By Evan Andrade, CHBA Economist
Lack of access to proper construction financing products for factory-built construction is one of the major factors preventing greater industry growth in Canada. The challenge was one of several flagged by CHBA and its Modular Construction Council in CHBA’s Sector Transition Strategy.
There are legal differences between real property and chattels as well as lending practices that developed over time to support traditional site construction – which has become status quo. As a result, modules under construction in the factory or in transport to the installation site have been unable to secure traditional lending methods, since they aren’t considered real property until affixed to a permanent foundation. This means that funds can only disbursed to the builder when the modules are attached to the foundation and become real property.
The issue with this is that the capital that a modular builder needs during production must come internally before being compensated upon project completion. This is one cashflow risk that reduces the attraction of investing more into modular construction.
However, there are new financial products arriving that can help smooth the cash flow issues, allowing modular builders access to a steady stream of payments prior to and during the production of the modules. Two of CHBA’s Alliance Network Members, Canada Mortgage and Housing Corp. (CMHC) and RBC Royal Bank, have relatively new products geared specifically to financing residential modular construction.
Performance bonding allows for financing
Still in its pilot stage, the CMHC is attempting to fill an industry gap with a new insurance program for construction loans specific to modular multi-unit rental buildings of five units or more. Within their mandate, outlined by statutes in the National Housing Act, CMHC is unable to insure non-mortgage loans and can only insure new construction loans up to the amount of costs in place. To overcome this, the pilot program allows modular factories to get a performance bond from a third-party surety. This bonding is insurance that the modules will be completed to specification. The typical cost of the bonding ranges between 0.5 and two per cent of the contract value and depends on the factory’s project history and company financials. CMHC is then able to insure the construction loan, using the bonding as collateral, and work with the lender to make advances based the amount of bonding insurance in place. This means that the factory is able to receive funds prior to the modules being affixed to the ground.
While modular construction is not new, CMHC has little historical precedence that involve this construction method. It’s one reason why the pilot program is narrowly available for modular rental projects of five units or more. CMHC and its partnered lenders, while interested in supporting modular, are using this pilot program to better understand its unique risks. The multiple meetings with lenders and manufacturers throughout the application process will be used to refine CMHC’s internal processes, which have yet to be formalized. Two eligibility requirements have been finalized, though: Modules must be CSA labelled, and must be manufactured in Canada by a Canadian company.
The performance bond does not only allow the manufacturer to access funding but also allows the projects to benefit from the flexibilities of CMHC’s MLI Select. This includes larger leverage, lower overall borrowing costs and longer-term amortizations of up to 50 years. While the benefits will vary from project to project, the uptake for MLI Select is very high. CMHC feels that there is a strong likelihood that the benefits of construction loan insurance outweigh the cost of the performance bond – improving the project’s pro forma.
CMHC presented the product at CHBA’s Modular Construction Council meeting in October, where they were provided feedback on how it could be made more attractive, supportive and more broadly applicable to the sector. We look forward to the evolution of this product.
Earlier access to mortgage funds
As a separate product, RBC has expanded its residential lending suite of products to support retail individuals purchasing a detached or multi-unit (up to six units) modular building. Working with a growing list of pre-approved modular manufacturers, RBC can advance the contract amount to the manufacturer in tranches as stipulated in the purchase agreement. Typically, this gives the manufacturer access to 20 per cent of the mortgage funds before production begins, 20 per cent when all modules make it onto the production line, 40 per cent when the modules are complete, and 20 per cent when the modules are finally affixed to the foundation. These advances illustrate how lenders are willing to assume additional risk to support modular or off-site construction. This advance release of funds gives builders more cashflow to manage their trades, materials and other business costs.
The maximum leverage RBC can extend depends on the type of building being purchased. With insurance, buildings with two or fewer units can borrow 95 per cent of the property’s value while buildings with three or four units can borrow up to 90 per cent. A 20-per-cent down payment is required for buildings of five or six units. Finally, in line with new refinancing programs, buyers can access 90 per cent of the property value up to $2 million to build a secondary suite for a family member or relative.
For those looking to join RBC’s network of pre-approved modular manufacturers, there are some simple requirements. The details of the down payment structure in the agreement to purchase and sale needs to be accessible by RBC’s underwriters. The manufacturer must have transporters insurance with at least $5 million in liability. Finally, the builder must be in good standing with a provincial new home warranty program. Additionally, builders should be comfortable with RBC appraisers inspecting modules at different stages of production and installation to ensure disbursements are made on schedule. CHBA’s Modular Construction Council was pleased to see the advancements in this product when it was presented at the meetings in October – members have already started to engage RBC to secure funding and to help refine the offering.
Steps in the right direction
It is well known that Canada needs to address the systemic problems that prevent building needed housing supply at attainable prices. By alleviating some of the financial challenges that modular manufacturers face and providing greater certainty in business cash flow, these two products are step in the right direction.
