Energy-efficient renovation of investment properties

Energy-efficient renovations: why they are worthwhile

01.04.2022 | 3 Minutes

In Switzerland, 24 percent of greenhouse gas emissions are generated by inhabited buildings. It is thus not surprising that around 60 percent of single-family homes and 70 percent of apartment blocks are currently heated with fossil fuels, or that over one million households – out of a total of around 1.7 million – are either poorly insulated or not insulated at all. The need for action is therefore great.

The Swiss government and the cantons reward owners of single-family homes and apartment blocks with subsidies for making their properties more environmentally friendly. Specifically, the aim is to increase energy efficiency and reduce greenhouse gas emissions. After renovation, such buildings

  • use less energy (electricity, heating oil, natural gas, wood, etc.). This is because the various energy-users, such as heating, ventilation/air conditioning, hot water, kitchen and bathroom, light and elevator, etc., consume energy more efficiently.
  • no longer pollute the environment with greenhouse gases because they only use renewable energies which they generate themselves, where possible.

The key pillars of the Swiss Energy Strategy 2050

  • Gradual withdrawal from nuclear energy production
  • Commitment to halve greenhouse gas emissions by 2030 compared to 1990 (Paris climate agreement)
  • Net-zero emissions target by 2050 for greenhouse gases

According to the Swiss National Science Foundation, only about one percent of existing housing stock in Switzerland is renovated for greater energy efficiency each year. This number would have to at least double to achieve the goals of the Energy Strategy 2050 in the building sector. 

At the current rate, Switzerland will not reach its net-zero emissions target until about a hundred years later than planned. And the larger the backlog, the more serious the situation will become for the construction industry, which is already at full capacity with normal new buildings and conversions.

Where is the problem with renovation?

What are the reasons for the sluggish progress? Why are owners of apartment buildings in particular reluctant to renovate, despite the financial incentives? Time to research the causes.

Possible cause 1: waiting for (even) better technologies

Greater energy efficiency and lower greenhouse gas emissions are a question of technology, which is constantly getting better, cheaper and more efficient. It is thus understandable that people want to postpone their renovation by a year to wait for the next technological quantum leap, which they are certain is just around the corner and will provide far more energy for much less money.

But this is not realistic. According to the CECB (Cantonal Energy Certification for Buildings), although the technology will continue to improve over the next five to ten years, it will only do so in small steps rather than quantum leaps. A few examples:

  • Photovoltaic technology has become five times cheaper in the last 10 to 15 years – but not five times more efficient. The lower costs are due to economies of scale, more competition and more efficient production methods. In photovoltaics, the potential of silicon as a semiconductor is far from exhausted and will be the standard technology for years to come. Although newer semiconductors such as gallium arsenide (GaAs) are more efficient, they are also much more expensive and contain arsenic, which is highly poisonous. GaAs is therefore often used in particular circumstances where cost is not a factor, such as energy generation for satellites. For normal solar cells, silicon will continue to be the first choice for years to come. There are no further groundbreaking developments on the horizon, and prices are unlikely to change much.
  • Thermal insulation: The situation is similar with materials for façade insulation. Although they are constantly being developed and improved, a miracle material – which insulates twice as well at half the volume and at a quarter of the price – is still a long way off.
  • Heating: Biomass and thermal heat pumps are now well-established technologies that continue to be optimized and streamlined through ongoing development. However, quantum leaps cannot be expected here either.
  • Window: Triple glazing is considered the new de facto standard. Developments are moving in the direction of smart windows. It is quite possible that windows with self-regulating light transmission will soon be offered. These either reflect sunlight or allow it to pass through, depending on room temperature, season and the time of day.

Possible cause 2: short-term yield considerations

The capital expenditure for an energy-efficient renovation can be considerable, especially for older buildings. It might also appear scarcely worthwhile at first glance.

However, both the depreciation and the cost of capital on the value-adding portion of the investment can be passed on to the tenants. This portion is usually set at a flat rate of between 50 and 70 percent of the investment sum. Since energy investments are tax-deductible, the increase in rents will usually cover the costs.

A numerical example to illustrate:
Suppose you decide to replace the oil-fired heating system in your apartment block with an air heat pump. Since the existing system has reached the end of its service life anyway, the calculation is as follows:

Total investment for replacement of an oil-fired heating system with an air heat pump

CHF 100,000

Upgrading an existing oil-fired heating system

./. CHF 40,000

Additional investment for an air heat pump

CHF 60’000

Reduction of the additional costs of 60,000 at a 33% marginal tax rate

./. CHF 20’000

Net additional investment for heat pump

CHF 40’000

Increase of annual rent

approx. CHF 3,000

Net return

7,5%

With an investment of CHF 100,000 in an air heat pump, the annual rent can be increased by around CHF 3,000. Assuming that an upgrade of an existing fossil fuel heating system would have cost CHF 40,000, the additional investment amounts to CHF 60,000. With a marginal tax rate of 33 percent, the additional costs would be reduced to CHF 40,000. The effective rental yield would then be 7.5 percent. With a depreciation rate of 4 percent (assuming a service life of 25 years), the renovation of the heating system clearly pays off.

