Prefabrication holds key to solving global affordable housing crisis

Affordability gap must be closed by boosting construction efficiency and policies to release land, says McKinsey Global Institute 

Antony Oliver
24 October 2014

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Pre-fabrication and off-site manufacturing is key to solving the world's growing affordable housing crisis, according to a new report by McKinsey Global Institute and McKinsey's Infrastructure Practice.

In both the developed and developing world boosting the efficiency of construction methods is, the report says, crucial alongside other policy and financial levers to tackling the growing “affordability gap” that by 2025 will leave one third of the urban population unable to afford decent housing.

 “A lot of things need to be in place before pre-fabrication will take off. Land price is key and certainly where that is high then it is difficult. But where land prices are lower it becomes more relevant but you need to find the right scale and you need the right construction infrastructure and logistics.”  Jan Mischke.

“Urbanisation is certainly a solution to many of the world’s problems but the speed of development of some of the world's mega-cities is why we are seeing these large affordability gaps,” said report author Jan Mischke, a senior fellow at the McKinsey Global Institute. 

“It puts dramatic strain on the infrastructure,” he explained highlighting that by 2025 this housing problem could be affecting 1.6bn people. “But dealing with the challenges is quite achievable if you plan ahead,” he insisted.

The report “A blueprint for addressing the global affordable housing challenge” proposes to tackle the problem by first quantifying the challenge using the so-called “affordability gap” – the difference between the cost of decent housing in a particular city or region and the ability of the population to pay.

In the UK the challenge is particularly focused on London, where 35% of the households cannot afford a basic unit at market rate. The affordability gap is some $17bn or 2.2% of GDPand by 2025 an estimated 450,000 additional low income households will not be able to afford basic housing.

Four market-oriented “levers” are detailed that can guide development planning and reduce the cost of housing by 20-50% so making it affordable for households earning 50-80% of average income. 

These include measures to: 

• unlock land at the right location and so promote new construction
• reduce construction costs through value engineering, standardising design elements and industrial approaches such as prefabricated components manufactured off-site 
• increase operations and maintenance efficiency, and 
• reduce financing costs for buyers and developers. 

The report argues that bridging this affordability gap represents a huge opportunity for the construction industry worldwide. The ability to pay is measured as requiring no more than 30% of household income and the report estimates that the gap between what people can afford and the cost of housing currently stands globally at around $650bn a year and will increase as global populations continue to urbanise. 

McKinsey’s report says that the use of off-site manufactured components to boost speed and efficiency of construction is critical to boosting efficiency and, with other procurement and process improvements, project delivery costs can be reduced by about 30% and completion schedules can be shortened by about 40%.

 “A lot of things need to be in place before pre-fabrication will take off,” explained Mischke. “Land price is key and certainly where that is high then it is difficult. But where land prices are lower it becomes more relevant but you need to find the right scale and you need the right construction infrastructure and logistics.”

“You also need to overcome perception bias - that prefabricated homes are not place that people want to live,” he added. “So it is a mixture of overcoming natural and policy related issues.”

McKinsey estimates that to replace today’s inadequate housing and build the stock needed by 2025 would cost between $9tr and $11tr rising to as much as $16tr with land. Of this, $1tr to $3tr may have to come from public funding.

Unlocking land is also highlighted as critical to solving the housing crisis and, the report says, will require a mixture of incentives and penalties to help free up development land for house construction and overcome some widely-believed myths about what is possible.

“We would recommend a delivery unit be established at city level to drive through the levers,” said  Mischke pointing out that the key is for cities to work with the private sector and the community with a clear set of aspirations for housing.

“This problem can be solved if we really want to,” he added

The analysis draws on MGI’s Cityscope database of 2,400 metropolitan areas as well as cases studies from around the world, with profiles of four cities that represent different stages of economic development: New York City, Pune in India, Lomé, the capital of Togo, and Singapore.

The McKinsey report finds the affordability gap could be halved by applying the four levers in a comprehensive program. 

1. Unlocking land supply at the right location is the most powerful lever. In many cities, developable land remains idle, justifying incentives like idle land taxes. Even in New York City, 10 percent of residentially zoned land is undeveloped. Governments can also unlock underused public land in central locations, develop new land with transit and other infrastructure, and reform land use rules. Land can be brought forward for development through incentives such as density bonuses, which involve raising the permitted floor space on a plot of land and, therefore, the land value; in return, the developer is required to provide land for affordable units.
2. Reducing construction costs. While manufacturing and other industries have raised productivity steadily in the past few decades, construction productivity has remained flat or declined in many countries. In many places, residential housing is built in the same ways it was 50 years ago. By using value engineering (standardising design elements) and industrial approaches (prefabricated components manufactured off-site), and by adopting efficient procurement methods and other process improvements, project delivery costs can be reduced by about 30 percent and completion schedules can be shortened by about 40 percent.
3. Improved operations and maintenance, for example through energy efficiency retrofits or building maintenance operations at scale, can cut ongoing costs. 
4. Lowering financing costs for buyers and developers through better access to housing finance, including underwriting for low-income borrowers, developing mortgage markets, and helping developers reduce risk.