In last month’s blog post, I discussed creative solutions providing an easier path to home ownership and home equity release, particularly for those prospective buyers with sub prime FICO scores (ie 500 range). Technology startups, such as Divvy, Unmortgage, Easyknock, Hometap and Point offer promising rent-to-own and sale-lease back alternatives. However, none of those solves the fundamental problem of expensive home ownership. What if there actually was a viable solution that could theoretically reduce the price of a home and make financing options more readily available? The answer could be modular home building.

Modular home builders benefit from many cost savings and pass along some of those to prospective buyers. Manual labor is traditionally the biggest expense associated with every construction project. First, this cost driver is reduced by leveraging an assembly line format in a controlled, indoor environment allowing modular home builders to streamline many of the mundane, rudimentary and easily repeatable tasks either by assigning a smaller number of focused workers to specific responsibilities or eventually automating them with intelligent robots. Second, assembly line workers work in-line with managers, whereby shortening review cycles, expediting the development process, preventing delays and increasing throughput. Third, modular home build timelines tend to be faster and more accurate given the build cycle is not impacted by inclement weather (ie rain) which can normally cause rework. Fourth, modular home builders benefit meaningfully from economies of scale and volume discounts given their vertically integrated nature. Fortunately, modular home builders have more visibility into future demand and costs compared to traditional home builders which gives them the ability to purchase more supplies upfront and in a more repeatable fashion (ie supply chain optimization). However, lower price and faster time to build are not the only benefits.

One additional benefit is the ability to finance a modular home at potentially more attractive terms. Lenders could find module homes particularly compelling underwriting opportunities because the homes are built to pre-determined specifications and codes and given change orders are rather rare, the lender theoretically knows exactly how much the asset will cost to build, how much it will be worth and how long it will take to build even before the home is constructed. This removes a lot of ambiguity from the mortgage application, underwriting and financing process. Further, prospective sub-prime home buyers who may have originally found it difficult to receive a mortgage, may now be able to receive not only a mortgage but also with more favorable terms.

Module home buyers are not the only stakeholders well-positioned to benefit from this new paradigm. Module home builders are also positioned to benefit just as much or maybe even more so than module home buyers. Module home builders are expanding the market enabling new buyer candidates, particularly Millennials, to afford a home for the first time in their lives. Additionally, existing home owners who previously thought it was too expensive to add another room to an existing home or another home to an existing property, can now potentially afford a new modular room or home. Thus, builders are going to benefit from not only a growing market but also major efficiency gains. More specifically, traditional home building is a low margin business with single digit profit margins. However, new module home builders have the opportunity to create real, meaningful margin expansion from lower headcount, higher throughput and supply chain optimization, which is critical for any sustainable business. The more free cash flow a business can generate, the more the business can re-invest those earnings in itself including research & development to continually improve existing internal processes.

Multiple factors are enabling this paradigm shift today. First, interest rates are rising and increasing inflation disproportionate to lower and middle-class income growth have priced would-be first time homeowners out of the market. Second, an aging housing stock will require significant capital investment to fund improvements upon acquisition. This only drives up the cash required for a home purchase. Further, sometimes special permits are required for delivery which can present an extra hurdle. Third, consumer tastes are changing and the existing housing stock does not necessarily fulfill all of the preferences required by younger potential home owners.

Although there are many appealing advantages to modular home building for both buyers and builders, there are still some lingering outstanding questions and concerns. First, building materials are becoming more expensive and can potential offset some of the cost savings realized from economies of scale. Second, the actual transportation and delivery of the house is quite expensive as well as pouring the foundation, connecting the plumbing, etc. Third, although it would seem likely that lenders would feel more comfortable with modular home standardization, there are some lenders who have more uncertainties around modular homes than traditional homes because there are not as many historical resale value data points to choose and select from. Fourth, marketing is an incredibly important part of every modular home builder business and critical to success. More technical teams need to align themselves with great marketing professionals. Lastly, buying a home is a very emotional and personal decision and usually involves some level of customization. As a result, it’s imperative for modular home builders to balance standardization with customization because without offering any level of customization could inadvertently turn potential modular home buyers away but offering too many SKUs could increase costs too much.

Given the attractive converging market dynamics, Nine Four Ventures is paying particularly close attention to this space. If you are a founder automating modular home manufacturing and mitigating those outstanding questions, please reach out. It would be a privilege to learn about your business and explore how we can work together. In partnership with Laramar Group, Nine Four Ventures has access to 15k tenants around the country who will eventually want to own a home of their own. As a result, we can help with targeted customer acquisition. In addition, we have strong relationships with creative lenders that can help provide the debt funding you need to help finance property acquisitions.