Transcript:
Dean Wehrli:
Welcome to the latest episode of New Home Insights. That’s the podcast that brings you, you know, insights about new homes. It’s right there in the title. We hope that’d be obvious. Today we’re going to talk with the legendary Margaret Whelan about something I think that we’ll all be talking a lot about in the very near future and that is offsite home construction.
Dean Wehrli:
So let me introduce Margaret here real quick. She is a veteran of over 20 years on Wall Street in residential real estate industry and provides strategic and financial counsel to leaders, both public and private in the US and all over the world, actually.
Dean Wehrli:
Margaret, you’re at the forefront of innovation in the housing industry and have been for awhile. One of those key innovations is going to be offsite construction. So let’s start by just telling us real quick, how did you become involved with this innovation in the housing industry?
Margaret Whelan:
Sure. Hi Dean. Thanks for including me on your podcast.
Dean Wehrli:
Thanks for being here. I’m sorry I should’ve had you introduce yourself. Margaret, please introduce yourself.
Margaret Whelan:
Okay, I’ve been enjoying listening to your melodic voice for the last few months. I’m happy to be included. Offsite… It’s a great question. So many of the homes that are built in the US on the single family side are stick built. I have a global footprint personally because I grew up in Europe, but moved to the US in 1994 after I graduated from university and I moved here to work. I started working on Wall Street right away and have been working now with housing companies for more than 20 years.
Margaret Whelan:
My first position was at UBS and I was a global head of housing research. So I would travel all over the world, not just to Canada or to Mexico, but to Europe and to Asia and would always wonder why we were building houses the way we built them in the US, which is very rudimentary. It’s kind of 50, 60 years behind most of our colleagues globally. So I had a big interest in it, I think because affordability is very important to me. I think the fact that housing and home ownership creates more stable, local economy is important and offsite is a cost effective way to build and sell homes.
Dean Wehrli:
Yeah. Just give us a quick, what exactly is… Let’s step back at 30,000 feet kind of a thing. What does it mean to say we construct a home offsite?
Margaret Whelan:
Sure. It’s a good idea because everything is on a spectrum and I find anytime I’m talking to others about it, we often get confused and muddled about the terms and what they mean. When I talk about offsite, what I’m talking about specifically is pre-cutting lumber in a controlled environment in a factory. That lumber then gets brought to the job site as a kit and it’s installed via a crane. That can take 10 plus days out of a 14 day framing cycle for a traditional 2,500 square foot home.
Dean Wehrli:
I’ve heard some folks have, tell me if this is gross oversimplification, but this idea that is almost like doing kind of a giant Lego set.
Margaret Whelan:
Mm-hmm (affirmative).
Dean Wehrli:
Yeah.
Margaret Whelan:
That’s exactly what it’s like. And you know, we’ve, we’ve got framers and turnkey framers and shell operators around the country who I consider to be super subs. They’re bringing floor trusses, roof trusses, wall panels, in some cases the wall panels are precut for services, MEP, they’re fitted with insulation foam board. We saw that at the KB show house that’s going to be on view in February, 2019. They are installed very quickly, very efficiently with a huge level of precision and much less waste. It’s estimated that on our job sites we waste about 30% of the materials and in Europe and Asia it’s closer to two or 3%. When you consider that more than half of the cost of building a house is sticks and bricks and you consider that there’s a way to dramatically reduce the amount of waste, that leads to a more cost effective proposition for a home builder to offer the consumer. Makes the house more affordable.
Margaret Whelan:
Another important variable though is that if a builder can take 10 plus days out of 100 build cycle, then that’s 10% improvement in efficiency. And often they’re building twice a year, two inventory cycles, so they can improve their cashflow and their return on capital pretty meaningfully by leveraging this opportunity.
Dean Wehrli:
But it sounds like there’s multiple folks involved at the beginning. You said trusses and foam boards and the lumber and such. That’s true. So there’d be multiple offsite construction companies doing this that are providing all the different materials that go into the home? Is that fair to say?
Margaret Whelan:
No. The way this plays out, Dean, is that it’s one super sub that is doing all of this. Essentially they build the house twice. The first time they build it in 3D through some kind of BIM software online. And they rationalize the plans, they iron out the kinks, they find any bottlenecks. Once they’ve done so, then they run that software through the machinery in their factories. And that dictates how the lumber is precut, and that in turn puts a kit, that’s like you said a Lego box. It’s all numbered. It’s all assembled numerically. It’s put on the back of a flatbed truck. It can be delivered up to about a 300 mile radius from the factory and installed by crane within a couple of days.
