Optimizing costs and benefits in real estate construction and operation

Optimizing construction and operating costs has always been an important matter for all players in the real estate market. However, there are increasing signs that the topic will become even more signif­icant in the future.

Property owners have benefited from steady price increases in recent years. As a result, the optimization of costs has been somewhat neglected in many cases. The reason for this is that the excess demand for real estate in previous years has generated little price pressure. Now, however, interest rates have risen in general, and with them mortgage rates. In addition, global uncer­tainty has increased sharply due to the war in Ukraine, the pandemic, supply chain problems, inflation, etc. The real estate market will not remain unaffected by these changes in the medium term. Although record prices are still being paid for properties in good locations, some investors are already exercising a certain degree of caution as current prices don’t always match their real estate strategy or return expec­ta­tions.

We know what happens in the industry when prices can no longer be increased due to compe­tition or even fall: Optimization must be made inter­nally. Companies that come under pressure often manage to develop more efficient production processes and generally operate in a more innov­ative and agile manner to achieve attractive margins despite the pressure on prices. Companies operating in the real estate market also need to become more efficient again — and even more so in these troubled times.

Housing: Price-optimized or good value for money?

Optimizing costs has been partic­u­larly important for non-profit organi­za­tions such as cooper­a­tives or founda­tions that offer low-cost housing, often based on cost rents. Here, the idea is that rents should cover costs while only a limited return on investment, or none at all, is targeted. This means that construction and operating costs are directly included in the rent calcu­lation and have a corre­spond­ingly high signif­i­cance. In the case of low-cost housing, costs are delib­er­ately kept low. These insti­tu­tions aim to meet the basic needs of their tenants — and this includes keeping rents as low as possible. Never­theless, a certain level of comfort, to which tenants are accus­tomed nowadays, is rarely disre­garded.

With the goal of internal densi­fi­cation, many cities are increas­ingly granting use bonuses in the case of rezonings, combined with the requirement that a certain proportion of the apart­ments be offered at affordable prices. Such oblig­a­tions affect all investors, including those who are seeking returns and have not yet addressed the issue of affordable housing. There is a broad spectrum between affordable and luxury housing. Due to the above-mentioned increasing cost pressure, a category of apart­ments oriented towards excellent value for money is likely to increase in impor­tance. Investors who bring such cost- and use-optimized housing onto the market want to offer their tenants real added value while keeping costs and thus rents under control. For example, a laundry tower in the apartment is a relatively inexpensive purchase yet is highly appre­ciated by most tenants. However, tenants’ needs also change over time. While fireplaces were considered essential in condo­miniums in the 1980s, this need has largely disap­peared nowadays. The assessment of the value added depends heavily on the tenant segment and their willingness to pay.

Aspects of cost optimization

In the following section, five aspects will be highlighted that are important for those focusing on the categories of affordable or good-value housing:

1. Space efficiency and floor plan quality
2. Dealing with existing properties in need of refur­bishment
3. Sustain­ability pays off
4. Consid­ering the entire life cycle of a property
5. System construction

1. Space efficiency and floor plan quality

Many tenants are placing increasing impor­tance on floor plan quality. This is often weighted even higher than the total space of an apartment. The following aspects can play a role:

• Compact floor plans: Avoiding traffic areas while allowing for furniture to be placed easily.
• Multiple uses of rooms: A living room, for example, can be converted into a bedroom, office or fitness room in just a few easy steps.
• Common areas: Areas that are not perma­nently used are shared with other tenants (party room, roof terrace, studio, office).
• A home office does not neces­sarily have to be in one’s own apartment. A co-working space in the house, settlement, or neigh­borhood can serve this purpose just as well or even better. In this way, it’s possible to forgo the additional room for a home office and keep costs low.
• Building services: Building services (e.g. pipe routing or shafts for controlled venti­lation) deserve special attention as they often conflict with space efficiency. Although easily acces­sible building services simplify mainte­nance, they require more space, which in turn reduces the leasable area. Here, it is important to weigh the advan­tages and disad­van­tages of possible solutions.

Examples 1: Lymhof

Wüest Partner accom­panied the devel­opment of the Lymhof. The apart­ments, which are rented out at attractive prices, are charac­terized by a high use value while requiring little space.

Examples 2: Perfor­mative House

In the middle of the room there is a wall that can be rotated. Depending on the rotation, different room divisions are created. Another specialty are the storage spaces in the floors.

More infor­mation about the perfor­mative house (external link)

2. Dealing with existing properties in need of refur­bishment

Viele Investor:innen wenden über ihr ganzes Portfolio hinweg einheitliche Sanierungsstrategien an. Es ist jedoch in den meisten Fällen sinnvoller, für jedes Objekt eine eigene Strategie zu entwerfen. Investor:innen, die über Erfahrungen mit unter­schiedlichen Strategien und über das entsprechende Know-how verfügen, von der Pinsel­ren­o­vation über umfassende Sanierungen bis zum Ersatzneubau, sind hier im VoMany investors apply uniform refur­bishment strategies across their entire portfolio. However, in most cases, it makes more sense to develop a separate strategy for each property. Investors who have experience with different strategies and the corre­sponding know-how, from brush renova­tions to compre­hensive refur­bish­ments to replacement construction, have an advantage here.

