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