In an effort to put a dent in the state\u2019s housing shortage, California is considering something unprecedented: getting into the construction insurance business. <\/p>\n
Last week, Assemblymember Buffy Wicks, an Oakland Democrat, and a bipartisan coalition of lawmakers raised the curtain on a long-awaited package of bills<\/a> meant to push developers toward cost-cutting innovations in construction, with a particular focus on factory-based building. <\/p>\n Building homes in factories and then trucking them to where they\u2019re needed offers a wide array of potential benefits: Faster construction, safer working conditions and lower overall cost that ought to ultimately make housing more affordable. <\/p>\n But despite decades of hope and hype<\/a>, that promise has never materialized at scale. Boosters of the industry point to regulatory and financial hurdles that stand in the way of cost-effective mass production.<\/p>\n 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<\/a>, 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.<\/p>\n Taking on the role of re-insurer \u2014 committing to come to the financial rescue at a specific chokepoint in the residential construction process \u2014 is a departure from virtually anything the state has done before in its years-long effort<\/a> to cut the cost of housing in California. <\/p>\n \u201cThis is the first time I have seen something like this be suggested, drafted and potentially implemented by a state for housing,\u201d 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.<\/p>\n He added that though the bill is certainly the \u201cmost open-ended and technically complicated\u201d 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<\/a> on industrialized construction. <\/p>\n \u201cThis could be one of the highest impact things, but it has a lot of open questions,\u201d he said.<\/p>\n Avoiding a construction doom loop<\/p>\n 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. <\/p>\n 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. <\/p>\n A bonded project is one that \u201cputs the developers and the lenders at ease,\u201d said Michael Merle, business development director at Autovol, an Idaho-based housing factory. \u201cIf any portion of the project fails, they are not going to be holding the bag.\u201d<\/p>\n 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\u2019s 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.<\/p>\n But that\u2019s if the factory can even get bonded. Often they cannot. Why not? The text of the bill refers to a \u201cself-reinforcing cycle\u201d that the industrialized construction industry appears to be stuck in. <\/p>\n That doom loop looks something like this: <\/p>\n 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<\/a>, 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\u2019t, because developers and project lenders are wary. No bond for the factory means it can\u2019t attract any business. No business means the factory eventually fails.<\/p>\n Carrillo and Wicks\u2019 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 \u201cextreme\u201d are still undetermined). <\/p>\n 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\u2019ll be able to ramp up production, push down costs and start delivering on the long-offered promise of mass-produced housing. Doom loop terminated.<\/p>\n 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. <\/p>\n 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<\/a>, but none for the housing industry. A bill<\/a> last year that would have replicated the model for affordable housing projects died without a full vote in the Assembly. <\/p>\n The housing factory surety guarantee idea is \u201csuper innovative,\u201d 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. \u201cThis is what\u2019s needed if you really want to scale the industry.\u201d<\/p>\n Would cash be more helpful than bonding? <\/p>\n But even some off-site construction proponents are skeptical. <\/p>\n 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.<\/p>\n \u201cWho are we incentivizing?\u201d Ryan Cassidy, Mutual\u2019s vice president of real estate, asked of the bill. \u201cWe\u2019re incentivizing developers whose only go\/no-go is whether the factory stays in business. To me, that\u2019s a developer who is probably not very savvy.\u201d<\/p>\n 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. \u201cI don\u2019t think the risk of factory-built housing is whether Guerdon is going to go out of business.\u201d<\/p>\n Cassidy said he would prefer a \u201cmore direct\u201d approach of simply giving factory-built projects more money. <\/p>\n 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. <\/p>\n \u201cIf you\u2019ve only got two or three projects and a couple years under your belt, those are the ones that are required to bond,\u201d he said. But for the same reason, \u201cthose are the ones that very much struggle to bond.\u201d<\/p>\n It\u2019s unclear whether other lawmakers will be willing to tie the full faith and credit of the state to an industry that\u2019s 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.<\/p>\n The premise of the bill is that \u201cthe state can support the early adopters while the factory-built housing industry builds up its reputation,\u201d said Pullen at Terner. \u201cThis is a problem that could eventually be solved in the private market.\u201d <\/p>\n 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 \u201cif.\u201d<\/p>\n ___<\/p>\n