• Location: The quality of the location and, related to this, the local demand and willingness to pay should play an important role in deter­mining the scope of the investment. Central to this is the amount that can be passed on to tenants. Typically, more investment can be made in expensive neigh­bor­hoods because the higher costs can be passed on to tenants and the demands on the standard of the apart­ments are higher. In price-sensitive locations, the market price may inflate due to excessive investment, meaning owners have to bear a large part of the costs themselves. In many investment plans, too little consid­er­ation is given to the quality of the location, and fixed refur­bishment costs are calcu­lated per square meter or apartment. However, it makes sense to differ­en­tiate according to location and to renovate only what is necessary in price-sensitive areas.
• Depth of inter­vention: Floor plan adjust­ments in existing properties are relatively expensive and often not worth­while. Thus, the costs are usually only marginally lower than those for new construction — and in some cases, even signif­i­cantly higher. Another disad­vantage of properties that undergo extensive renovation as well as floor plan adjust­ments is that they are often not perceived as completely “new”  (and in many cases, they are not) despite the high cost. However, there is one major exception to note here: Building and zoning regula­tions may mean that a new building would have a signif­i­cantly lower utilization rate than the original building; this is especially true for high-rise buildings.

3. Sustain­ability pays off

• Environment: Switzerland wants to become climate neutral by 2050. Real estate must make a decisive contri­bution to achieving this goal — after all, the Swiss building stock is currently respon­sible for around a quarter of the country’s CO2 emissions.
• Owners: It is obvious that invest­ments in the sustain­ability of buildings incur costs — and higher costs in themselves lead to a lower market value. For owners, however, invest­ments in the sustain­ability of their properties can pay off finan­cially at various levels. For example, a property’s attrac­tiveness is increased by sustainable construction, which can be reflected in discounted prices and higher net rental income. In addition, there are usually lower utility costs for tenants and lower mainte­nance costs for owners. Last but not least, the buildings are more durable and it is possible to apply for subsidies. The study “The effect of sustain­ability on real estate values”, which Wüest Partner recently conducted on behalf of the Federal Office for the Environment (FOEN), shows that in many cases it is actually possible to increase the market value of a sustainably operated property despite higher costs. In principle, ecological construction methods have long since ceased to be in conflict with economic profitability. On the contrary: the fact that invest­ments in sustain­ability pay off in the long term applies to most building compo­nents.
• Tenants: CO2-free heated apartment buildings can be operated at signif­i­cantly lower costs. Incidental costs, for example, fall so sharply when switching from oil or gas heating to a heat pump that the gross rent often increases only slightly – even after the investment costs have been passed on to the tenants. In some cases, housing costs can even fall, as the study “Energy refur­bish­ments: 3 winners” conducted by Wüest Partner in 2020 showed.

4. Consid­ering the entire life cycle of a property

When consid­ering the entire life cycle of a property, construction accounts for only about one-third of the total cost. This means that two-thirds are spent during the opera­tional phase. Accord­ingly, the conse­quences can be far-reaching if savings are made in the wrong place during the construction of a property. For example, a heat pump may be more expensive to buy than an oil-fired heating system, but it is so much less expensive to operate that the decision to opt for a heat pump is also finan­cially worth­while in the long term — not to mention the positive conse­quences for the environment.

Naturally, the greatest scope for action in a building project is at the planning stage. The further a project progresses, the smaller it becomes (see figure). Alongside the room for maneuver, the ability to influence future costs also decreases. Careful strategic planning, therefore, also pays off finan­cially. Moreover, adjust­ments made in the course of a construction project often result in high additional costs. Equally important is careful quality and cost control throughout the planning and construction phase to ensure that deadlines are met and building costs do not get out of hand.

5. System Construction

Modular construction is a method in which the building is assembled from prefab­ri­cated compo­nents or modules. The compo­nents are produced in a factory, trans­ported to the construction site, and assembled according to the modular principle. System building has many advan­tages:

• Shorter construction time
• Lower costs
• Many years of experience
• Indepen­dence from weather condi­tions during the prefab­ri­cation phase
• High precision of the often mass-produced compo­nents
• Better planning and reduction of unforeseen events
• Individual archi­tecture is also possible

A building produced by system construction tends to be cheaper to manufacture than a conven­tionally built property. The biggest advantage, however, is the time saved by the shorter construction period: faster completion means earlier rental income.

In Switzerland, the system construction method is currently used mostly for temporary and commercial buildings and is rarely used for residential properties. Other countries, such as Germany or the Nether­lands, are already somewhat further ahead in this respect. There is a good chance that the use of system building methods or the combi­nation of these with conven­tional building methods could also become more popular in this country. At present, their reputation is still somewhat tarnished, as they are often associated with prefab­ri­cated buildings from the 1970s. However, this image could change if it becomes increas­ingly visible that system building also allows for modern and individual archi­tecture.

Conclusion

In the current period of high inflation and construction costs as well as increased interest rates, optimization regarding the costs and benefits of housing is becoming ever-more important. The five aspects presented here represent options that owners can act upon. Finally, remember this: Buildings are there for the people who occupy them. And it is precisely for these target groups that they should be optimized in terms of costs and benefits.

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