Dean Wehrli:
Wow. Does it have those super annoying Ikea type numbers with almost no explanation and just a diagram that no one can follow. And there’s always a missing Allen wrench. Does it have that?
Margaret Whelan:
No. I mean we have personally experience of that in our home with IKEA furniture and cribs and things for our kids, so I’ve lived it. Plan needs to come with a six pack of beer just to make it all work out.
Dean Wehrli:
At least.
Margaret Whelan:
No, I think it’s actually much easier and more efficient because the house plan has already been built in 3D. I think it’s a lot simpler. In fact, you see a lot less paperwork and frustration at the job site because these pieces, they’re built with such precision that they’re easier to assemble.
Dean Wehrli:
Okay. Okay. Okay, now we’re going to start doing this more and more in the US. Is it going to change? Is this process going to be different as it migrates into the US, you think?
Margaret Whelan:
No, I don’t think it needs to be different. I think that’s one of the real opportunities for the US, that we can do something. We don’t have to be pioneers. We can do something that’s been very successfully done in the past. And it’s actually already been done on a small scale around the US. We do have big truss manufacturers. We do have big shell contractors who will sell a builder a kit for about 40-$50,000 depending on the size of the house, primarily depending on the size.
Margaret Whelan:
And then they’ll go in and set all of this up for them. So it’s already being done, the question is why isn’t it being done more. Actually one of the interesting surveys that Todd put out on your team from the building products companies is that more than 25% of the builders are already using some kind of turnkey solution, and more than 50% want to. It’s concentrated geographically. The big challenge, the NAHB did an interesting survey in June as well about this, and they do it every June. And the big challenge that they’re builder, customers and members stated was there’s not enough scale. It’s not available enough to them. But if it was, they would use it more often.
Dean Wehrli:
So we’re not quite at that critical mass yet where it becomes even easier and it just grows and grows and grows.
Margaret Whelan:
I think that we’re very close for a couple of reasons. My personal views, I’ve been saying this for a while, is that we’re all going to look back on 2018 as the inflection point for when offsite really took over. And it took over and started to grow and to be accepted because until now it’s not really been accepted in the US. That’s one of the reasons it hasn’t really grown. But the reason I say that is primarily because of what I do, which is raising capital. And the capital that’s coming into this industry asset class right now, the growth is exponential. You know, it’s doubling, tripling every year. We have not just folks like Katerra who are getting a lot of of media attention and who are doing a very nice job, but Entekra, which is the European team that set up a factory in Northern California, got an investment from LP, Louisiana Pacific earlier this year.
Margaret Whelan:
I think that tells you that the wood products companies are looking at and saying, “Okay, we don’t want to be displaced. We want to add value. It’s going towards install sales. Let’s be a part of the solution.” CertainTeed, which is a global insulation company, made investment in a company in New Hampshire earlier this year. Benson Homes, which is a modular company. And so I think that when you look at the dollars coming in, there’s a lot of investment in construction technology companies, which are primarily software, BIM and property technology companies, which are essentially consumer interfacing. But all of this is increasing the digitalization of our industry, which is very important.
Dean Wehrli:
So I think you just actually answered my next question and tell me if you want to expand though, is that what are the catalysts for offsite construction? Why? What’s different now that will make it more accepted this time around?
Margaret Whelan:
I think there are two big ones. One is that after the election two years ago, we started to see very substantial tariffs that were directly impacting the cost to build a home. So lumber was going up 30, 40% and you could say, “Yeah, that’s $8,000 or $10,000 more in cost per home.” At the same time, rates have been going up this year, mortgage rates, and so a monthly payment is getting tougher for the new home buyer to justify. We started to see this over the last few months, that buyers are staying on the sidelines to some degree. You couple the higher cost with the fact that labor, the challenge there in my mind is more secular than cyclical. I think a lot of people thought that because we had such a strong, big correction 10 years ago, that labor left our industry and didn’t come back.
Margaret Whelan:
And I think it’s a secular issue in part because of the new president that we can bring in the undocumented labor we’re so used to using in our industry and in particular on the job sites, but also because so many young people are going to university now in America. I think I heard John being quoted last week saying that this new generation is the most educated generation.
