Sunday, May 31, 2009

What Michelle Kaufmann's Closing Says About Construction

Last week, the news of California Architect Michelle Kauffman's closing of her Pre-Fab Housing business was met with heavy hearts in the design community. Kaufman announced the closing on her blog, where news of the closing quickly made its way through the blogosphere, the Green /Sustainable, and architectural communities. I first read the news via Twitter.

There is no doubt that architect Michelle Kaufmann is a talented designer, and has done a lot (almost single handedly) to get the world to see the potential of pre-fab construction. Kaufmann demonstrated that sustainable design need not be ugly, nor sacrifice modern conveniences in the pursuit of being environmentally conscientious. While I have often told clients that "best practices" -- at least as I learned them at Berkeley, have always been "green", environmentally conscientious, cost-saving measures, it took, perhaps, one of Kaufmann's popular designs and the costs of a war waged over oil, before "green" resonated with middle America.

In the summer of 2008, my tree-hugging friends and I eagerly went to the Museum of Science and Industry (Chicago) to see Kaufmann's Smart Home Exhibit which showcases sustainable design practices, systems and materials. (See post on the MSI/Kaufmann Smart Home Exhibit.) Visits the MSI Smart Home Exhibit (2008) -

However, as I read Lloyd Alter's interview with Kaufmann posted on , I couldn't help but be annoyed about another missed opportunity for the country and the architecture & construction industries to take a step forward toward a more sensible way to design and build communities.

Alter makes an important point early in the Kaufmann article -- one probably missed by the majority of home owners and casual readers.

Alter says, "When times were good, Michelle could not find factories to build her stuff; they were making too much money building crap. When the crap market dried up, so did they. "

The problem I have found with many residential contractors (especially those with less than 10-12 years of business experience), is that they seldom seem to learn from their mistakes-- which are many and varied. I am fighting many of the same dumb battles with contractors that I fought 15 years ago: their refusal to follow the plans, and their continual quest to dumb down safety, performance, and long-term economies. Contractors are NOT interchangeable with Architects any more than EMTs can replace surgeons.

One would think that with the economic climate we had post September 11th, contractors would have been more open to different ways of thinking about customers & business in an effort to RETAIN and cultivate more business. But it seems many of them didn't learn much from that period. Housing contractors keep hoping the way they were gouging property owners between 1984 to 2007 (with the exception of a few months following September 11th), would NOT require they adjust the way they built structures going forward.

I had hoped that the economic climate after September 11th also would have served as a warning for the construction industry, but it seemed to be little more than an inconvenient interruption of the mortgage, real estate and construction industries' large-scale, 3-Card Monte Scam-A-Thon of the public. President Bush called on Americans to "go shopping", and a lot of Americans made no adjustments to their lifestyle, financial strategy nor their business practices. Instead, it seemd like the race was on by business to suck the most money out of the economy before another national disaster interrupted "the game".

British Prime Minister Churchill is to have said of Americans, that [we Americans] "..will do the right thing.. once all other possibilities have been exhausted." Among a major portion of the residential builder culture, they seem not to have yet exhausted all the wrong strategies. There is real contempt from contractors toward the greater public (as it relates to quality, value, price, and service rendered.) Many contractors don't seem to take pride in their work product-- they just want to "get paid" before their mistakes are noticed by home owners or the architect.

The seemingly infinite number of home contractor/builder horror stories doesn't show any signs of diminishing in number any time soon either.

While I admit my observations/opinions of "what went wrong" with Kaufmann's business are only based on the one interview, I can't help but also be severely disappointed at what appears to be some business mistakes that might have --from an outsider's perspective, been avoided. I know for Kaufmann it must be a regrettable financial mess for all those involved: for Kaufmann & her entire staff, the home owners/clients, the construction/material suppliers, and perhaps even Kaufmann's pre-fab manufacturer/s.

Here's what I am gleaning from the comments in the TreeHugger interview:

It seems Kaufmann was (on paper) acting as a design/build firm-- or at least a developer/re-seller offering these pre-fab homes to people. She essentially sub-contracted the construction to an unreliable contractor (pre-fab manufacturer/builder), who basically screwed Kaufmann, the suppliers and the would-be home owners all at once. (See, this is why I hate residential contractors !!) Even though Kaufmann had 20+/- clients (at $250-750k construction value+/- each), her mistake was in essentially vouching for the pre-fab company, verbally(?) and contractually.

She really took on too much liability for what she got in return. It's not a position most architects assume (unless they are also acting as a design/build company or re-seller in-charge of the construction accounting and all that it implies.)

Also, unless Kaufman had equity and a management control in those pre-fab construction companies (i.e. the pre-fab manufacturer), she would have no idea of how the pre-fab contractor was managing costs, nor the true cost of the product she is re-selling! So, when the contractors mis-managed their (portion of the) money, it was easy for said contractor to leave Kaufmann holding the bag.

In the TreeHugger interview, Kaufmann claims it was a tightening of available financing. Nonsense.
Because you don't start making anything (incurring more costs) until you have money or a note guarantee for the loan, imo. You don't treat pre-fab like a normal Design / Bid/ Build project with progress payments. It has upfront costs, so you have to treat it financially like a widget-- like any other "manufactured product". You need the (up-front) capital to achieve the economy of scale. (I do, however, believe the challenges of getting to the "economies of scale" part.) You can't hope the money trickles in (to cover costs), lest the financial mechanics of such a structure work more like a ponzi scheme than manufacturing-like. It's all about cash-flow, baby !

