Builders call for banks to stop stifling innovation and rethink rules that prevent first home buyers from getting mortgages to build prefab houses 

Image from Makers of Architecture

Here is Auckland: It doesn’t have enough houses, so property is ridiculously expensive. Auckland desperately needs people to build houses quickly. 

Here are Zach and Emma: They’re a fictitious couple in their early 30s. They’ve made peace with the fact they can’t afford to buy in central Auckland, but are open to building in the outer suburbs.

They’re keen to use a company that makes prefabricated houses - or components of houses - as these can be cheaper, more space efficient and are quicker to build.   

Here is Jae Warrander: He’s a director of Makers of Architecture - an architecture and construction start-up he founded with three mates in 2014, after they graduated from university.  

The company uses technology to cut all the pre-framing for a house to size in its Wellington workshop, before trucking the components to the building site and putting them together like a jigsaw. Makers of Architecture is big on sustainable building, smart design and evolving with technology.  

Zach and Emma like Makers of Architecture’s ethos and want Jae to build them a house.

Here is the government: It is incentivising first home buyers to build, by offering a HomeStart grant worth up to $10,000 to eligible KiwiSaver members who build, or purchase land to build a new home on. This is double the amount available to those who want to buy an existing home.

Zach and Emma have it sorted, right?

They have the government’s support for taking some of the pressure off Auckland’s housing supply shortage. They’re supporting a bunch of innovative New Zealand builders and designers, who refuse to be slaves to the handful of building and materials companies that dominate the New Zealand market. Yes, land is still very expensive, but they are realistic about what they need and aren’t getting neck-deep in debt to buy a big, uninsulated Ponsonby villa.

But there’s a spanner in the works.

Getting a mortgage when you have nothing to secure it against

Jae needs Zach and Emma to pay $100,000 upfront to cover the cost of the cross laminated timber he uses for the pre-framing of the house. But Zach and Emma’s bank won’t approve their mortgage.

The issue is banks require home loans to be secured against an asset.

If the property being built traditionally onsite is the security, banks will lend up to the value of that security as construction progresses. They will therefore advance more money to a home owner, as the value of their house being constructed increases.

However with prefab houses, banks don’t consider any parts of a house to belong to the home owner - ie Zach and Emma - until they are fixed to the land. They therefore can’t create security against anything being constructed offsite.

The New Zealand Bankers’ Association chief executive, Karen Scott-Howman, says this is the norm as: “From a responsible lending and risk perspective, banks will not lend without security, or lend an amount greater than the value of the security.

“There are ways to deal with this depending on the individual circumstances involved. If the customer already owns the land the house will be built on, they could use that as security for a deposit on the prefab building before it is constructed.

“Another option may be for the prefab building contract to allow for progress payments to be made on the completion of construction milestones, such as building the foundations and fixing the building to the land.

“The home buyer may also be able to provide additional security, or access short-term debt, to cover the build costs.”

A change in thinking over who owns what, when

Jae acknowledges there are alternative solutions, but says banks’ inflexibility on the issue is a major roadblock.

He says Makers of Architecture works around these constrains with suppliers, banks and clients rather than losing the contract.

“The point is that it takes lots of management and negotiation time for the client and building company. There is no defined pathway to support this innovative way of building,” he says.

“It’s really hard for the banks to understand that just because the product is in the factory, it doesn’t mean it isn’t owned by the client.”

He maintains banks could start “tagging” building products to clients, regardless of whether they’re on the building site or still in the workshop.

They do this for large building projects, so could roll it out to smaller residential builds.

“We can’t put our own money on the line is the issue,” he says.

If a customer can’t proceed with the build anymore, Makers of Architecture sits with custom designed materials that may be hard to be reused for another project.

Currently, he says the only way forward is for him and his clients is to build relationships with individual bank managers or other lenders receptive to thinking outside of the square, to secure funding.

He says Nelson Building Society has been particularly helpful.

If the builder has the equity, what’s the risk?

The director of the prefab construction company PLB, Philip Leather, has experienced similar issues to Jae.

“You might have the right deposit, a good job and your earnings qualify, but most of the banks will say: 'Sorry we haven’t got any security on the loan until the building is on site’” he says.

The difference is Philip’s been in the business since 1982, so has had more time than Jae to build a relationship with the banks.