Margaret Whelan:
There’s so many different factors that are coming into play and then you put capital with that. The sustainability of a business is always a function of the capital being available, and it’s available now. And the partnerships. I love to see the partnerships between the building products companies and the builders so that they’re really aligned in creating a better, more durable house. More energy efficient house that’s also cost effective.
Dean Wehrli:
So it sounds like we’ve got this sort of swirl of money that wants to do it, of partners that are in place to do it. A lot of it sounds like, if I’m reading it right, sort of necessity. We need it because of the labor shortage. We need it to save money and pass it along to the consumer that’s already stretched thin. Are those kind of the main catalysts that make it different this time?
Margaret Whelan:
Necessity breeds invention, right Dean. And so that’s it more than anything else.
Dean Wehrli:
Okay. So, okay. But you know, let’s be honest there is a little bit of, maybe stigma is too strong a word. Maybe it’s not though, toward offsite because people think of it, “Oh that’s manufactured housing,” or something like that. What are going to be the biggest hurdles to offsite this time around?
Margaret Whelan:
The concept of stigma around offsite is interesting because I think it’s an excuse. It’s kind of like the concrete industry in South Florida argues that stick-built is not as hurricane resistant as concrete. But actually it is. It’s been tested for decades. And so there’s some funny stories coming from the RCI, Buddy Raney in Central Florida from his job sites recently, which is that consumers are going to a master plan and seeing that their house is taking weeks and weeks say a frame, where’s the house next to them is going up in two or three days. And they’re saying, “Why can’t mine be crane installed?” So I don’t think it’s a stigma from the consumer.
Margaret Whelan:
I think what I say about our industry is that we need so much more diversity in our thinking. We have an industry that’s run by leadership that’s very seasoned, very senior, and in some cases, stale. It’s primarily pale and it’s primarily Caucasian. If you go to tech conferences, most people are a lot younger than we are and it’s not lost on me that I’m sitting here as a Gen Xer talking to an industry usually that’s mainly baby boomers in the audience, about millennials. But millennials are much more open to new technologies and they actually expect it.
Margaret Whelan:
Again, going back to the stigma question, if you were buying a phone today, are you going to go and buy the Nokia flip phone that you would have gotten 10 years ago? No. You’re buying a car today. Are you going to buy the kind of car that you would have got 10 years ago? No. But why are we accepting that on a house? The houses, the technology is changing. Energy efficiency is super important and as great as California mandating it, and actually that government intervention is going to be another catalyst because it was this year that California came out and said zero net energy homes by 2020. And they’ve relaxed a little bit, now they’re saying all solar. But homes that are built with a more energy efficient envelope, thermal envelope, will have lower bills per month.
Margaret Whelan:
When you go to Europe, you get a HER score. You can see that on your house when you’re buying it. You know exactly what your power and utility bill is going to be month to month through the seasons. Yet we don’t have that now on new houses or on old houses. I think the difference between new and existing homes is not enough to support the difference in the average price right now. That’s another reason sales have slowed.
Dean Wehrli:
Oh, okay. So, effectively then maybe stick-built becomes the Blackberry of housing in five or 10 years from now. We’ll wonder why we ever did it that way. I mean, is that right? And that’s potentially true, isn’t it?
Margaret Whelan:
I loved my Blackberry and I still miss it.
Dean Wehrli:
I loved my, I’m not going to lie, I loved my Blackberry. I was the last hold out at the company at the time for the Blackberry, but I can’t imagine using it. I can’t imagine not having a smart phone. I feel like maybe that’s the consumers or even the industry, builders in 10 years or something. Maybe that’s too fast because this is going to be a little bit of a longer process or maybe not. But we’ll wonder why we didn’t do this much earlier and it’s amazing how we waited so long to do it and now it’s so obvious that we should do it this way in five or 10 years. Because like you said, millennials are going … if they don’t attach that kind of stigma to it and they see it as being more efficient, more cost effective, you’re crazy not to do it. So we’ll follow what the consumer says as we should.
Margaret Whelan:
I think the consumer would prefer to not pay for all that waste in the dump site and [inaudible 00:16:02] house and pay for a more energy efficient house with a HER score and that’s the way our industry, our leadership needs to start thinking about this.
Dean Wehrli:
Could you even see the government intervention being the waste idea where you know, here’s the amount of waste we will accept and you can’t get to that goal without being offsite.