If her fabricator couldn't get a loan (to capitalize), they could have shown the bankers that the customers had the loan and/or cash. With money in hand (as a promissory note -- not just a lousy $3-5K down payment, from the customer's bank), that would be enough to finance each home-- if only home by home, one at a time (with some SERIOUS financial penalties/deposit forfeitures should the customers back out once construction/manufacturing has started.) Hey, even though it's a widget, it's not like it's got the mere cost of a toaster or something.

If Kaufmann's customers couldn't get a loan, then it's not on her (as architect) to continue the transaction, ever. No money, no sale, no start of production. She shouldn't have been on the hook for any of it, in my opinion (otherwise, she is basically guaranteeing a product be delivered as the pre-fab home retailer AND designer.)

I don't find Kaufmann's explanation about the financing difficulties reasonable either -- not because credit wasn't tight, but because regardless of the economic climate, one doesn't take on risk (and unnecessary costs) without a promissory in hand (i.e. the loan approved), cash (a sizable down payment to cover costs) or the money in escrow.

Even if the bank wouldn't finance the home owners for pre-fab, she could have gone to a more traditional build method and hired a contractor to build parts off-site the more traditional way (in a garage or warehouse). That surely would have gotten "traditional" financing. It wouldn't have been 100% pre-fab, but they could have done a "component build", which is still more-or-less "pre-fab" credible. Her contracts with her customers should have given her the latitude to do just that. And if her customers didn't have the credit nor the cash to provide such a down payment, again, you don't start the job! It's not MK's role to finance the customer's dream (i.e. assume the majority of the financial risk.)

Knowing that it only takes about $200K (or less) for a GC to build a 1900SF home the traditional way, it's not clear to me how you can burn thru $500K (avg. sales cost) PER HOME (pre-orders, promissory notes, a loan) on a system that is suppose to SAVE money and save costs to the BUILDERS (due to pre-fab, pre-purchase material agreements, factory economies, etc.). It makes no sense.

Thus, I think the pre-fab contractors lied to her. They had to have inflated the actual costs . (And frankly, I bet the pre-fab contractor burned through the money he received-- but NOT on expenses directly related to the actual projects under contract. And if the down payments or progress payments from customers weren't enough to cover initial expenses, that structural business fault (no pun intended) lies with the MK business-- not the credit availability climate.

Hell, you could still build that same house via traditional on-site means for the same amount of money (not more.) $500K?

I know from working with major national chains, when you use a repeat material en masse, you negotiate (like futures) the material cost for a set volume of material in advance. It's a way to guarantee sales for the supplier, and control costs for the builder. It appears Kaufmann may have done that with some suppliers so as to control costs. However, did she negotiate the costs, or was that task left up to the pre-fab contractor? was that under his legal obligation? or hers?
How much of the built-in costs did Kaufmann really know about? (She should have known about every piece of material down to the cost of each nail.) By negotiating many of the material costs in advance with suppliers, Kaufmann should have been able to offer incentives to buyers to stick w/ the pre-negotiated options. It appears this may have been the case, so it is even MORE baffling as to why this didn't help them control costs (enabling them to increase profitability and cash reserves).

Kaufmann's bankruptcy is a shame, because she is a great designer, but her business explanation doesn't make business sense.

This underscores MY POINTS (in previous ShantyWorld posts) that costs and reliability rests mostly on the contractor as to how well (or poorly) the home building experience goes for the home owner. I feel contractors have artificially (greedily) inflated the cost of home building -- not architects. Builders have behaved very DETROIT-like in how they market and price homes. Home pricing has a lot less to do with how architects design homes, than how much greed is inherent with the selected contractor.

Or, perhaps Kaufmann's major mistake was thinking the pre-fab companies would be as conscientious (and fair minded) as she is. Residential Builders aren't. Almost never. In fact, the factory assembly of homes SHOULD be a profit incentive for builders. Apparently, builders are too accustomed to the greedy way they marked up $160K homes and sold them for $400-800K. Sorry, boys, those days (I hope) are over.

Trusting the pre-fab contractor was Kaufmann's mistake. You don't put millions of dollars on the line without:

a) money being in escrow, enough that people won't just walk away from it, or
b) cash on hand that is verifiable (the contractor's money via bond, and the home owners' via loan approval);
c) your own cash on hand to cover the risk (because people lie);
d) never tie your business risk (and profit) as architect to the CONTRACTOR's ability to fulfill HIS financial obligations.

Guess what (?) Most residential contractors don't care (about you)!! They just file bankruptcy and move on to the next home owner who doesn't do proper due-diligence.

I know I am speculating here about the mechanics of what happened. If Michelle wants to yell at me or post a reply, that would be great. We would all be happy to have her shed some light on what actually happened-- free of spin yet (more) truthful about what could (or should) have happened differently. The closing of her venture is not what architects and environmentalists want for the nation, nor the world. Kaufmann's closing is a tremendous loss for all of us.

Yet, there is no economic reason why pre-fab shouldn't work in the USA. It is builders, mortgage companies and realtors who have been sabotaging affordable housing. This bad behavior is costing Americans quality homes-- much in the way the Big-3 auto management culture sabotaged quality, energy efficient American-built cars.

No economy can sustain a model for pricing housing as if housing is seen and treated as a luxury item available to the highest bidder. [Read ShantyWorld's post on what is wrong with Housing Valuation (i.e. costs) in the USA.]

Precisely because shelter is a basic human need, we have to discard these notions about trying to leverage our homes in a manner which will afford each owner a luxurious lifestyle and a net worth that is perpetually growing (environment be damned and debt levels be damned.) That is not the purpose of shelter and that economic model is not sustainable for any nation. Have Americans yet learned this lesson, or will we continue to exhaust all options before arriving at the proper solution: affordable, sustainable housing instead of McMansions ?

- Also read the inaugural post (from 2006) on what is wrong with housing in America. See what we predicted would happen to the USA housing market (before it actually happened.)

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