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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