Money in the Walls: How Green Factory-Based Construction Can Improve Developer Returns

The latest annual report of Real estate advisors highlights ten major issues expected to impact the housing industry by 2024, but developers are painfully familiar with at least two of them: labor shortages and skyrocketing capital costs.

Current market conditions illustrate the case for green factory construction as an effective solution for developers, especially those who have put projects on hold due to rising interest rates and dried up investor pools. Switching from factory construction to on-site construction reduces construction costs by 20% and significantly improves delivery time; and by using green materials, developers can create new financing options that, together, are shaking up project economics.

Addressing a declining workforce and rising labor costs

The construction industry in the United States is facing an extreme labor shortage, which is grossly inadequate 650,000 workers needed to complete critical housing and infrastructure projects across the country. The root cause of this shortage is multi-faceted – but is largely driven by an aging workforce and a lack of interest from young talent. The result is a sharp increase in labor costs and longer construction times. U.S. developers spent an additional $30 to $40 billion in 2022, dramatically impacting the bottom line and the ability to get new projects financed. And the problem is only getting worse.

Factory-built homes are not new, but they are severely underutilized by developers for multifamily construction. First, factory construction reduces labor costs by making work more efficient and tapping into labor resources that traditional construction cannot access. Traditional construction requires workers to move from home to home and project to project – spending less time actually building. And the itinerant nature of the work makes it unattractive to a large portion of the workforce.

Good factory builders, on the other hand, operate like car production lines, with the structure shifting to workers who are specialized and stationary. These workers produce more per labor hour, which means less labor costs per square meter of structures built. And because the work is done in one place and in more pleasant and controlled factory conditions, it is easier to attract talent, especially people who would not normally consider construction as a profession, such as women and younger workers.

Time is also money. Building a factory not only gives a developer confidence in delivery times by avoiding bad weather or schedule delays; it can also reduce construction times and the number of skilled labor hours by up to 50%. Shortening construction time means less project overhead and less interest transfer. These are savings that go directly to a developer’s returns.

Green isn’t just the color of money – it’s the source of untapped funding

In addition to higher development costs, projects are also being sidelined due to reduced availability of bank financing, higher interest rates and investors unwilling to pick up the slack. Just a few years ago a developer could borrow up to 80 percent of the project cost, but in the current economic climate only 50-60 percent of a project is likely to be financed, leaving a significant gap. Green factory construction can also be a solution here. Energy-efficient homes open the door to new and better financing options.

There are innovative factory builders who use materials and assembly methods that enable significant energy savings that last the life of the home or building. The energy efficiency of this type of construction makes it eligible for “green” financing. Green bondsfor example, are intended to raise money for climate and environmental projects, and they enable sustainably minded investors to fill the gap left by traditional investors.

By reducing the overall cost of a project through labor and material savings and then adding better financing options, a developer can once again deliver projects that meet financial goals. For example, take a project with a total cost of €50 million. With traditional on-site construction and current capital costs, this project may only yield an unattractive 15% IRR. But consider a scenario where factory construction allows a developer to reduce the total cost of the project by 10% or more and also access green financing to cover more than 30% – that same project would have an IRR of more can yield more than 30%.

Given market conditions, it’s no surprise that multifamily construction starts are down substantially, but not because of a lack of demand: There is an estimated shortage of 3.8 million homes in the US. In other words, there are opportunities for developers who can structure economically viable projects. With the right factory-based, durable builder it is possible to return to strong IRRs and durable gain.

Chris Anderson is the CEO of Vantem.

This column does not necessarily reflect the opinion of HousingWire’s editorial staff and its owners.

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