Why Private Lenders Are Embracing Modular Construction

Bayport Funding CEO Marcia Kaufman on the benefits of prefab solutions for capital providers and borrowers.

Marcia Kaufman

Modular construction has already become more mainstream, according to Marcia Kaufman. Image courtesy of Bayport Funding

Alternative lenders are seeing an increase in multifamily deal prospects as institutional lenders tighten their underwriting standards or sit on the sidelines. Not every transaction or development proposal passes muster, however. One strategy that is getting a fair amount of interest from these lenders is modular construction. Pre-fabricated modules are cost-effective and allow for faster construction times. They are also highly flexible, which helps mitigate risk and allows for quick adjustments to changing conditions.

Multi-Housing News asked Bayport Funding CEO Marcia Kaufman to expand on why alternative lenders are embracing modular construction.

How is decreased liquidity impacting your private lending operation? 

Kaufman: Bayport has seen an increase in the number of borrowers turning to alternative/private lenders to move their multifamily projects forward. This may be due to banks sitting on the sidelines, and access to capital becoming limited.

We have seen an influx of seasoned real estate investors analyzing new multifamily transaction opportunities. The theory behind this influx is fundamental. If the analytics support the transaction today based on interest rates at the highest they have been for over a decade, then, if interest rates come down over the next few years, the cash flow will become even better.

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What type of multifamily projects currently appeal to you as a lender?

Kaufman: Private lenders’ criteria for financing multifamily projects hasn’t changed substantially over the past year, but macro conditions certainly have us considering very carefully whether a project is delivering on real demand. We want to finance projects in areas where there is a strong pipeline of renters, of course, but the experience level of the sponsor, sustainable components, and the project’s design and value-add potential are also major factors.

Our firm specializes in small balance multifamily bridge financing, which includes ground-up construction, mid-construction, acquisition and stabilization. We also don’t shy away from other types of opportunities and, in general, favorable financing terms and having a trusting relationship with borrowers can go a long way.

Modular construction has been gaining ground recently. Why should alternative lenders finance these projects? Are they a safe bet from a lender’s perspective

Kaufman: Lenders should be taking a good look at projects that employ modular construction. This delivery strategy is great for reducing risk and paves the way for faster construction times, improved quality control, and creation of value-add potential.

Another critical aspect of why developers and lenders are embracing modular construction is that the process is far less likely to be slowed down or delayed due to weather. In areas that are susceptible to hurricanes and other instances of inclement weather, the ability to construct these buildings off-site—such as in warehouses—means that timelines aren’t easily affected. Modular construction benefits both lenders and borrowers.

Tell us about a modular multifamily project you recently financed. What did the borrower need and how did you cater to their needs?

Kaufman: We work with a borrower who performs a significant amount of work in The Hamptons, N.Y. This borrower understands how cost-effective it can be to build modular housing and, in some of his projects, he has done either complete homes or the finishing works on a high-end property.

Through our work with this developer and his portfolio, we’ve seen that each project’s success with modular truly on how it is being deployed at the particular project. Modular can be brought in to perform high-end finishes, but affordable housing projects might only require one level of finishing. It’s important for the developers to understand the more cost-effective methods they want to employ, and then communicate that to their lenders so that all parties are aligned in the work being done.

There are still several misconceptions about this method that have left some developers wondering if this the way to go to meet their delivery, design, budget and schedule goals. What are the most frequent myths about modular building that you come across?

Kaufman: Many of the strategy’s benefits are well-understood broadly. I’ve heard it said that modular buildings aren’t durable, customizable, energy-efficient, safe and so on, but ultimately the practice has endured because these notions are untrue. Modular construction can be performed using high-quality and sustainable materials, and modular buildings can be far easier to customize and renovate as a direct result of how they’re constructed. Beyond that, they can be just as energy-efficient as any other building, and their cost-efficiency and ability to mitigate risk are why lenders find these projects attractive.

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How does lending for modular differ from conventional development projects?

Kaufman: There are aspects of modular construction that many lenders are either unfamiliar with or don’t fully understand. The difference when lending for modular is that lenders must not only do their due diligence on the sponsor, but they must also look into the history, financials and insurance of the modular company as well. It’s a different layer of diligence.

Additionally, a large part of a construction loan is not funded until the actual modules are delivered and installed on the site. This differs from the usual process of providing financing at certain milestones of a project, such as when you see foundations, the steel beams and walls are put up, and so on. Understanding how to lend to modular is the biggest hurdle for today’s lenders, but I expect that, as more lenders learn the process, more will become open to it.

Do you expect modular to become a significant alternative in the development of multifamily housing?

Kaufman: Modular construction has already become more mainstream, particularly due to how many multifamily developments are built horizontally rather than vertically. In areas of particularly high demand—such as Brooklyn, where we’re seeing a tremendous amount of activity—it makes sense to continue employing modular construction due to its cost-effectiveness. It all comes down to cost efficiency for developers, and modular is a fantastic avenue for the multifamily sector to achieve this.

Additionally, the delivery method will likely retain its newfound popularity as individual states approach their deadlines for local sustainability initiatives, some of which are only a few years away. Modular will be key to expanding portfolios while minimizing green footprints.

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