Modular Construction Finance – A Sector For The Mainstream?

News broke recently about the real estate division of Investec providing a £10.8m debt facility for a modular student development in Guildford. This is to my knowledge the banking group’s first foray into funding UK modular construction.

Modular construction is increasingly popular with UK residential developers. It entails the fabrication of a building’s core components in a factory and their on-site assembly. The practice carries a number of benefits including:

Shorter development cycles

Multiple components can be produced in tandem rather than consecutively. Their construction indoors means adverse weather conditions do not impact on development progress.

Reduced environmental impact

Modular construction methods use up to 60% less energy than traditional processes, less raw materials and/or significantly more recyclable products. As components are pre-engineered in a factory, transportation requirements and site disruption are reduced and wastage minimised.

Lower development costs and reduced project risk

Developments built faster, more efficiently and with less potential for unpredictable disruption should cost less and, logic would dictate, present less risk to the project funder.

But hold on just for a second. One of the key reasons I believe ‘traditional’ finance has been slow to embrace ‘the next big thing’ in residential development, is that modular construction actually carries a broader set of risks than conventional construction, not narrower.

For a start, lenders need to be comfortable with the fact that works are being carried out off site. Generally, under the traditional model, every pound spent on-site improves the site’s value and reduces its risk. Conversely, the modular approach draws significant funds to the construction of modules off-site, meaning significant capital expenditure before the lender’s security improves.

Add to this the additional due diligence that needs conducting; the monitoring of progress at multiple locations; the increased reliance on individual entities rather than a sole operating business…Suddenly the loan administration becomes more complex and, potentially, more risky.

Investec’s deal suggests they feel the benefits of financing modular construction outweigh its challenges. This is something we at Hilltop have understood for some time:

Case Study 1 – Ashford

Pascoe Homes use light gauge steel superstructures produced using recycled materials, engineered to last in excess of 200 years and with over 80% of the building recyclable at the end of its life.

Case Study 2 – South Molton

Our Sponsor Nalu’s development extensively uses Structural Insulated Panels (SIPs) – insulated foam sandwiched between engineered wooden boards that require 50% less energy to maintain heating temperature – as a key component of its net zero-carbon houses.

Investec have expressed their intention of growing their modular residential construction finance portfolio. The big question is how many other banks will follow suit? The rewards are definitely there, but will traditional lenders build up the appetite to wholeheartedly entertain the underwriting process required in this sector?

As a specialist SME lender we approach such opportunities on a case-by-case basis. It’s the only way, given their intricacies. Our ‘Smart Capital’ specifically addresses every element of the development cycle and, by its very nature, assumes greater risk. 18 months down the line both our modular projects are progressing according to schedule and within budget, with substantial eco-friendly credentials…