Reckoning ROI for Green Multifamily Development
Sustainability is becoming the norm, but determining returns is more complicated.
At first glance, the business case for sustainable building seems to be straightforward. These projects operate more efficiently, reduce energy usage and raise net operating income. A higher NOI often leads to an increased valuation, and multifamily investors are willing to pay more for sustainably built communities. And, of course, renters—particularly eco-conscious Millennials and Gen Z—seem to be willing to pay higher rents for living in green apartments.
What’s less easy to discern, however, is the return on investment to an owner or operator of a sustainable apartment community.
“It’s hard to put a number on the ROI, since ROI depends on so many factors, like the capital stack, the cost of debt and equity and the period of holding,” said Ganesan Visvabharathy, founder of Hawthorne Development Corp., which is developing Eco Terra, a 348-unit, mixed-use luxury apartment building that broke ground in June 2022 in Villa Park, Ill.
The project, which is being built to Passive House Institute U.S. (PHIUS) standards for zero-carbon built environments, is designed to provide 40 to 60 percent energy savings compared to conventional buildings, as well as superior air quality and uniform temperatures. It’s slated for completion in the fall of 2024.
Other factors complicate the issue, as well. “I don’t have two sets of buildings—one that’s sustainable and one that isn’t,” noted Sloan Ritchie, president of Seattle-based Cascade Built. Among the firm’s Passive House developments is Solis, a 45-unit project in Seattle. “Every building is unique, so it’s difficult to prove the ROI,” Ritchie added.
Although certain mechanical elements allow cost comparisons and calculations of returns, “as a whole, it’s difficult because it’s a holistic approach,” Ritchie said. Many factors impact the ROI equation, including tax credits, utility company programs, applicable rent premiums and vacancy rates. “So, there are a whole host of things on both sides of the ROI equation, and it’s difficult to [calculate] in any precise fashion,” he said.
Still, a variety of indicators point to the conclusion that green is good for multifamily developers and that building sustainably pays off.
According to a March 2022 analysis by Cushman & Wakefield, LEED-certified multifamily properties in Gateway-plus urban markets generated a 3.1 percent rent premium between 2000 and 2021.
Although those premiums came at the cost of slightly higher vacancies, an analysis of revenue per available square foot (RevPAF) further showed that higher rents more than offset the lower occupancy.
In a 2022 survey of more than 4,100 residents by AMLI Residential, 43 percent of respondents said that green features factored into their decision to live at their communities; 55 percent said they believe their community’s green features saved them money. Perhaps that’s why 52 percent of residents said that they would be willing to pay more to live in a sustainable community, according to Erin Hatcher, vice president of sustainability for AMLI.
At Solis, where rents range from $1,850 to $3,800, renters benefit from the Passive House construction. Units are separately metered, so residents receive 100 percent of the energy savings. “We believe (the property) has a rent premium because it is ultra-sustainable,” said Marc Coluccio, chief operating officer of SolTerra, which purchased the community pre-construction in 2018.
Apartments built sustainably, whether to a standard like Passive House or LEED, save energy. While PHIUS-certified multifamily projects cost 1 to 2 percent more than other comparable projects, they can yield energy savings of 40 to 60 percent compared to regular buildings, according to PHIUS Executive Director Katrin Klingenberg.
Even when the exact calculations are unclear and the ultimate payoff for a sustainable project may take some years, developers say they have a high degree of confidence in the returns. Such is the case with 425 Grand Concourse, a recently completed mixed-use project in the Bronx and North America’s largest Passive House project to date. The project, which includes 277 affordable units, will cost 1 to 3 percent more to build than a conventional property but also will use 65 percent less energy, estimates Christoph Stump, the firm’s vice president of design and construction.
He noted that it’s difficult to calculate ROI exactly because the owner pays for heat while residents pay for air conditioning. “How the energy savings are sliced up and who benefits is the question, but the overall project definitely will have a return on investment of eight to 12 years,” he said.
Water recycling and on-site solar generation are keys to improving ROI at a 461,000-square-foot mixed-use project that Lendlease and Aware Super plan to launch in Los Angeles next year. Located between Culver City and L.A.’s West Adams neighborhood at 3401 La Cienega Blvd., the project will comprise 260 apartments, 250,000 square feet of office and ground-floor retail.
Sara Neff, head of sustainability for Lendlease Americas, estimates that the project’s green features will generate energy savings of 20 to 30 percent.
For merchant builders, building sustainably can lead to a premium sales price, as investors increasingly seek out green projects due to their financial benefits and expected demand from renters. According to Cushman & Wakefield, LEED-certified assets averaged a 9.4 percent sales premium between 2012 and 2021 compared to non-certified assets.
Alex Brown, executive director of Cushman & Wakefield’s Sunbelt Multifamily Advisory Group, cited several reasons for the price premium: investors’ drive to match asset acquisitions with ESG strategies, energy efficiency, preferential financing by the GSEs and renters’ demand for green homes.
Michael Zaransky, managing principal of MZ Capital Partners in Northbrook, Ill., is incorporating sustainable features into his new projects because “we think it’s the right way to build.” He estimates that building sustainably costs 1 to 1.5 percent more than traditional methods, a premium that can be significant on a large property.
But Zaransky is also capitalizing on tax credits of $2,000 per unit under Section 45L of the Internal Revenue Code. “It’s quite a big incentive,” he said. “That recovers a substantial amount of the initial investment, and with that and the energy savings over time, the return on investment is actually pretty good.”
How good? “To the extent that operating expenses are lower because of the sustainability features, and rents are higher, that means NOI is higher, which means you get a premium for an efficiently run property,” Zaransky said. “It’s not brain surgery.”