The operating costs after the renovation will be much lower than before. And if the increase in the net rent is compensated by the lower ancillary costs as a result of the renovation, tenants will also benefit.

Possible cause 3: fear of voids

A purely energy-efficient renovation – heating or insulation – can be carried out as a partial renovation. But if a large part of the building technology also needs to be replaced or if the floor plans need to be modernized, a total renovation with termination of all tenancies will be necessary, including the associated risk of objections. Apart from structural reasons, a total renovation is often also desirable for purely financial reasons. The loss of two to three years’ rent during the renovation period must be accepted. However, rents can be increased more for new rentals than in the case of an energy-efficient partial renovation. This is due both to the improved quality of the building and the adjustment of the rents to the usual market level.

The total renovation pays off if the added value created exceeds the renovation costs. With an average rent increase of around 40 percent for an apartment in excellent condition compared to one from the 1970s, the rent for a 3-room apartment can be increased by an average of CHF 500 per month. For example, with investment costs of CHF 150,000 per apartment, this corresponds to a renovation yield of 4 percent. A higher return can be achieved if the rentable space is also expanded and the utilization improved. According to calculations by the UBS Chief Investment Office, the total increase in rent potential should be at least 30 percent.

These considerations strongly depend on the location of your property. A total renovation is especially worthwhile for older buildings in need of renovation in central locations and booming conurbations. This is because the quality and market rent premium are likely to be particularly high here and the risk of vacancies relatively low.

In peripheral areas and parts of extended conurbations, where vacancy rates are significantly above average, major investments in energy-efficient renovations are less worthwhile. Although people are willing to pay more for high-quality apartments, the market will probably only be able to absorb a limited number of such apartments. The potential for rent increases is therefore low. If higher gross rents are not feasible, the effective rental yield will dwindle and the investment may be less worthwhile from a purely financial perspective.

A woman on the balcony of a renovated apartment looks into the distance.
Back view woman in backlight standing at the window at home looking out

Good reasons for an energy-efficient renovation of your investment property

Don’t let these reasons stop you from renovating your investment property to make it more energy-efficient. There are lots of good arguments for doing so:

Long-term rental considerations

In central locations, a full renovation offers far higher returns than acquiring an additional property.
But even a partial renovation can yield a solid return thanks to high tax rebates, subsidies and possible rent adjustments.

In the current low interest rate environment, debt financing can often generate yields in the low double-digit percentage range.
Don’t have the necessary liquidity for an energy-efficient renovation? Many banks support energy-efficient upgrades with special loans or grant a lower mortgage interest rate.

Are you planning energy-efficient renovation work?

We reward sustainable investment properties with financial benefits.

Possible political direction: from funding to bans

Unless framework conditions are tightened, the federal government will likely miss its net-zero interim targets for 2030.
In the medium term, increased political interventions in the form of bans and taxes can be expected in order to accelerate the renewal process.
In other words, instead of rewarding energy-efficient renovations with subsidies, the state may more or less compel owners to carry them out.

In addition, a possible future ban on new fossil fuel heating systems and a surge in demand for alternatives are likely to trigger capacity bottlenecks in the construction industry. This will result in higher renovation costs. There will also be supply bottlenecks, usually a consequence of unforeseeable events such as economic crises, war, political tensions or pandemics. They lead to a shortage of crude oil or natural gas and thus drive up the prices of these commodities.

Growing ecological awareness among tenants

The sooner you replace your old oil-fired boiler with a heat pump, for example, the more grateful future (and present) generations will be to you. And your tenants will also be pleased if their heating costs fall. If the electricity for the heat pump is also generated by your own photovoltaic system, the cost advantages of renewable energies become even clearer. And although you won’t need to justify the replacement of an oil-fired heating system with a heat pump to your tenants, you may have to justify not doing so. This is the same trend that has become apparent in recent years regarding the social sustainability requirements for pension funds and consumer goods brands.

Summary

The perfect energy-efficient renovation of an investment property will benefit the environment, the owners and the tenants. The environment and the whole of society benefit if a building can be operated in a more environmentally friendly way thanks to an energy-efficient renovation. Owners can increase the market value of their properties if they can finance the investment costs through higher rental income.
And tenants benefit too if their ancillary costs end up being lower than the increase in net rent as a result of the renovation.


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