Why is Money Flowing to Off-site?

Mergers, acquisitions and investments are helping grow off-site construction. What’s behind this trend and how does a builder get involved?

Recent years have seen a lot of consolidation and growth in the off-site construction world. Judging by the activity we’ve seen—mergers, acquisitions and investments—there’s widespread belief that off-site is poised for growth. And while the COVID-19 shutdown has no doubt put some pending deals on hold, long-term factors make it likely the pace will resume once the country gets back to work.

This article offers a short overview of the trend. Subsequent articles will look at specific deals or deal types.

We want to encourage Alliance members—builders, off-site providers and investors—to think about what actions they can take to help grow their business and the industry as a whole.

The Deals Landscape

Margaret Whelan, founder and CEO of Whelan Advisory, which has been involved in several high-profile deals, says there have been more than 500 venture capital deals involving U.S. construction technology providers over the last five years. Most of the companies involved supplied software, robotics and off-site construction products.

One example is Pulte’s acquisition of Jacksonville, Fla. integrated panel manufacturer Innovative Construction Group (ICG). (Whelan Advisory was the exclusive advisor to ICG.) Chuck Chippero, Pulte’s National Director of Strategic Sourcing, predicts more such deals as builders try to solve their most pressing problems. “We are aware of significant investments being made in machinery, equipment and software focused on increasing off-site production, particularly for wall panel and floor cassette components,” he says.

While big transactions like Pulte/ICG make the news, Whelan says that 70% of those 500 deals were Seed or Series A financing—the first time a business offers an investment opportunity to outside investors. That’s an opportunity for smaller companies to get involved.

Investopedia.com puts the average Series A financing at $12.5 million, but the money often comes from venture capital firms that accredited investors can help fund. (One such firm is Los Angeles-based Fifth Wall, which focuses on real estate.) “Investing in a venture capital fund provides an opportunity [for building industry companies] to make small investments without too much risk,” Whelan said during a talk at the Industrial Wood Based Construction Conference in late 2019.

Why Now?

Why has the pace of mergers and investments picked up now? We believe there are at least three reasons.

  1. General industry consolidation. Off-site M&A activity is part of a wider trend. Builderonline.com includes several articles detailing recent mergers and acquisitions. Toll Brothers bought Thrive Residential, which builds infill housing in Nashville and Atlanta. Stanley Martin Communities acquired Carolinas-based Essex Homes to strengthen its presence in that region. Japan’s Daiwa House, which purchased Stanley Martin in 2017, took a majority stake in California-based Trumark communities. (Whelan Advisory also advised on this transaction.) Sumitomo, and Sekisui House have also been acquiring U.S. builders.

    The driving force behind this activity is the need for buildable land, according to the magazine. Shrinking lot supply means that small regional companies’ best chance for growth is to align with a larger player.

  2. Productivity problems. Labor constraints are another issue for builders who want to grow volume. To make matters worse, the workers they have are less productive than they could be. According to an oft-cited 2017 McKinsey report, construction has the second-lowest labor productivity of any US. industry. Engineered, off-site construction offers a solution by making it possible to complete more homes in less time with smaller crews. That has led to large investments as well as strategic partnerships.

    One of these was the combination of two Wisconsin companies, panel manufacturer Drexel Building Supply and general contractor Blenker Building Systems, which is scheduled to be finalized at the end of April. The new operation, called Drexel Systems, promises to cut the rough framing schedule from 15 days to four days without increasing labor needs.

    Commercial builders are also grappling with labor. “The biggest threat to our industry is the shortage of skilled tradespeople,” says Daniel McMurtrie, CEO of Vesta Modular in Southfield, Mich. which Inc. Magazine named last year as the fastest-growing U.S. construction company thanks to strategic acquisitions of complementary modular providers. McMurtrie says he is hearing strong interest from conventional builders on using modular to raise productivity.

  3. Cost control. Many factors contribute to rising construction costs, including the cost of materials. Estimators routinely add an 8 to 12% waste factor to framing lumber estimates, which homebuyers end up paying for. By contrast, a side-by side comparison of homes framed using traditional stick framing and pre-assembled components by the Structural Building Components Association found that the component-based home used 25% less lumber.

Evaluating a Deal

Companies looking to acquire or to be acquired, or even those just wanting to invest in deals, need to consider a range of variables.

For public company transactions these include financial factors like EBITDA power, top and bottom-line growth. We won’t go into those, however—there’s plenty of expertise available elsewhere. A large builder looking for a strategic acquisition might task an in-house financial analyst with scrutinizing those numbers, while a small investor who wants to put money into a VC fund would seek help from a knowledgeable broker.

Of course, these numbers don’t tell the whole story. The deal still needs to make sense for the market and the companies involved. If it’s a merger or acquisition, promising signs include the following.

  • It Poises The Company For Growth
    If there’s unmet demand for new homes in markets where a company builds, a good deal will make the company better able to supply those homes. This is a matter of overcoming the constraints mentioned above, including shrinking lot supply and the labor shortage. Some people think off-site can grow even if construction activity is flat. “The construction industry is one of the last bastions of resistance to technological change, but modular is being more widely embraced now because people are searching for answers to the industry’s problems,” says Lad Dawson, CEO and Managing Partner at Guerdon Modular in Boise, Idaho
  • The Companies Complement One Another
    Complementarity is a hallmark of any good deal. The strengths a company can seek to acquire are many, and range from from market access to design enhancements. For instance, Louisiana Pacific invested $45 million in Entekra, a California-based off-site framing manufacturer, in 2018. Entekra had proven engineering and automated framing expertise but lacked the capital to build new factories, and needed to access to more builder customers. According to Whelan, LP’s investment solved for both of these challenges and facilitated Entekra’s ability to grow more quickly.

    Another example is the purchase by Horizon North in Calgary, Alberta of British Columbia-based Karoleena Luxury Homes in 2016. “Our modular products looked very industrial and utilitarian,” says Horizon CEO Rod Graham. “There wasn’t enough flair, so we bought a high-end bespoke design and manufacturing company.” He believes that Karoleena’s architectural prowess will help Horizon build something “that nobody knows is modular.”

  • Their Visions Align
    Obviously, the more two companies have in common, the better their chance of success. “It starts with a shared vision for the future of the combined businesses, says Pulte’s Chippero.  “If there is agreement on how things will operate AFTER the transaction, you can focus on a deal structure that works for both sides and is supportive of the business going forward.”

    A shared vision will be easier to implement if the companies share other attributes. “It’s important that core values align,” says Graham. Things like safety, integrity, how you deal with customers, how you deal with the community. It may sound soft and squishy, but it’s important that people come to work every day and feel good about what they’re part of.”