“If you’ve got a rapport with the bank; you’re not just a pop-up builder, you’ve been around for a long time, you’ve got a good banking record and a good statement of position; it’s okay,” he says.

He notes individuals at Westpac and ANZ have been particularly helpful, but it’s still back to square one when a new manager comes along, who sticks to the rules hard and fast.

Philip recognises banks are worried that if the builder goes broke, it’ll be difficult for them to get their hands on the house in the workshop, as it’ll be at the hands of the receivers.

He therefore often supplies banks with a legal document saying that if anything happens the bank can come to the factory and take the property.

His solution, which won’t necessarily help Jae, is that there should be a set criteria builders need to meet for their clients to secure bank loans.

If the builder’s books are healthy and they have a lot of equity, there is nothing for the bank to worry about, he maintains.

In the meantime, Philip says he has to be flexible.

“We normally find a way around it rather than lose the contract,” he says.

He requires a 10% deposit and then four or five other payments throughout the six to eight-week building process.

His customers often do whatever they can to scramble some money together until they get the house on the site.

‘Where’s New Zealand’s housing strategy?’

The CEO of the advocacy organisation PrefabNZ, Pamela Bell, is working with finance providers to try to get a solution for the industry.

She says it doesn’t make sense for each prefab builder and their client to do their own ground work with a bank manager, rather than having some standardised direction or guidance.

“Where’s New Zealand’s housing strategy? Where’s the vision for what kind of country New Zealand wants to be?” she says.

The Ministry of Business Innovation and Employment is doing some work in this area, further to in 2015 releasing a Cabinet paper on the outcomes of a study into competition and productivity in the residential construction sector.

“Transportable housing is not accessible to first home buyers like it should be, unless you go to a really big outfit, like Keith Hay homes, and they can do their own financing,” Pamela says.

She is working with two finance providers to explore whether they can set up a kind of bond guarantee, where an intermediary steps in and covers the builder for if anything goes wrong. This de-risks the process so the bank can lend to the client.

She believes the culture of our financial institutions is too “straight jacketed” and there are huge opportunities for lenders with the vision to adjust their offerings in line with what New Zealand needs.

Pamela says: “There’s actually a really great social story there. Whichever financier cracks that could be the leader in that space.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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22 Comments

Simple. Make the favorable tax treatment investors prize in NZ exclusive to new builds, as investors are supposed to have equity somewhere to cover this off. First home buyers can buy existing/older housing stock.

What this article didn't go on to explain was this: Zach and Emma have a $100k deposit. This deposit needs to be paid to the building company to pay for materials at Jae's company, but Zach and Emma now require a 100% LVR loan on a piece of dirt. So the writer of this article/ and pre-fab building company owners are suggesting that the banks take all the risk and that the building company takes no risk. Providing 100% LVR loans on vacant land is insane and what if Jae's building company goes bust and the $100k of Zach and Emma's goes up in smoke with all the partially completed construction materials locked up in a warehouse somewhere waiting for the liquidators to get their hands on it. By putting their $100k into the land then at least they know that the land won't go bankrupt and they will have something to show for it.

Well done you have got it in ONE.
As the builder says they worked around the situation. Which is the way it should be . That is part of being in business solving all of the problems. Being a builder is not just about constructing the dwelling. It is about making it happen.

This is the kind of problem the Minister of Housing could solve!

Who is that, or isn't it a split job these days?

John Key must hav plenty of spare time now
Let him trade his way out of it

This is a pure finance/working capital timing issue. In essence, Makers of Architecture is undercapitalised: it clearly cannot afford to buy materials on its own account out of cashflow. This renders it susceptible to all manner of woes: buyers falling over, non-delivery of materials ordered, poor quality of said materials once delivered - it's a potentially long list.

Simply put, Makers of Architecture is a business failure waiting to happen.

The solution is equally straightforward.

If banks need assets on site before they lend, then bridging finance is needed: in two senses:

1 - working capital for MofA, so they don't have to rely on a finely balanced deposits cashflow in order to purchase inventory, pay staff to make stuff, and deliver componentry to site. Working capital is then secured against assets such as premises, inventory, plant and vehicles.
2 - pure interim finance for Z&E, so they can pay a hopefully much smaller deposit to a better-configured firm to secure their place in the queue. Solicitors used to offer this exact service: there are always short-term, high-interest deals around which are tenable for the few months needed.

