Margaret Whelan on How Capital Is Fueling Innovation

This is a longer version of an article that appeared in the November/December 2020 issue of Pro Builder.

During her career—20-plus years as a Wall Street investment banker and operating her own boutique firm since 2014—Margaret Whelan has participated in more than $20 billion worth of transactions, representing builders for sale and raising capital for construction companies. One such deal involved fellow Ireland native Gerard McCaughey’s Entekra, which, after failing to secure capital with another advisor, brought on Whelan, who brokered a $45 million deal with Louisiana-Pacific to buy half of the off-site construction firm. Whelan also was involved in the acquisition of another off-site builder, Innovation Construction Group (ICG), by PulteGroup in early 2020. Other clients include RCI Builders, Thomas James Homes, Thrive Home Builders, and Trumark.

She recently talked with Pro Builder’s senior editor Mike Beirne about labor constraints and how access to capital is fueling innovation in an industry not generally known for it.

PRO BUILDER: You mentioned that 2018 was an inflection point for capital investment in the construction industry. What is permanent capital, and are you seeing recent investment producing more innovation in the field or is it producing more digital technology aimed at engaging homebuyers?

Margaret Whelan: Permanent capital is what it suggests, long-term capital that is typically achieved through the public equity markets—in contrast to private equity–type capital, which is typically returned to the investor in eight years.

Yes, we’re seeing interest in investing in innovation from public companies, such as Pulte’s acquisition of ICG earlier this year, which we advised on. This is what I consider “contech”—investment in the construction technology process to drive a more efficient build process through off-site solutions and to deliver a more affordable home.

Property technology solutions, from AI [artificial intelligence] to consumer-oriented tools to facilitate the homebuying process have been well received for the past few years, with more adoption during the last few months, accelerated by COVID-19.

Also, I’m on the board of the first property technology SPAC [special purpose acquisition company, PropTech Acquisition Corp.], which announced a merger with Porch.com in August. There’s a lot of interest from public equity investors in financing the growth of innovative construction-related companies and the outsized returns that are achievable when done successfully.

PB: As for home builders holding back from trying factory off-site construction or modular, what are the advantages and benefits they’re not perceiving when they compare the cost of turnkey framing with stick framing? For builders that have dipped a toe in these waters, what benefits are they reaping?

MW: Those builder management teams that are holding back are too focused on the cost and not on the value that’s realized as a result of off-site solutions.

Their thinking needs to pivot to considering these costs as an investment rather than as an expense. They want to see someone else make the first move and capital investment, which is surprising, given how successful factory building and off-site have been for companies such as NVR, which enjoy an above-average return on capital.

But the adoption rates of successful models, such as Entekra, which was acquired by Louisiana-Pacific in 2018—we also advised on that one—has been high. When a credible operator brings a solution to the market, it’s well received and quickly displaces the prior model.

In terms of true modular versus panelization, Clayton Homes is addressing this more than any other home builder, leveraging its network of regional stick builders with its substantial manufacturing capacity of mobile homes.

PB: Is Clayton Homes connecting the dots between its manufacturing facilities and on-site builders with bending the cost curve or even transitioning from stick building?

MW: The folks [Clayton Homes] bought, for the most part, were more innovative than their peers. For example, Oakwood Homes, in Denver, already had its own turnkey factory. [Clayton] tends to look for builders that are already progressive, relatively speaking, and a year ago Clayton announced it was opening a new factory in Knoxville to provide off-site solutions to local stick-frame builders.

PB: So, at some point, the stick-building companies in Clayton’s portfolio could be ordering modules and panels for construction?

MW: Yes, and other builders, too.

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PB: Is there a size threshold for builders that can participate in off-site and prefabrication? Do you see room for a builder that completes fewer than 50 houses annually, or even fewer than 25, to participate in off-site?

