In an effort to end the state’s housing shortage, California is considering something unprecedented: getting into the construction insurance business.
Last week, Assemblymember Buffy Wicks (D-Oakland) and a coalition of legislative advocates lifted the curtain on a long-awaited package of bills aimed at pushing developers to innovate to reduce construction costs, with a particular focus on factory buildings.
Building homes in factories and trucking them to where they are needed offers a variety of potential benefits: Faster construction, safer working conditions and lower costs should ultimately make housing more affordable.
But despite decades of hope and agitation, that promise has never materialized on a large scale. Industry boosters point to regulatory and financial barriers that hinder cost-effective mass production.
Half a dozen new bills are designed to help the fledgling industry overcome those hurdles. Most will do so by imposing or imposing a regulation. But one, Assembly Bill 2166, authored by Wicks and Assemblyman Juan Carrillo (D-Palmdale), is different. Although still unclear on the details, the bill aims to guarantee insurance coverage for developers and lenders interested in factory-based construction, but still need more assurance.
Taking on the role of reinsurer — a commitment to help financially in a particular housing development — is a departure from anything the state has done before in its decades-long effort to reduce housing costs in California.
“This is the first time I’ve seen something like this proposed, written and used by the state to find housing,” said Tyler Pullen, a researcher at the Turner Center for Housing Innovation at UC Berkeley, who provided technical assistance to Wicks and other legislators on the bill package.
He added that while the bill is “too open and too complex” in the legislative package, another version of the idea came up in almost every interview he and his colleagues conducted with industry stakeholders as part of the latest Turner report on industrialization.
“This could be one of the most impactful things, but there are many open questions,” he said.
Avoiding the construction doom loop
Construction is a dangerous job. Engineers are running out of money. The cost is over. There are many cases. Projects fail. There is a complex array of financial resources to help everyone involved, from lenders and investors down to the smallest contractors, to reduce their exposure if things go wrong.
One of the most important of those levers is the surety bond, a financial arrangement where the insurer, in exchange for an upfront payment, agrees to pay if, say, an electrical subcontractor fails to deliver.
A bonded project is one that “puts developers and lenders at ease,” said Michael Merle, director of business development at Autovol, an Idaho-based real estate developer. “If part of the project fails, they won’t hold the bag.”
Depending on the type of project and contract, the bond may cost the factory a third of a percentage point to 3% of the total contract cost, he said. In the industry working on a large apartment project, those few percent can add up to a million dollars or more.
But that’s if the industry can’t even be arrested. Usually it can’t. Why not? The bill’s text refers to a “self-reinforcing cycle” in which the advanced construction industry appears to be stagnating.
That doom loop looks like this:
A developer or project lender is wary of starting a project with a housing factory, a new player in a new industry that has seen high-profile failures, so it requires a factory to tie up the project. An industry will be able to convince a bond company to provide that coverage if it has a track record of financial success. But this is not the case, because the developers and lenders of the project are aware. No factory bond means it cannot attract any business. No business means that the firm eventually fails.
Carrillo and Wicks’ bill would have federal insurance for insurers. If the project fails and a bond is required, the state will pay a portion of the payment in certain extreme cases (the size of that portion and what qualifies as “excessive” has not been determined).
The main hope behind this law is that by making insurance companies more comfortable with providing insurance, developers will be more comfortable signing with industries, industries will have a more stable business and, ultimately, they will be able to increase production, reduce costs and begin to fulfill the long-term promise of mass-produced housing. Doom loop is broken.
Although the state of California has never taken a role like this before, the idea is consistent with other policies at both the state and federal levels.
The US Department of Veterans Affairs and Fannie Mae and Freddie Mac, two federally funded companies, guarantee loans issued privately as a way to promote more and cheaper loans to American consumers. The Small Business Administration guarantees surety bonds to (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. Last year’s bill that would have replicated the affordable housing project model died without a full vote in the Council.
The idea of guaranteeing the housing industry is “very innovative,” said Jan Lindenthal-Cox, chief investment officer at the San Francisco Housing Accelerator Fund, a nonprofit that directs philanthropic money to affordable housing projects. “This is what it takes if you really want to grow the industry.”
Can cash be better than a bond?
But even some proponents of offshore construction are skeptical.
The Carrillo-Wicks bill is intended to push developers who are interested in building off-site but are hesitant about its financial viability. That doesn’t explain Mutual Housing California, a Sacramento-based affordable development nonprofit committed to using factory-built housing for a number of its upcoming projects.
“Who are we encouraging?” Ryan Cassidy, vice president of Real estate, asked about the bill. “We only encourage developers who go/don’t go if the factory stays in business. To me, that’s a developer who may not be very experienced.”
Accordingly, this method will help new factories with less experience to gather more business, he said. Mutual Housing has a contract with Guerdon Modular Buildings, another Idaho-based manufacturer with one of the longest track records in the industry. “I don’t think the risk of factory-built houses is that Guerdon will go out of business.”
Cassidy said he would prefer a “straightforward” approach to simply giving factory-built projects more money.
Autovol’s Merle agreed that the surety bond proposal would likely benefit new manufacturers. Autovol, another industry heavyweight, rarely has trouble getting help when it needs it, he said. And because of its relative financial stability and long-term customer base, it can go without bond more often than not.
“If you only have two or three projects and a couple of years under your belt, those are the ones you need to commit to,” he said. But for the same reason, “those are the most difficult to meet.”
It remains unclear whether other lawmakers will be willing to pledge full faith and federal credit to the emerging industry. The bill is scheduled for its first legislative committee hearing later this month. How much money the bill could put state taxpayers on the hook for remains an open question. But for uncertain lawmakers, one potential selling point is that the plan’s need may be temporary.
The premise of the bill is that “the state can support early adopters while the factory-built housing industry builds its name,” Pullen at Terner said. “This is a problem that can ultimately be solved in the private market.”
If all goes well in the industry, private insurers may be happy to offer factories their own operations without a national backstop and developers and lenders may no longer insist on that extra protection. For now, that remains a big “if.”
Ben Christopher writes for CalMatters.
