Modular construction can significantly shorten project schedules and accelerate income generation. In some cases, it may also reduce construction costs. These potential advantages make modular construction appealing to developers, but access to commercial financing remains one of the largest institutional barriers to modular or off-site construction.
This article compares the key financial and cash flow requirements of traditional site-built construction to modular construction.
Specifically, a cash deployment schedule has been developed comparing site-built construction to modular construction from the developer’s perspective. For most projects, the developer decides which delivery method to use, and this decision is often determined by the amount of equity the developer must invest in the project for costs not covered by the construction loan.
Financing Challenges in Modular Construction
For each project, materials must be purchased and production lines reconfigured months ahead of fabrication, since materials alone can account for 60% or more of the total job cost. Consequently, manufacturers require large upfront deposits, often as high as 30% or more of the off-site contract. Given the capital-intensive nature of modular construction, regular progress payments are essential to maintain cash flow.
Off-site progress verification and past instances of financial distress in construction result in some commercial lenders rejecting modular projects. Many lenders that do approve modular projects often require developers to bear additional risks, such as line
reservation fees and material deposits 3-6 months in advance.
As an unsecured loan, modular financing often comes with higher interest rates and lower loan amounts. Additionally, modular manufacturers typically discourage retainage as suppliers, further increasing developers’ equity requirements, particularly in the early stages of the project.1
Comparison Methods
To effectively compare the two different types of construction methods, finance and cash flow data was collected from factory visits and interviews were conducted with seven large modular manufacturers.
Together, these manufacturers have completed more than 50 commercial multi-family projects since 2015, averaging 150,000 square feet each.
Data was also collected from interviews with three lenders specializing in modular financing.
A cash deployment schedule was then developed comparing site-built construction to modular construction using budgets and construction schedules from two multi-family project case studies.2
Results
Manufacturers included a combination of modular suppliers, acting as suppliers or prime contractors or developers, and were primarily producers of volumetric modular units for multi-family construction.
Most manufacturers used machine-assisted manual assembly, producing 2-3 modules per day complete with interior finishes and exterior weatherproofing. One manufacturer used semi-automated assembly, producing 3-5 modules per day. Module construction costs ranged from $100-$180 per square foot and $5,000-$10,000 per module for transportation and placement onsite.
Combined with onsite construction, total project construction costs for modular construction were generally 5-10% less than site-built construction (range -20% to +10%).
Site schedules for construction averaged 11 months (range 7-15 months), which is approximately 30% faster than site-built construction (range -20% to -50%).3
Since the off-site portion of the project is considered unsecured, loan-to-cost ratios for modular projects were on average 5-10% lower than comparable site-built projects. As a result, financing available for modular projects was lower, requiring more equity investment from the developer.
Often, the unsecured portion of the construction loan covering the modular work was underwritten against the developer’s credit, resulting in higher interest rates.
A letter-of-intent and non-refundable deposit of 5% of the modular contract is usually required six months ahead of production. A 25% (or greater) material deposit is usually required three months ahead of production. Often, both line reservation and material deposits are paid by the developer before project financing is available.4
In parallel with onsite foundation work, modules progress through 2-3 factory workstations per day and are finished in approximately 10-15 days. With machine-assisted manual assembly, manufacturers can produce 2-3 finished modules per day or 40 modules per month on average.
There are online fees of 30-35% for each module start and offline fees of 30-35% for each module completion. Manufacturers generally invoice for module starts and completions every 15-30 days.
The final 5-10% of the modular contract is usually billed following module transport and placement onsite, provided transportation and placement is included in the modular scope. As suppliers, manufacturers typically discourage retainage on progress payments.
An advantage of modular construction is the ability to lock in a fixed-price contract for the off-site portion of work 3-6 months before the start of construction.5 For most projects, the modular portion of work is approximately 40-60% of the total project construction cost.6
As a result, manufacturers most often have owner-direct contracts with the developer. While this form of delivery bypasses the GC’s markup on the off-site work, the developer assumes more risk and must play a greater role in project coordination.
