Renovation strategies taking into account economics and ecology

Real estate owners are caught between the legal oblig­ation to reduce green­house gas emissions to zero by 2050 and the desire to achieve the best possible return for investors. But how can they reconcile these two goals and find a compre­hensive and sustainable strategy for their portfolio? Our proposal is to put a price on green­house gas emissions. This takes into account both the emissions generated during property opera­tionand the so-called gray energy that is produced when real estate is newly built, converted, expanded, demol­ished, or renovated. This article explains how this full-cost calcu­lation works.

Starting point

Switzerland still has just under 30 years left before it has to reduce green­house gas emissions to zero. This should be achieved by 2050 at the latest. The real estate industry must act now; after all, more than a quarter of green­house gas emissions are still attrib­utable to real estate. It is important to start planning now – 30 years roughly corre­sponds to a property renovation cycle.

Wüest Partner has inves­ti­gated the question of how real estate portfolio owners can best navigate this challenge. Typically, the individual properties within a portfolio differ greatly. Key factors are, in particular, the age of the property, the time of the last refur­bishment, and the measures taken. Moreover, any utilization reserves, and thus a densi­fi­cation on the existing plot, should also be included in the planning.

Standard strategies

In principle, four standard strategies are available for existing properties. The choice of one of these four strategies has major conse­quences, both econom­i­cally and ecolog­i­cally.

0. Contin­u­ation

This strategy corre­sponds to a contin­u­ation of the current stock, i.e., no energy-related renova­tions are carried out. This strategy is not really an actionable option, since the period under consid­er­ation of almost 30 years is so long that there will not be many properties that can achieve both the economic goals of the investor and the ecological require­ments of the legis­lator without repair measures or energy refur­bishment.

1. Energy renovation

A substi­tution of the fossil heat generator, combined with necessary energetic renovation measures (e.g. instal­lation of new windows or insulation measures for facade, basement ceilings, and roof) and possibly with the instal­lation of a photo­voltaic system, is in most cases the preferred strategy if there are no or only very low utilization reserves.

2. Extension

Exten­sions (expension, devel­opment, additional buildings) are considered if there are utilization reserves on the property according to the current zoning plan. Furthermore, this strategy assumes that the existing buildings are simul­ta­ne­ously subjected to energy renovation.

3. New replacement buildings

New replacement buildings can only be considered if the existing building is of a certain age (built before 2000). Otherwise, it is rarely the best choice, neither econom­i­cally nor ecolog­i­cally, due to the destroyed substance.

In all strategies, it is assumed that the struc­tural measures carried out comply with the speci­fi­ca­tions of sustainable construction and that the buildings do not (or no  longer) emit green­house gases after completion, regardless of the strategy chosen.

Economic calcu­lation of the value reserve

To determine the economic component of the full-cost calcu­lation, the value reserve is calcu­lated for each strategy.

1. Energy renovation

Energy retrofits incur investment costs, but rental income increases due to three factors:

• Saved ancillary costs lead to a higher income potential in the case of a new lease. This is due to the fact that tenants’ willingness to pay is based on the gross rent, i.e. the sum of net rent and ancillary costs. Due to the decrease in these costs, owners can increase the net rent and thus increase their income without tenants experi­encing a rent increase.
• The transfer of investment costs leads to a higher existing rent (passed on according to rental law).
• The market rent for the now higher-quality energy-efficiently renovated property is often higher than the existing rent after passing on the investment costs. When a tenant moves on, the rent can be increased accord­ingly and adjusted to market condi­tions.

2. Extension

For newly constructed spaces, the following applies: capitalized rental income value minus construction costs, minus initial rental costs, minus risk compen­sation. For existing spaces, the same effects apply as for the energy renovation (see above).

3. New replacement buildings

For new replacement construction, the following applies: capitalized income value from leasing the new building minus construction costs, minus demolition costs, minus initial leasing costs, minus risk compen­sation, minus loss of income during the construction phase.

The additional income is capitalized to make it compa­rable to the investment costs. Each of the three strategies described takes into account that the discount rate is lower for a sustainably operated property than for an older, non-renovated property. There are several reasons for a lower discount rate: Cash flows can be better planned; the value of rental income on the trans­action market increases; after an energy refur­bishment, a property becomes more inter­esting for investors; the risk of a property becoming a stranded asset can be prevented.

