Introduction

Over the past 5 years, construction costs in the Puget Sound region have risen by over 30%.  Expansion from large tech firms continue to drive high demand for commercial projects. At the same time, increased levels of hiring have also driven demand for housing and the shortage of available construction labor has resulted in rising construction costs.  While we have seen some tempering of construction prices recently, it is important to consider that the largest section of the US population is the Millennials.  As the average age of Millennials are between 25-29, this demographic is the prime age for family formation, which will likely continue to drive demand for housing for years to come.

The Modular Method

Modular construction has gained increasing popularity over the past few years as an alternative to traditional construction methods, promising reduced project timelines and increased cost savings.  A recent article by Mckinsey showed that modular could speed up construction times by as much as 50% and has the potential to reduce costs by 20%.  But to this date, there has been no evidence of consistent savings using modular construction and in some cases, the modular route ends up being more expensive.  This article answers the question of what types of projects would benefit the most from modular construction and what types of projects would be better suited using traditional methods.

Types of Modular

When we first think of modular, the image that comes to mind is massive 50×10 ft modules being lowered into place by a heavy duty crane, and the whole project coming together like a set of legos.  But this is actually only one type of modular construction – 3D, the other main method being 2D.  3D modular is akin to the lego analogy mentioned earlier, while 2D components are often delivered in a flat pack assembly similar to how furniture is packaged at Ikea and then assembled on site.  Each of these types have their strengths and weakness – for example, 3D modules work best for projects with a high level of repeatability, such as student housing and hotels.  Whereas 2D modules are more suitable for projects with large open plans and low repetition such as offices and high end residential.  It is worth noting that labor costs in the factory are typically cheaper than onsite, so rooms requiring high levels of finish work such as kitchens and bathrooms would benefit from being delivered as a nearly completed 3D module in either case.  Most manufacturers today typically focus on one method or the other, but as the industry evolves, future manufacturers may find an optimal balance by combining both methods.

Suitability of Product Types

In determining the suitability of a project for modular, there are three main factors that determine the cost savings that can be achieved: repeatability, unit size, and value density (or the finish level of a room).  The chart below from Mckinsey shows that hotels, schools, and hospitals all show high potential for cost savings using modular, the same could be assumed for student and affordable housing.  These product types all have low variation, small rooms, and high intricacy rooms which make them compatible with modular construction.  Retail spaces and warehouses would benefit the least from modular construction as these are primarily open spaces and would not achieve a high level of cost savings versus building on-site.  Office buildings and multifamily sit in the middle as they can either be highly repetitive or variable depending on the project.

Time Savings

There is little debate that modular construction is faster than traditional.  Onsite, a team of 5 workers can assemble up to six 3D modules per day.  At an average of 500 SF per module (50×10 ft), that would equate to 3,000 finished square feet per day.  At this rate, a 30,000 SF building could be erected in 10 days!  Add to the the time savings of being able to perform the offsite manufacturing work simultaneously with the horizontal site development work, and it is easy to see how the 50% time savings is achievable. 

The chart below from Mckinsey shows a traditional project timeline vs a 3D modular project.  The upfront planning and design does take longer, but once production starts, the time savings becomes apparent.  It is worth noting that modular process have to be fairly standardized due to the size restrictions of the modules and the assembly line type processes at the manufacturer.  As such, change orders and rework are less likely as modular build processes are fairly inflexible to mid-process changes.

Cost Savings

Cost savings are the most debatable benefit of modular construction.  In some cases, especially in the single family residential space, the total project cost of modular is oftentimes more expensive than traditional.  But as we have seen, these projects frequently have neither the scale nor the optimal layout that would maximize the full benefit of modular construction.

However, a counter argument to this would be that it is considerably easier for an end user to self-manage a construction project using the modular method as there are far fewer subcontractors involved – most of the work is handled within the factory.  In this case, the premium may be worth the ability to manage the project without requiring a fair amount of technical knowledge or the increased level of certainty associated with using a centralized process.  There are a number of examples of these projects on YouTube and social media where end users opted to self-build via the modular process, oftentimes as a first time build.

Outside of the single family product type, there are a number of product types that can achieve consistent savings (see Suitability of Product Types above).  For these product types, there are 5 key areas where true cost savings can be realized:

Materials:
  • Centralized location allows for factory direct procurement versus retail markup closer to site
  • Economies of scale for procurement across multiple projects
  • Optimization of entire build process results in lower wastage rates
Labor:
  • Salaried vs contractor rates
  • Geographic arbitrage – cheaper labor market
  • Lower skilled labor required for some functions
  • Increased productivity from standardized processes and automation
Site Overhead:
  • Less onsite time significantly reduces overhead
Rework:
  • Templated workflow and repeatability allow higher quality control
Financing:
  • Shorter construction timeline incurs less interest, however there are challenges with existing financing policies, read more in our article here.

While some areas of modular are cheaper, there are some areas which are more expensive.  Developers must factor in whether the cost savings achieved from the benefits listed above outweigh the additional costs incurred below:

Materials:
  • Transport may require structural redundancy
Design:
  • Accounting for modularity requires more upfront work – as an emerging industry, best practices have yet to be established
Logistics:
  • Transportation costs are much higher plus additional costs for crane
Fixed Costs:
  • Factories need to price in substantial margin to recover high initial capital expenditures
Final Thoughts

While far from being streamlined, the modular construction industry shows high potential for both time and cost savings.  Further standardization and automation across the industry should drive more consistent cost savings as best practices are identified and incorporated.  But there are far more opportunities to improve the construction process beyond the walls of the factory, as modular could enable efficiencies that were not possible before.

As the industry evolves, there will no doubt be disruptive innovations that could greatly tip the scales in favor of modular.  One such idea (suggested in the Mckinsey article) was that one day building codes could become so standardized that factories could simply submit the plans electronically to the local municipality, obtain online approval and begin manufacturing immediately.  In markets like Seattle where permitting times can take in excess of 1 year, an expedited entitlement process like this would be a game changer for both developers and municipalities.

If modular construction continues to gain adoption, capabilities of existing factories will expand and may ultimately prove that modular can consistently achieve cost savings versus traditional, provided that they are adapted to the appropriate use case. While vertical construction is only one element of the true cost of real estate projects, having a consistent method for delivering upwards of 80% of the total construction budget at a fraction of the cost of traditional will be a significant win in addressing the rising costs of construction.