Margaret Whelan:
United Kingdom, you’re not allowed to have a dumpster on a job site. And all of the lumber is precut so there’s no waste. You get fined if there’s a dumpster. Here we motivate the framers, to overbuy because we pay them by the yard, or by the foot.
Dean Wehrli:
Yeah. That’s going to change. It’s going to have to. How about, you mentioned it a couple of times, let’s focus on it for a moment. Affordability. I mean affordability or the lack of affordability is a massively important issue in the US with respect to the housing market, especially on the two coasts. Is that going to be a catalyst? Is this going to be something that could really have a real impact on that issue here and going forward.
Margaret Whelan:
You know, affordability is a consumer saying, “No, I’m not going to buy the most expensive house.” Prices have gone up too much over the last couple of months because the builders … starting in May, the lumber prices spiked and we saw a lot of price appreciation or an effort, price increases that didn’t get realized because the market slowed as a result. But I do think that the affordability will be a part of it. And the buyer just saying, “Look, I need a smaller house. I mean a simpler house.” And, and again, your research team, John Burns Research Team, has done a really nice job of outlining which are the builders are moving. [Icort 00:17:37] and Express and LGI is doing so well. These are very simple homes. They don’t need all the options and upgrades and elevations. They just want an affordable monthly payment that feels reasonable to them.
Dean Wehrli:
Yeah. And they’ve been remarkably successful with that kind of model. I mean, it makes perfect sense that offsite could be that part of a model for a lot of different builders now. Okay, so kind of a two part question here. Who are some of the leaders right now in the US for offsite? And as you mentioned a few times is it’s already accepted in the norm in places like Japan and Europe, are we going to have some disruption from those folks into the US market with onsite as their sort of entree?
Margaret Whelan:
Yeah. So in terms of who’s doing it in the US BMC brought out a product called Ready-Frame a couple of years ago and that has been very well accepted by builders. The only complaint I hear about is they can’t get enough of it in all their markets. BMC has a national footprint and they’re making Ready-Frame available through their dealers and I think that’s very smart. In some cases they’re installing it as well.
Margaret Whelan:
The super subs, Buddy Raney RCI Construction in Central Florida there. Louisiana Pacific has just invested in Entkra. Right. I think the growth is going to be very accelerated from Entekra because they’re working with the national builders in Northern California and those builders are saying, “This is great.” Like KB started using them in Northern California and then immediately rolled them out for the Vegas house. They actually drove that kid for the Show House in Vegas 2019 from Modesto, California to Vegas because they really wanted to underscore how important it is to KB.
Margaret Whelan:
So I think it’s the builders that are going to invest in it. I think it’s the products companies that are really going to be the independent third parties. A couple of builders have tried stuff like this before with mixed success. NVR and Toll have done a phenomenal job of it for decades. You can see it in their profitability and their return on capital. I believe it will be the third parties in the US and they’re already there.
Margaret Whelan:
In terms of the Japanese real estate companies, Japanese home building is dramatically different to the US. The country is very small. It’s very mountainous. They build in very concentrated geographic markets and in fact Japan would fit inside of California. It’s not that big and it’s got three times the population with 120 million people. So modular is much more accepted in Japan. Full 3D closed panel, modular is about 10% of the market there versus 2% here. And I have not seen any of the Japanese companies talk to me or suggest that they want to invest in any of these opportunities.
Margaret Whelan:
I have seen them buying well run US home builders and actually I think one of the stealth operators is Clayton Homes. I was in Knoxville a couple of weeks ago and spent a day touring some of their factories. It’s phenomenal. They ship five finished houses a day at a wholesale cost of $50,000. And they’re well-made homes. They’re well sized homes. They’re well-appointed. It’s a company with a great brand, a great culture. They’re owned by Berkshire Hathaway who, last time I checked had about a hundred billion dollars in the [inaudible 00:21:01] balance sheet.
Dean Wehrli:
They made some good decisions.
Margaret Whelan:
Yeah, I think they could buy the whole of the [inaudible 00:21:08] publicly traded home builder if they felt like it, but they have a little bit of modular. They’ve a lot of manufactured housing. Obviously they’re the biggest in the country and I think they are selling more than a 5000 stick-build homes now based on the home builders that they’ve bought over the last couple of years
Dean Wehrli:
You mentioned some of the Japanese, some Japanese firms have bought into American home builders. Do you think they might inject some of that culture in some of those processes that way or are they just really more relatively passive investors? I know that’s speculation, but …
Margaret Whelan:
Yeah, it would be hard for them not to. Right now they’re just injecting capital that’s very attractively priced relative to the cost of equity here in the US, public or private. And so I think that it’d be hard for the expertise not to rub off a little bit. I know that most of those companies that have been acquired by the Japanese real estate companies, those US teams go back and forth to Japan, a couple of times a year. I think they’re looking at some of the best practices. I think that Japan is very, very different to the US.