All this is BIZ101, really. No need for 'the Gubmint to Do Somefink'.......

why should the risk go back on the builders. The flaw appears to be that because the construction isn't onsite, there are no assets connected to the site during construction . On a traditional build, if a builder goes bust, they can't then remove the building from the site so the bank has that security of an partly complete asset on the site.

I think those assets right be owned by the bank funding the builder Rob, not necessarily the bank that is funding the home owner. If that is indeed the case then its a question of why should the bank shareholders take all the risk

Bank stakeholders ?
Fractional banking system
The bank lends more than it has itself in assets !
What an oxymoron this is
One for miracle trader Key

Waymad if Makers of Architecture is under capitalised then it is also probably not at its economies of scale sweet spot i.e it is not producing enough volume through its prefabrication factory to minimise its average costs, also with greater volumes they probably could get better deals for components and raw materials. A lack scale is a common problem in New Zealand's building industry. KiwiBuild would solve this problem by purchasing hundreds and thousands of homes from many building companies like Makers of Architecture. This would create a competitive eco-system of building supply firms. Wouldn't that be a good thing?

Exactly, Brendon. I've argued for exactly this: a wholesale dismantling of the crazy planning regimes, and the release of the now-unemployed planners into the State House Factories, here: http://waymad.blogspot.co.nz/2016/06/building-lotsa-houses-fast.html

I see the Makers of Architecture example through the lens of MBA business analysis: the analogy that springs to mind is putting a deposit on a new car only to be informed that they need more money to buy the steel.....building in NZ, as the Productivity Commish has long since noted, is a cottage industry. Pun fully intended.

Most builders construct one house at a time: in the year to May 2010, 4,604 firms built just one house during the year. In contrast, only 30 firms built more than 30 homes, while just 5 firms built more than 100 houses

See P21 of the pdf at http://www.productivity.govt.nz/sites/default/files/Final%20Housing%20Af...

I agree with your analysis in your blogspot Waymad. The only small alteration I would add would be NZ needs to get at least 6 independently owned house factory's up and running with completely different supply chains. From memory of 25 year old uni lectures on -cartels and game theory -anti-competitive behaviour breaks down once there are 6 or more independent firms in an industry. This is important because it ensures the lower average costs resulting from economies of scale are transferred to the end consumer -the house buyer -not to higher profits or managerial inefficiencies benefiting the business/managerial elite which is more common in NZ.

..and I am sure it would take a click of the fingers to have our Chinese friends suppying such products. That's the sort of trade i would like to see encouraged, as opposed to the current speculative housing nonsense the govt is so keen on welcoming.

Isn't it time that people looked beyond housing?
And actually did something productive?
Things that grow the economy, generates income from exports.
Because selling houses ain't gonna do that.

People need a house to live in. This type of house will not likely be a spec house they will flog on a for a quick profit.

Well the Moa is extinct so we cant make $ from them anymore so housing ain't bad
It's just been ruined by foreigners allowed to come in and dump their grey $ to escape taxation back in China

I think NZ's govt needs to wake up as does the world outside China
The Chinese are not going to stop buying up property in any western country now regardless of any taxes.
The Chinese do not trust their govt and seek a safe haven outside China
No tax on foreign buyers will change that fact so Chinese will continue to buy up properties outside China
NZ must surely be feeling the impact on its healthcare system already
At least the German car sales are leasing more high end models than ever
I guess its a win for them

the 'makers of architecture' problem should not be a problem because it is not so different a process from the current. I get a builder to build a house now and he just orders up just a bunch of frames, trusses and all of those come predone. Frames trusses and roof can come together within days.
Builder puts up the frames, asks me for money, bank sees the frames are up and releases me some money to pay the builder.
Makers of Architecture needs to have some funds, as does the builder, and so should I at the start. If there is any problem I agree with waymad, it's just financing.

The truss manufacturer will need at least a deposit for the trusses before they will start building them which the owner would need to pay. But the trusses and framing materials are a relatively small part of the building compared to prefab housing.

A real example for you. I have just started a prefab build. The reason behind it is to improve quality rather than reduce cost (I am building a Passive House). The walls, mid-floor and ceilings are all being pre-fabricated in a factory then will be craned onto site.

I had to pay for materials in advance but this only amounted to 7% of the total house cost. The bank wont release mortgage funds until all of your deposit is in place so, in my case, I am putting down 20% which includes this 7%. No risk to the bank as it is my money.