Investec sees opportunities, and challenges, in financing modular construction

After underwriting a modular construction project for the first time, the bank says the building method can be efficient and sustainable but comes with specific lending risks.

Modular construction, in which a building’s components are built in a factory and assembled on-site, is increasingly popular with UK developers, particularly in the residential sector. Some property lenders are also showing their willingness to support the adoption of this modern method of construction.

Among them is Investec Real Estate. Last month, the banking group provided its first loan for a UK modular development – an £11 million (€13 million) facility for developer Stelling Properties’ student accommodation project in Guildford, Surrey. The facility was structured to include an investment tail to enable the borrower to retain the property once stabilised.

Ian Burdett, a loan originator from Investec’s real estate team, told Real Estate Capital that, when underwriting modular construction projects, lenders need to consider a broader set of risks than with conventional development projects.

A key consideration, Burdett explained, is that lenders need to be willing to advance loan monies to pay for works that are taking place off-site and, therefore, are not adding value to the site over which the lender has security.

Generally, on a traditional building, every pound spent on-site improves the value of the bank’s security while, on a modular scheme, you need to understand that funds will be drawn towards the construction of the modules prior to installation and delivery to site,” he explained. “Therefore, capex can be quite significant prior to the value of the bank’s security improving.”

Staying up to date on the project’s progress both at the factory and the site itself, as well as being clear about where the responsibility lies if something goes wrong, are, according to Burdett, other challenges associated with financing modular schemes. Therefore, he explained, when underwriting this type of development, lenders need to step up their efforts to better understand who is responsible for each stage of the build process.

Burdett noted that, with the Guildford student scheme, the fact that the borrower was both the developer and the manufacturer of the modules helped mitigate those risks and boosted the bank’s confidence.

“The fact they had their own factory to support this method of construction gave us reassurance on who is constructing the modules and gives the bank full visibility to the balance sheet and their order book,” he explained. “This method of construction does carry additional complexities and it’s important that we mitigate some of these risks in order to avoid deliverability issues.”

Stelling’s expertise and experience in delivering modular construction projects, as well as the scheme’s location close to the University of Surrey, were also crucial to Investec’s funding decision, Burdett explained.

“Stelling has a track record in delivering student accommodation through both traditional and modular construction methods,” Burdett said. “The project’s location further boosted its appeal. Guildford’s student-to-bed ratio is over three times, so the supply and demand imbalance also plays in its favour.”

Burdett believes modular construction’s multiple benefits, including shorter build times and a potentially reduced impact on the environment, outweigh its challenges.

He argued that off-site manufacturing can help a scheme complete faster than traditional building methods, which reduces the project risk and can also help address the UK’s “chronic” housing shortage. Burdett added: “Also, these structures are often built in tandem, and inside, which eliminates any impact of adverse weather conditions on construction projects.”

The construction approach can also deliver greater environmental and social sustainability benefits than conventional construction which, according to Burdett, aligns with Investec’s own approach when it comes to sustainability. “Over 60 percent less energy is required to build these modules, with less transportation involved, because everything is pre-engineered in a factory and delivered to the site,” he said. “We feel this is the direction of travel, which is why we are looking to grow our exposure.”