Assessing the carbon footprint

The topic of the circular economy is becoming increas­ingly signif­icant. In modern ecological optimization, it is therefore important to consider not only the green­house gas emissions generated during property opera­tions, but also the gray emissions that occur when real estate is newly built, converted, expanded, demol­ished, or renovated.

For the emissions from ongoing opera­tions, C0₂ equiv­a­lents are calcu­lated in tons per year. The heating of the property and its electricity consumption are taken into account. The emissions saved are similar for energy-related renova­tions, exten­sions (incl. energy-related work), and new replacement buildings.

The gray green­house gas emissions resulting from the building measures are also calcu­lated. Naturally, theyare highest for new replacement buildings. Exten­sions also cause substantial amounts of gray emissions. Energy-efficient renova­tions are much more climate-friendly in this respect.

In order to make the economic and ecological criteria directly compa­rable, CO₂ emissions are given a price. Wüest Partner bases its calcu­lation of this price on, among other things, the amount of the CO₂ tax, the price of CO₂ certifi­cates, and the cost of filtering CO₂ from the air.

Results

Wüest Partner carried out the calcu­la­tions for an entire portfolio as part of a client mandate. Thereby, the results can be inter­preted according to two different approaches:

• Absolute:
  Here, the absolute added value is calcu­lated (after completion of the struc­tural measures and taking into account the newly generated and the saved green­house gas emissions).
• Relative:
  In this approach, it is examined with which strategy one achieves the highest equiv­alent value per invested franc. For this purpose, the absolute added value is divided by the investment costs.

In the majority of cases, energy-efficient renovation yields the best result, both in absolute and relative terms. The main reasons for this are the signif­i­cantly lower gray emissions and the lower investment costs. The higher the C0₂ price is estimated, the more often energy renova­tions are the strategy of choice. However, the larger the utilization reserves and the older the existing properties, the more appealing exten­sions and replacement buildings become — but this is mainly in absolute terms. Compared to the investment costs, the invested franc is actually worth more in the case of energy-efficient renova­tions if utilization reserves are available. This is because in terms of emissions from ongoing opera­tions, the three standard strategies hardly differ. After completion of the struc­tural measures, emissions in all three cases drop to a fraction of the previous value. The difference in the C0₂ balance between the three strategies in question is due to the gray emissions.

With the imple­men­tation of the chosen renovation strategy, both the value of a property and its C02 balance change. For the client mandate mentioned above, the results were as follows:

• Economics:
  From an economic perspective, an average value reserve of about 2 million Swiss francs per property was calcu­lated. In other words, imple­menting the most suitable of the three possible standard strategies would create an average added value of around 2 million Swiss francs per property. The investment costs amount to an average of just under 4 million Swiss francs per property.
• Ecology:
  From an ecological point of view, after imple­men­tation of the most suitable standard strategy, each property would emit a total of about 2600 tons less C0₂ over the subse­quent 30 years. The struc­tural measures would trigger an average of about 700 tons of gray emissions. In total, almost 2000 tons of CO₂ would be saved per property.
• Economy and ecology:
  If one compares the economic with the ecological added value, it becomes clear how important the price estimated for a ton of C0₂ is. If we assume 200 francs per ton of C0₂, the ecological added value amounts to 0.4 million and thus 20% of the economic added value. With a C0₂ price of 1000 francs, an equilibrium would be reached.

It should be noted that on the whole, even a low three-digit C0₂ price has conse­quences for some properties. Certain exten­sions and even more so some new replace­ments are no longer worth­while in comparison with an energy-efficient refur­bishment once the gray emissions have been priced in. And the higher the C0₂ price is estimated, the more the pendulum swings in the direction of energy refur­bishment, even if from a purely economic point of view a new replacement building or an extension would be more advan­ta­geous.

Services provided by Wüest Partner

The services offered by Wüest Partner in the area of conflict between sustain­ability goals and the realization of utilization reserves follow the procedure outlined in this article: For each property, the effects of the individual strategies are calcu­lated, and, based on this, the appro­priate strategy is deter­mined. It is then decided when, ideally, this inter­vention should take place. The avail­ability of financial resources (annual investment volume) and the customer’s human resources are taken into account when setting the exact schedule.

Further infor­mation

The following blog articles also address the relationship between real estate values and sustain­ability:

Investor survey on the value relevance of sustain­ability

10 factors that influence the value of sustainable properties

Contact our experts to learn more