The half-dozen new bills are meant to help the nascent industry clear those hurdles. Most would do so by standardizing or trimming regulation. But one, Assembly Bill 2166, authored by Wicks and Assemblymember Juan Carrillo, a Democrat from Palmdale, is different. Though still light on detail, the bill aims to guarantee insurance payouts for developers and lenders who are interested in factory-based building, but still need a little extra assurance.
Taking on the role of re-insurer — committing to come to the financial rescue at a specific chokepoint in the residential construction process — is a departure from virtually anything the state has done before in its years-long effort to cut the cost of housing in California.
“This is the first time I have seen something like this be suggested, drafted and potentially implemented by a state for housing,” said Tyler Pullen, a researcher at the Terner Center for Housing Innovation at UC Berkeley, who has been providing technical assistance to Wicks and other legislators on the bill package.
He added that though the bill is certainly the “most open-ended and technically complicated” in the legislative package, some version of the idea popped up in nearly every interview he and his colleagues conducted with industry stakeholders as part of a recent Terner report on industrialized construction.
Avoiding a construction doom loop
Construction is a risky endeavor. Developers run out of cash. Costs overrun. Lawsuits abound. Projects fail. A complex array of financial levers exist to help everyone involved, from lenders and investors down to the lowliest subcontractor, to minimize their exposure should things fall apart.
One of the most important of those levers is the surety bond, a financial arrangement in which an insurer, in exchange for an upfront fee, agrees to pay out if, say, an electrical subcontractor fails to deliver.
A bonded project is one that “puts the developers and the lenders at ease,” said Michael Merle, business development director at Autovol, an Idaho-based housing factory. “If any portion of the project fails, they are not going to be holding the bag.”
Depending on the nature of the project and the contract, a bond might cost a factory anywhere from three-quarters of a percentage point to 3% of a contract’s entire cost, he said. For a factory working a large apartment project, those fewer percentage points might add up to a quarter million dollars or more.
But that’s if the factory can even get bonded. Often they cannot. Why not? The text of the bill refers to a “self-reinforcing cycle” that the industrialized construction industry appears to be stuck in.
That doom loop looks something like this:
A developer or project lender is wary of starting a project with a housing factory, a new-ish player in a new-ish industry that has seen some high-profile failures, and so requires a factory to bond the project. The factory would be able to convince a surety company to provide that coverage if it had a track record of financial success. But it doesn’t, because developers and project lenders are wary. No bond for the factory means it can’t attract any business. No business means the factory eventually fails.
Carrillo and Wicks’ bill would have the state insure the insurers. If a project fails and a bond is called upon, the state would cover a portion of the payout in certain extreme circumstances (the size of that portion and what qualifies as “extreme” are still undetermined).
The ultimate hope underlying the legislation is that by making insurance companies more comfortable offering insurance, developers will become more comfortable signing on with factories, factories will have more steady business and, ultimately, they’ll be able to ramp up production, push down costs and start delivering on the long-offered promise of mass-produced housing. Doom loop terminated.
Though the state of California has never taken on a role quite like this before, the idea rhymes with other policies at both the state and federal level.
The U.S. Department of Veterans Affairs and both Fannie Mae and Freddie Mac, two federally-sponsored companies, guarantee privately-issued mortgages as a way to boost more plentiful and cheaper lending for American homebuyers. The Small Business Administration guarantees surety bonds for (you guessed it) small businesses. The state of California operates one loan guarantee program for health care facility construction, but none for the housing industry. A bill last year that would have replicated the model for affordable housing projects died without a full vote in the Assembly.
The housing factory surety guarantee idea is “super innovative,” said Jan Lindenthal-Cox, chief investment officer at the San Francisco Housing Accelerator Fund, a nonprofit that directs philanthropic money toward cost-cutting affordable housing projects. “This is what’s needed if you really want to scale the industry.”
Would cash be more helpful than bonding?
But even some off-site construction proponents are skeptical.
The Carrillo-Wicks bill is meant to push developers who are interested in off-site construction but skittish about its financial viability. That does not describe Mutual Housing California, a Sacramento-based nonprofit affordable development that has committed to use factory-built housing for the bulk of its future projects.
“Who are we incentivizing?” Ryan Cassidy, Mutual’s vice president of real estate, asked of the bill. “We’re incentivizing developers whose only go/no-go is whether the factory stays in business. To me, that’s a developer who is probably not very savvy.”
Likewise, the approach will help new factories with limited experience garner more business, he said. Mutual Housing contracted with Guerdon Modular Buildings, another Idaho-based manufacturer with among the longest track-records in the industry. “I don’t think the risk of factory-built housing is whether Guerdon is going to go out of business.”
Cassidy said he would prefer a “more direct” approach of simply giving factory-built projects more money.
Merle at Autovol agreed that the surety bond proposal would likely benefit newer manufacturers. Autovol, another industry heavyweight, rarely has trouble getting coverage when it needs it, he said. And because of its relative financial stability and its list of long-term clients, it can go without bonding more often than not.
“If you’ve only got two or three projects and a couple years under your belt, those are the ones that are required to bond,” he said. But for the same reason, “those are the ones that very much struggle to bond.”
It’s unclear whether other lawmakers will be willing to tie the full faith and credit of the state to an industry that’s still proving itself. The bill is scheduled for its first legislative committee hearing in late April. The total amount that the bill could put state taxpayers on the hook remains an unanswered question. But for lawmakers who are unconvinced, one possible selling point is that the need for this program may be temporary.
The premise of the bill is that “the state can support the early adopters while the factory-built housing industry builds up its reputation,” said Pullen at Terner. “This is a problem that could eventually be solved in the private market.”
If all goes well in the industry, private insurers might be happy to offer factories their coverage without a state backstop and developers and lenders may no longer insist upon that extra layer of protection. For now, that remains a big “if.”
Photo by Jungho Kim for CalMatters
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