Site-built Case Study
The site-built case study explores a 200-unit multi-family building in Seattle, WA. The building consists of six stories of Type-III residential over one story of Type-I commercial podium. The duration of the project was 21 months, with construction cost at completion (in 2023) totaling $45 million.7
Using control budgets and construction schedules provided by the GC, a cost-loaded schedule and project cash flow curve were developed. The cost-loaded schedule (Exhibit 1) identifies each of the major construction activities, when each activity occurs, the duration of each activity, and the cost of each activity as a percentage of the total construction cost.
From this information, the value of work completed during each 30-day “draw” period can be determined. The value of work completed in each 30-day draw period is an approximation for what the developer can expect to pay to the GC and its subcontractors and suppliers each month.
As shown in Exhibit 2, construction costs for the site-built project average more than $2 million per month and can exceed $3 million per month.
To absorb such a cash flow burden during construction, developers often secure commercial financing, which typically covers up to 80% of the
construction cost.8 For this site-built project, a 75% loan-to-cost ratio provides approximately $33.8 million in financing for a $45 million project.
Loan proceeds are released after all of the developer’s equity funds have been used or as a percentage of the value of work completed each month as verified by lender draw inspections. As loan funds are released, the developer incurs interest costs on the cumulative amount of funds borrowed during the project, which can either be paid in cash each month (e.g., interest carry) or paid from an interest reserve.
If, for example, the developer’s cash flow requirement for work completed in month 12 is $3.2 million, or 7.2% of construction cost, then the developer may request disbursement of $2.4 million, or 7.2% of the construction loan.
Given that the total value of work completed by the end of month 12 is $24.3 million, or 54.1% of construction costs, the developer may have requested disbursement of $18.2 million, or 54.1% of the construction loan by the end of month 12.
As a result, the developer may incur an interest expense of roughly $121,600 for the cumulative amount of funds borrowed by the end of month 12 (8% APR).
Of note, developers often withhold retainage on contractor payments until the project is substantially complete. Retainage amounts may vary but are typically 5-10% of the construction contract.9 Considering only these factors, the developer’s net cash flow for month 12 is summarized in Exhibit 3.
The developer’s monthly and cumulative cash flow requirements for the $45 million, 21-month site-built project are shown in Exhibit 4. The developer’s equity requirement for construction is approximately $13.7 million. Roughly $4.8 million (35%) of this equity is deferred until the end of the project in the form of released retainage. The total interest carry during the project is $2.3 million.10
Modular Case Study
The modular case study is a 200-unit multi-family building in Minneapolis, MN. The building consists of five stories of Type-III residential over one story of Type-I commercial podium. The duration of the project was 15 months, with construction cost at completion (in 2023) totaling approximately $45 million.11
Similar to the site-built case study, a cost-loaded schedule and project cash flow curve were developed for the modular case study. Overall, the off-site scope for 200 residential units on floors 2-6 was approximately 60% of the total construction cost ($27 million).
As shown in Exhibit 5, the timing, duration, and cost of onsite construction activities in the modular case study were similar to those same activities in the site-built case study. Exceptions include mechanical, electrical, and plumbing systems and interior finishes.
Since mechanical, electrical, and plumbing systems and interior finishes for residential units were completed off-site in the factory, onsite scopes for those were largely reduced to common areas and corridors. Lobbies, offices, retail, and other common areas were located on the site-built ground floor. Residential corridors in modular units were unfinished in the factory to allow for mechanical, electrical, and plumbing connections onsite.
Overhead and profit was also reduced due in part to a construction schedule that was six months shorter and subsequent reductions in jobsite overhead (e.g., general conditions). Overhead and profit was also reduced due to the consolidation of GC and subcontractor markups in a single modular contract with few (if any) allowances for change orders or contingency.12