of a percentage point and 3 percent of the total contract costs, he explained. For a factory working on a large apartment project, those smaller percentage points can add up to a quarter of a million dollars or more.

But that’s if the factory can get the bond. They often don’t get it. because? The bill’s text refers to a “positive feedback loop” in which the industrialized construction industry appears to be caught.

This doom loop looks like this:

An entrepreneur or lender is wary of starting a project with a housing factory, a relatively new player in a relatively new sector that has experienced some known failures therefore requiring the factory to approve the design. The factory could convince a bond company to provide such coverage if it had a track record of financial success. But it’s gone because developers and lenders are distrustful. Without a guarantee, the factory cannot attract customers. And without customers, the factory eventually fails.

Carrillo and Weeks’ bill calls for the state to insure insurers. If a project fails and the bond is fulfilled, the state will cover a portion of the payment under certain extreme circumstances (the size of that portion and what counts as “extreme” has yet to be determined).

The main hope behind this legislation is that by making it more convenient for insurance companies to offer policies, developers will be more comfortable signing contracts with factories, factories will have a more stable business, and ultimately they will be able to increase production, reduce costs and begin to fulfill the long-touted promise of mass housing production. End of the vicious cycle.

Although the state of California has never taken on such a role before, the idea ties in with other policies at both the state and federal levels.

The US Department of Veterans Affairs and Fannie Mae and Freddie Mac, two federally sponsored companies, guarantee private mortgages to promote access to larger and more affordable loans for American homebuyers. The Small Business Administration guarantees surety bonds for (not surprisingly) small businesses. The state of California has a loan guarantee program for construction of health centers but none for the real estate sector. A bill presented last year, which would have replicated this model for affordable housing projects, was not voted on in the Assembly.

The idea of ​​guaranteeing housing factory bonds is “extremely innovative,” said Jan Lindenthal-Cox, chief investment officer of the San Francisco Housing Accelerator Fund, a nonprofit that directs philanthropic funds to affordable housing projects that reduce costs. “This is necessary if we really want to grow the sector.”

Will the money be better than the warranty?

But even some proponents of prefab construction are skeptical.

The Carrillo-Wicks bill aims to encourage real estate developers who are interested in prefab but question its financial viability. That’s not the case, however, with Mutual Housing California, a Sacramento-based nonprofit dedicated to developing affordable housing that has committed to using manufactured housing for most of its future projects.

“Who are we incentivizing?” asked Ryan Cassidy, vice president of real estate at Mutual, referring to the bill. “We’re incentivizing developers whose sole purpose is to keep the factory running. In my opinion, that’s a very unwise developer.”

Also, this approach will help new factories with little experience get more customers, he said. Mutual Housing hired Guerdon Modular Buildings, another Idaho-based builder with one of the industry’s longest track records. “I don’t think the risk in prefab is whether Guerdon will go bankrupt.”

Cassidy said he would prefer a “more direct” approach, simply giving more money to prefab projects.

Autovol’s Merle agreed that the bond proposal would likely benefit newer manufacturers. Autovol, another industry heavyweight, rarely has trouble getting coverage when it needs it, he said. And because of its relative financial stability and long-term customer base, it can go without a guarantee in most cases.

“If you only have two or three projects and a few years of experience, those are the ones that require commitment,” he said. But for the same reason, “they are the ones who have the most difficulty getting it.”

It’s unclear whether other lawmakers will be ready to fully support the state with an industry that’s still proving itself. The bill is scheduled for its first legislative committee hearing in late April. The total amount the bill could mean for state taxpayers is not yet known. However, for lawmakers who are not convinced, one possible argument in its favor is that the need for this program may be temporary.

The premise of the bill is that “the state can support the early adopters of this technology while the manufactured housing industry builds its reputation,” Terner’s Pullen said. “This is a problem that, over time, can be solved in the private market.”

If all goes well in the sector, private insurers could offer coverage to factories without government support, and entrepreneurs and lenders could stop requiring this extra protection. For now, that remains a big unknown.