How industrialised construction will be funded

Industrialised construction uses new technologies and new ways of working, but the upfront costs involved, and unproven nature of the technologies or processes, may make potential traditional financiers wary.

Moving to industrialised methods is likely to result in a requirement for more balance sheet funding; market consolidation, and the ring-fencing of industrialised construction innovation.

However, opportunities could arise for pension funds and private capital to take a lead on funding innovation in industrialised construction, helping them to meet growing requirements to fund green projects. Industrialised construction has the potential to reduce the carbon emissions of projects.

The relationship between risk and traditional lending

As with any investment, access to funding for industrialised construction projects will be influenced by the risk profile.

Traditional bank lenders are a regular source of finance for construction projects and ongoing debt for companies in the sector. For them, funding new technology which is not tried and tested and does not have a track record is a risk that needs to be properly assessed and may pose a challenge. Yet, like all lenders, banks are subject to increasing pressure to support the decarbonisation agenda – but they have to do this while balancing, mitigating and managing any increased risk presented by a decarbonising technology, which an industrialised construction model will, in some cases, be.

Banks, like most commercial lenders, typically look for fixed-price construction contracts using tried and tested methods of construction to properly quantify and attribute risk to projects and work out appropriate terms for lending. From a commercial lender’s perspective, this is the lowest risk option, but for industry it may not be the most effective way to reduce and manage cost, and in practice, doesn’t prevent cost overruns. Perhaps more important, this contract model doesn’t provide the scope companies need to invest in innovation that will decrease emissions and lower costs in the longer term, which can only come from more collaborative forms of contract.

All of this means that construction companies embracing industrialised construction need to do things differently to unlock senior debt. They need to capture and present evidence to would-be lenders that enables them to undertake their own due diligence and analysis and be willing to recalibrate traditional finance arrangements in relation to the balance of risk and equity capital. Data and demonstrator developments are tools industry can use to prove technology and convince lenders to provide finance. Mirvac’s data comparisons between 'stick and brick' construction and digital twin construction of the same product are a perfect example of how this can be done and how better outcomes can be measured.

From a lenders’ perspective, a sophisticated approach is needed that fully understands the risks associated with traditional methods of construction and uses data and analysis to compare those risks against industrialised construction. Experience suggests a fixed price contract will not always provide the certainty it promises.

Where a low risk-high impact event is identified, senior debt lenders will need the potential consequences of default to be covered by equity and/or insurance.

As with all developments, some level of credit support in the form of bonds and guarantees will be needed, and for early projects using industrialised construction, there may be a requirement for a lower debt-to-equity ratio.

Opportunities for non-bank lenders

However, the opportunity is there for commercial lenders to support borrowers that are heavy carbon emitters and can use industrialised construction methods not only to decarbonise, but also to increase efficiency and profits. Where some traditional lenders may be constrained by the risk profile of loans they can make, there will be an opportunity for non-bank lenders to take the lead in funding industrialised construction.

It is increasingly common for non-bank lenders to have cash ring-fenced for investing in more sustainable projects, so where companies or projects deploying industrialised construction methods can demonstrate an environmental and social (ESG) benefit, those funds may be available for developments where bank funding can’t be accessed. There is currently a push by pension funds for ESG and wider green financing which looks to be overtaking traditional bank debt financing.

Funding investment in industrialised construction

For construction companies, financing their investment in innovative industrialised construction before it has a track record is an obvious challenge. While industrialised construction should bring benefits both in terms of profitability and decarbonisation, consideration is needed on how to match funding to the risk.

Providers of private capital, such as venture capitalists, could be attracted to invest in companies’ shift to industrialised construction because of its scope to boost profitability and deliver decarbonisation.

In some countries, construction companies may be able to borrow and raise equity against their respective balance sheets to fund their investment in industrialised construction. We are already seeing some balance sheet funding by some companies in the Australian market. This circumvents any need to ask commercial banks to lend against new technology.

However, a need for balance sheet funding could spur an uptick in mergers and acquisitions in the construction sector. Often innovators are start-ups that lack the balance sheet strength to provide credit support for a project, so, where innovation comes from smaller companies, larger companies may seek to buy that innovation through acquisitions. Consolidation may be needed to create companies that are the right shape to deploy industrialised construction at scale. 

Companies may want to consider ring-fencing their activities in relation to innovative industrialised construction in a separate corporate vehicle. This vehicle could own any new technology and related intellectual property separately from the traditional construction operations, which could serve to attract outside investment. It would also insulate the rest of the balance sheet from any downside.

Companies can also investigate whether “green loans” are available for specific developments or to develop specific industrialised construction technology. 

The role for the board

As industrialised construction becomes more common, the boards of directors at construction companies will be watching how the risks and opportunities are balanced.

Deploying efficient industrialised construction methods provides an opportunity to increase profitability, but it will also involve committing balance sheet to fund early projects and provide additional comfort to senior debt lenders.

It will be important to identify and support the “right” industrialised construction methods, but it may be necessary to support a diverse range of methods to spread and mitigate risk while technology is tested and proved.

As lenders themselves come under increased pressure to decarbonise their loan books, construction company boards can expect the lenders to apply their own pressures to ensure decarbonisation does not increase funding costs. Collecting and reporting data to show the decarbonisation benefits of industrialised construction will be needed to comply with any “green” covenants in the company’s finance documents.