Dean Wehrli:
Okay, that makes sense.
Margaret Whelan:
In terms of the digitalization, they can build a house in days in Japan. They quote a 50, 60 day delivery time, which is what they do in Europe as well. Whereas here we’ve gone from days to weeks to months, in some cases more than a year. In part that’s because of the lack of investment in research and development in innovation. If you look, going back to the US, if you look at other public companies, leadership companies, consumer oriented companies, they’ll spend about 5% of revenue on R&D and new product development. Whereas for US construction, it’s less than 50 basis points. And so just the digitalization would make it much more efficient.
Dean Wehrli:
Yeah, we do kind of rely on individual, in this case builders, to do that kind of R&D on their own as opposed to maybe even more concerted industry wide effort with private public partnerships. We just don’t have that here. At least not in housing. So you don’t get that kind of innovation, do you? Not naturally, I guess.
Margaret Whelan:
No, but that’s why I think that 2018 is the inflection point. You’ve got some really smart prop tech investors like the guys at Fifth Wall who are investing, who are looking for new ideas. They got capital, I believe from Lennar and Toll and Opendoor. You know there are lots of new solutions that are coming. I think Clayton is the one to watch versus the Japanese. I think as an industry, the single family rental rates have percolated into what I call B2R, build to rent, because they’ve run out of opportunities to buy homes at scale and they’re very efficient. They’re very cashflow focused because they’re looking at the month to month cash returns. And so they’re adopting some of the offsite solutions more quickly than the traditional stick builders.
Dean Wehrli:
That makes a ton of sense, doesn’t it? I mean they don’t have to worry so much to the degree there is this consumer stigma again and maybe there isn’t anyway, but to the degree that they perceive that. The single family rental aren’t really … that’s going to be a much less of a factor for those folks and costs is much more of a factor that actually … I had not thought about that. That makes a ton of sense to a degree, we see build to rent offsite makes perfect sense, doesn’t it?
Margaret Whelan:
Well also building a very simple home and they dictate how it gets back, not the consumer. So I think that helps with the efficiency because then the repetition helps any kind of automated process.
Dean Wehrli:
Definitely. And that renter is not having the same necessarily demands as the buyer is in that environment. Let’s wrap this up with let’s get you uncomfortable here. We know there’s going to be some winners. Let’s go ahead and tell us who in this process of offsite housing construction becomes a bigger part of the picture. Tell us who the winners are going to be, but tell us also maybe who might be the losers. I know we hate those terms, but who might lose out in this proposition?
Margaret Whelan:
Well, the opportunity is open. It’s an open playing field right now. I think the greatest beneficiary will be the National Home Builders and I hope that even if they decide not to invest in this directly, that they will partner and support the building product companies that are writing the checks, so that they can build and to sustainably offer these types of homes.
Margaret Whelan:
I think the building products companies like Louisiana Pacific are really smart, really ahead of their time in terms of adopting. And that’s in part because they have a global footprint. It’s the same with CertainTeed and their investment this year. Beyond that, the losers, I haven’t figured that out yet. It could be the lumber industry itself because there are other … we’ve talked a lot about offsite in the process of offsite, but there are also products like HercuWall, which is the cement wall product, Quad=Lock. Some other products like that, that are coming to the market that could displace some of the stick-build all together, and that in of itself might make the lumber companies a little more innovative.
Dean Wehrli:
That’s interesting. Do you think it’s fair to say that the losers in this process are going to be folks who don’t get on board?
Margaret Whelan:
I think that we’re already seeing that, yes.
Dean Wehrli:
Okay. Well, Margaret, this was very insightful. I did introduce you as the legendary Margaret Whelan. I’m glad I did because I think you’ve lived up to it.
Margaret Whelan:
Thank you very much. I appreciate it. I enjoy your podcast and thanks for including me today.
Dean Wehrli:
Well, thank you and we’d love having you. That’s it for today. I’m your host Dean Wehrli with New Home Insights. Please join us next time. Margaret, please say goodbye.
Margaret Whelan:
Goodbye, everybody.
