Compromising on the sustainability performance of a residential development may well diminish, rather than preserve, the financial return.
12 August 2010 – Sustainable communities are places where people want to live and work, now and in the future. While the benefits of delivering these new communities are obvious, adoption by large-scale residential developers beyond boutique, special-purpose developments has been limited.
Too often in a residential project life cycle, initiatives to improve the sustainability performance are dismissed outright, or dropped during the process as being too costly. Traditional thinking dictates that the home buyer won’t (at present) pay more for a sustainable home, yet is happy to reap the benefits of one, especially those related to lower operating expenses. This means that in order to deliver a more sustainable home, the developer must absorb the additional up-front capital costs, eroding the rate of return.
It’s simple thinking: increasing the cost of delivery without increasing project revenue will lower the internal rate of return. However, this traditional focus on cost impact ignores a number of points in the development process where delivering to a higher sustainability standard can provide returns not previously accounted for.
A live case study
The author undertook a study of the cost of improved sustainability performance on a real residential development project and 21 different incentive and non-incentive offset scenarios. The results show that there are means, already within the control of a developer, that can deliver sustainable communities while preserving, and at times enhancing, the project return.
Two financial performance metrics were used for the analysis: the traditional project internal rate of return (IRR), being the discount rate that generates a zero net present value; and, an in-house metric used by the participating developer, the value add (VA).
The VA metric is based on the concept of time-value of money and captures the timing of profits – a key driver in value creation. It measures the movement in the net present value (NPV) of a project’s cash flow between the start and completion of the project, using a predetermined discount rate.
Types of incentives
For examples of incentives for developers to deliver improved sustainability performance it was necessary to look internationally. The list of incentives explored, while by no means exhaustive, serves to inform the type of incentives available.
- Federal Government Energy-Efficient New Homes Tax Credit for Home Builders (US)
- Sales and Use Tax Exemption for Energy-Efficient Products (US)
- Corporate Income Tax Credit for Green Buildings (US)
Rebates and subsidies:
- Roseville Electric — Residential New Construction Rebate Program (US)
- Section 94 contribution exemption (an option for consideration)
- Expedited Permitting for Green Buildings (US)
It should be noted that the study does not attempt to accurately reflect all the intricacies of the different incentives in application. Rather it provides an indication of different incentive impacts.
The results are encouraging
The most encouraging offset is the impact of an increased sales rate. Sustainability, while not generally generating an increased price, is an acknowledged tie-breaker in a purchaser’s decision-making process. If just a few buyers are swung towards your development based on its sustainability performance, providing a sales rate uplift of just 2 percent, nearly the full impact of increased development costs on the internal rate of return is offset. This offset can only be created if you ensure that the sales people are fully trained on selling the benefits of sustainable living.
Combine this with the impact of incentives offered elsewhere in the world, such as tax credits for ‘green’ construction elements, ‘green-door’ expedited development approvals, and the redistribution of local government levies, and the project internal rate of return can exceed the base case standard development.
Where to from here?
Both developers and governments need to act to crystallise this potential. Developers of more sustainable product need to clearly, consistently and accurately sell the sustainability benefits of their product over that of their competitors. Governments need to seriously consider incentives for developers that extend beyond the traditional homeowner grant and rebate mindset and deliver them in a way that melds with the commercial reality of development. Tax credits for sustainable construction products, redistribution of local government levies and ‘green-door’ expedited development approvals all have significant potential to encourage the development of sustainable housing.
It is possible to meet the society’s need for sustainable communities while meeting developers’ expectations on financial returns.
Due to the commercially sensitive nature of the information on which the analysis detailed in this report was performed, the identity of the participating developer, referred to throughout as the developer, has been kept confidential. Additionally only percentages, rather than specific dollar amounts, of costs and revenue are disclosed.
The full report
The full report, produced from work undertaken to satisfy the requirements of the Bond University’s Master of Real Estate (Sustainable Development) degree final capstone project, is available here.