CA is mulling a first-of-its-kind idea to promote factory-built housing

from Ben ChristopherCalMatters

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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, Assemblywoman Buffy Weeks, D-Oakland, and a bipartisan coalition of lawmakers lifted the curtain on long awaited package of bills aims to push developers towards cost-cutting innovations in construction, with particular emphasis on factory-based 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 hope and hypethis promise never materialized at scale. Industry boosters point to regulatory and financial hurdles that stand in the way of cost-effective mass production.

Half a dozen new bills aim to help the fledgling industry overcome these hurdles. Most would do this by standardizing or reducing regulation. but one thing Assembly Bill 2166authored by Weeks and Assemblyman Juan Carrillo, D-Palmdale, is different. While details are still few and far between, the bill aims to ensure insurance payouts for builders and lenders who are interested in factory-based construction but still need a little extra collateral.

Taking on the role of reinsurer – committing to come to the financial rescue at a particular juncture in the housing development process – is a departure from almost anything the state has done before in its years of effort to reduce housing costs in California.

“This is the first time I’ve seen anything like this proposed, drafted and potentially implemented by a housing state,” said Tyler Pullen, a researcher at UC Berkeley’s Terner 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 is certainly 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 stakeholders as part of a recent Turner report on industrialized construction.

“It might be one of the things with the biggest impact, but there are a lot of open questions,” he said.

Avoiding a construction cycle

Construction is a risky venture. Developers run out of money. Cost overruns. There are many lawsuits. Projects fail. There is a complex set of financial levers that help everyone involved, from lenders and investors to the lowest subcontractor, minimize their exposure if things fall apart.

One of the most important of these levers is the surety bond, a financial arrangement where the insurer, in exchange for an upfront fee, agrees to pay if, say, an electrical subcontractor fails to deliver.

The bond project is one that “appeases developers and lenders,” said Michael Merle, director of business development at Autovol, an Idaho-based housing factory. “If any part of the project fails, they won’t be holding the bag.”

Depending on the nature of the project and the contract, a bond can cost a factory anywhere from three-quarters of a percentage point to 3 percent of the entire contract price, he said. For a factory working on a large apartment project, those fewer percentage points can add up to a quarter of a million dollars or more.

But that’s if the factory can even connect. Often they can’t. why not The text of the bill refers to a “self-reinforcing cycle” in which the industrialized construction industry appears to be stuck.

This doom loop looks like this:

A developer or project lender is wary of starting a project with a housing factory, a new player in a new industry that has seen some high profile failuresso it requires a factory to link the project. The factory could have convinced a warranty company to provide this coverage if it had a track record of financial success. But it is not because project developers and lenders are cautious. The lack of bonds for the factory means it cannot attract any business. Lack of business means the factory will eventually fail.

Carrillo and Weeks’ bill would have the state insure insurers. If a project fails and a bond is required, the state will cover a portion of the payout under certain extreme circumstances (the size of that portion and what qualifies as “extreme” have yet to be determined).

The biggest hope behind the legislation is that by making insurance companies more comfortable offering insurance, developers will feel more comfortable contracting with factories, factories will have a more stable business, and ultimately be able to increase production, lower costs and begin to fulfill the long-held promise of mass-produced housing. The Doom cycle is over.

Although the state of California has never taken on such a role before, the idea resonates 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 privately issued mortgages as a way to stimulate more abundant and cheaper credit for American homebuyers. The Small Business Administration guarantees surety bonds for (you guessed it) small businesses. The State of California operates a loan guarantee program for construction of a health facilitybut none for the housing industry. A bill last year, which would have replicated the model for affordable housing projects, died without a full Assembly vote.

The idea of ​​a housing factory warranty is “super innovative,” said Jan Lindenthal-Cox, chief investment officer at the San Francisco Housing Acceleration Fund, a nonprofit that directs philanthropic money to cost-cutting affordable housing projects. “This is necessary if you really want to scale the industry.”

Would money be more beneficial than commitment?

But even some proponents of off-site construction are skeptical.

The Carrillo-Wicks bill aims to encourage developers who are interested in building off-site but fear its financial viability. That doesn’t describe Mutual Housing California, a Sacramento-based affordable nonprofit that has committed to using factory-built housing for the majority of its future projects.

“Who are we incentivizing?” Ryan Cassidy, Mutual’s vice president of real estate, asked about the bill. “We’re incentivizing developers whose only choice is whether the factory stays in business. To me, that’s a developer that’s probably not very understanding.”

Likewise, the approach will help new factories with limited experience garner more business, he said. Mutual Housing contracted with Guerdon Modular Buildings, another Idaho-based manufacturer with one of the industry’s longest track records. “I don’t think the risk with manufactured housing is whether Guerdon goes out of business.”

Cassidy said he would prefer a “more direct” approach of simply giving more money to factory-built projects.

Autovol’s Merle agreed that the warranty offer is likely to benefit newer manufacturers. Autovol, another industry heavyweight, rarely has trouble getting coverage when it needs it, he said. And because of her relative financial stability and long-term client list, she can get by without a commitment more often than not.

“If you only have two or three projects and a couple of years behind you, those are the ones you need to commit to,” he said. But for the same reason, “these are the ones who struggle a lot to connect.”

It’s unclear whether other lawmakers will be willing to place the state’s full faith and credit on 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 put state taxpayers on the hook for remains an unanswered question. But for lawmakers unconvinced, one possible selling point is that the need for this program may be temporary.

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

If all goes well in the industry, private insurers may be happy to offer factories their coverage without government protection, and entrepreneurs and creditors may no longer insist on this extra level of protection. For now, that remains a big “if.”

This article was originally published on CalMatters and is republished under Creative Commons Attribution-NonCommercial-No Derivatives license.