MW: I do believe this solution is viable, but not to do it on their own. The beauty of the Entekra-type model is they do it for everybody. So a builder who is within 200 to 300 miles of their factory can be serviced by them. And with multifamily—because the projects are bigger—the dollars being saved are even larger, so you can deliver to an even greater radius.

It costs $10 million to $15 million dollars to build one of these factories. There’s not a lot of people that are going to make that investment. NVR, Toll Brothers, are very concentrated in the Northeast, and that’s a market where the ground is frozen in winter, so there’s a real benefit to having factories. They’ve demonstrated they can generate that return over the years, but their home sales are concentrated geographically. You can drive to thousands of houses that you are building in those markets, whereas the other builders have to rely on third parties.

I believe that the builders have given up too much control over their costs to the framers. I think what Pulte is doing with their acquisition of ICG is to try to take that back.

PB: What do you think will be the primary path (or the lowest hanging fruit) builders will likely pursue to address the skilled labor shortage; taking labor out of the process or bringing in/recruiting more young people into the industry?

MW: I believe that the most opportunity is in improving the framing process; for example, the business model that ICG pursues and that Pulte recognized as valuable. They build each house twice, the first time in 3D, to iron out the kinks, rationalize the plans, and reduce waste from the process. As a result, each home is delivered more quickly and efficiently, and with a higher level of precision than a stick built home.

In turn, the full construction process is accelerated with less waste, theft, rework, and delays. Do we have a labor shortage or just a lack of process? If there wasn’t so much rework on each jobsite, we wouldn’t need so much labor. If there wasn’t so much waste in the dumpster outside each house, we wouldn’t have such an affordability challenge.

Young people are not attracted to our industry, while more seasoned and efficient contractors are aging out. Offsite solutions will bridge this gap as they require less labor, and in particular less skilled labor, overall.

PB: In your opinion how long before disruption will take hold in home building, and what will be the advantage(s) for the first adopters?

MW: Too long. Overall builders and construction companies could really benefit from more diversity in thought, which should start at the board level. I describe the culture of our leadership as having PMS—Pale, Male, Stale. There is a lot of room for improvement! It’s smarter to anticipate what’s around the corner, control the pivot, and jump versus get pushed.

By embracing a broader frame of mind—no pun intended—they’ll see how many companies and industries have been completely displaced by business-to-consumer models. Amazon, Uber, Netflix, and Airbnb have all been successful disruptors by pursuing a B2C strategy.

What happens if Tesla starts to pursue a housing strategy and delivers sleek, modern, energy-efficient homes directly to consumers? It’s only a matter of time before the new entrants focused on modular start to take market share. In an industry that changes so slowly, the benefit of being a first adopter is that they’ll have a material first-mover advantage versus the laggards.

PB: Why will modular construction be more disruptive than accretive for the home building sector?

MW: It depends who leads the new entrants. If home builders step up to address this market and offer modular homes, then they might see a product mix shift but not lose share. Alternatively, if they don’t embrace this opportunity, and Tesla or a new entrant does, they’ll eventually lose market share. Consumers are sophisticated and they’re placing high value on energy- and air-efficient homes that meet their priority of wellness, which is easier to achieve in a factory-build setting.

PB: How has the impact of the pandemic affected merger and acquisition activity?

MW: We haven’t seen a slowdown in M&A or investor interest. In fact, given the increased demand for new homes, we’ve been as busy as ever. For example, we represented a private builder client in the Pacific Northwest on their sale to a large national builder in July. We represented a private builder in the southeast on the sale of dedicated rental communities to a private equity firm this summer. We raised a $250 million joint venture for a single-family rental operator in September, and we received several term sheets for joint venture equity on behalf of a private builder on the West Coast—all in the last few months and despite the pandemic.

The large builders have very robust balance sheets, they have access to attractively priced capital in the debt and equity markets, and they’ve been very prudent over the last few years in keeping their leverage rates low. On the flip side, U.S. housing demand is a sweet spot in the global economy and the large builders are running out of finished lots in many markets. As a result, we expect M&A to continue to be active in the future.