The Real Cost of Multifamily Passive Building

How much extra does PHIUS+ certification cost?

By KATRIN KLINGENBERG

Almost everything in the process of passive building, design, construction, and development involves trade-offs. Quantifying the cost of an enclosure system without considering what other things are, or are not, being done that affect the total cost, is hard.

Everyone’s pro forma looks different, but it generally contains costs, resources, and revenue. Costs break down into hard costs, soft costs, land, and construction costs. Resources include equity investors and debt from banks. Revenue comes in the form of rent or vacancy rate. Lower vacancy means higher revenue.

If it costs more to build, you need to cover those costs, likely through investors who are locked in with attractive valuations based on higher rents, lower vacancy, and less maintenance.

Net operating income drives value

Net operating income (NOI) is what is left of the revenue after property taxes, utilities, maintenance, and management are paid for. NOI is typically used to value the property at some sort of rate. If we expect a five percent return on equity, the value of the property is 20 times the NOI.

Typically, there is a premium for adding PHIUS+ certification to the plans. Experienced developers can do it for no premium and first time PHIUS+ developers report premiums around five percent. It is difficult to get the extra five percent from banks because appraisers don’t recognize added value for comfort, durability, and healthy indoor environments yet.

“We depend on a lot of outside capital,” said Sloan Ritchie of Cascade Built in Seattle. “We do not have $50 million laying around, so we have to validate our model with investors, appraisers, lenders, underwriters, executive loan committees — if any one of them does not like the project, we are finished.”

Part of Ritchie’s process is validating the model to outside risk-averse people, whereas a developer’s job is to take risks. Ritchie presented a business case for PHIUS+ development at a recent North American Passive House Conference using the new Pax Futura affordable housing complex as an example.

The 35-unit apartment building, located in Seattle, offers 350-sq.ft. units which rent for $1,000 per month, an affordable price since the typical price for rent in Seattle is normally twice that amount. An extra $50 per unit per month at this location could translate to $400,000 when it comes time to sell the building. This return is easier to get if the location offers superior IAQ, comfort, and low energy bills.

Ritchie’s rule for communicating with bankers is, “Never say ‘passive house,’ ‘passive building,’ or anything like that. They don’t know what it is, so it is a red flag.” Rather, talk about qualities like comfort, air-conditioning, exterior shades, quiet, low-energy, and future-proof.

High rent + low vacancy = big revenue

On the revenue side, it is safe to expect higher rents and lower vacancies for a passive building. The allocation is more favorable, too: utilities will be extremely low and maintenance will likely be lower, too. Higher revenue and lower allocation expenses mean a higher NOI, which translates into value when selling the building.

It is hard to estimate and prove how much more a tenant will pay in a PHIUS+ building. Even for the “affordable” $1,000 apartments that Richie built, most people are willing to pay $20 extra. That is $8,400 per year for the 35-unit building. Dividing by the capital rate (20 times the NOI) gives a value of $170,000 for adding PHIUS+ certification.

Five percent vacancy is a common rate to use for underwriting. It is reasonable to bet that tenants will stay longer because PHIUS buildings provide a superior environment. A study by the University of North Carolina and the Institute for Market Transformation backs this up, explaining that “the odds of a mortgage default on an ENERGY STAR residence are one-third lower than those of a home in the control group.” This is true across the pond, too; a recent study by the European Commission’s Joint Research Centre showed energy-efficient buildings have higher appraisal values and lower default rates.

Dropping to a three percent vacancy rate on Ritchie’s 35-model unit would create $183,000 of value every year.

If people in affordable housing will pay an extra $20 per month, tenants in more luxurious accommodations will likely pay an extra $50/ month — an additional $20,000 per year, and $400,000 in value. When the building sells, someone is going to pay an extra $400,000 for your $50 bump in rent. Not only does that pay for the PHIUS+ certification, but it is also a nice return to the investor.

Katrin Klingenberg is the Director of Passive House Institute US. She can be reached at www.phius.org or info@passivehouse.us