Philip Payne, CEO of Ginkgo
Residential, is cochair of ULI’s Climate Change, Land Use, and Energy Advisory Group. A ULI governor and founder of the ULI Responsible Property Investment Product Council, he has a long history of engagement in the organization. Payne also is a member of the Fannie Mae Green Lending Task Force. We asked him how the issues of energy and climate change are influencing professional practice and how he, as a chief executive, is shaping business strategy in the multifamily marketplace.
Tell us about Ginkgo Residential.
Ginkgo Residential is a fully integrated real estate company with a focus on the management and redevelopment of middle-market apartments. While Ginkgo Residential is only about two years old, the senior management team has been together for approximately 20 years, much of that time as the management of BNP Residential, a publicly traded multifamily real estate investment trust that was sold in February 2007. Throughout our history together, we have focused on middle-market multifamily housing. What has changed with the formation of Ginkgo is an increased emphasis on using substantial rehab as a means of providing high-quality workforce housing that is energy efficient, environmentally sensitive, and affordable to a large segment of middle-market renters.
In which markets are you active?
We have operations in six southern states, with our primary focus being Virginia, North Carolina, and South Carolina.
Do you see the broader issues of climate change influencing the real estate marketplace?
I do not believe that the issue of climate change, per se, has been much of a factor in real estate. There are some exceptions, notably AAA central business district office development, where major corporate clients with sustainability policies have insisted on energy efficiency and environmental sensitivity. But for the most part, the debate over the existence of climate change has distracted the real estate markets from the widespread implementation of energy and environmental initiatives.
However, this is changing. There now appears to be a growing awareness in virtually every segment of the real estate market that energy efficiency and environmental concerns are actually economic issues. The simple truth is we, as an industry, must come to terms with the economic impact of ever-increasing energy costs, the limits of certain natural resources, and waste. In purely economic terms, we must become more efficient.
How important have the issues of energy and energy-associated costs been in the multifamily marketplace?
In my opinion, energy and energy-associated costs have not received the proper amount of attention from the multifamily market. This is especially true in the case of existing buildings. We routinely see rehab projects that are focused on cosmetic repairs and upgrades while completely ignoring fundamental energy and natural resource issues such as inefficient and outdated HVAC systems, inadequate air sealing and insulation, and high water consumption. The argument we frequently hear is that residents either do not care about or will not pay additional rent for increased energy efficiency. We believe this argument represents a misunderstanding of the multifamily market.
Our focus is on total cost of occupancy: rent plus utilities. Our position is that every dollar a resident saves in utility bills increases his or her ability to pay rent. I am not asserting that we recover one dollar in rent for every dollar of energy savings. All I am saying is that reduced energy bills make the apartment more affordable and therefore available to a larger number of potential residents. A larger pool of potential residents translates to increased pricing power.
There are other benefits from energy efficiency improvements that, while not as obvious as increased rent, provide tangible economic benefits to the owner of a multifamily rental property. The new HVAC systems not only are more efficient, they also provide far more comfort. The temperature and humidity in the apartment are more consistent and stable. Air sealing and insulation add to this by reducing or eliminating drafts and hot or cold spots, as well as reducing the introduction of excess humidity from outside sources. Also, maintenance calls are reduced, which reduces owner costs and resident complaints. The overall effect is higher resident satisfaction, which we believe reduces turnover and increases referrals. In short, our goal is to produce a more attractive rental apartment that over time will experience higher occupancy, somewhat higher rents, less turnover, and lower maintenance and turnover costs. We believe this results in a long-term increase in value that can far exceed the cost of the improvements. While we would agree that cosmetics are important, we believe that energy efficiency is as or more important a component of creating value.
As a ULI member, how have you seen the sustainability dialogue evolve over time?
There has been a dramatic awakening at ULI over the past few years. Not that long ago, there was little conversation about or focus on energy or environmental issues. Now, energy and environmental issues are at the forefront of virtually every conversation and a component of nearly all ULI-sponsored meetings and activities. This is a profound and important change. There is no organization better suited than ULI to be a leader with regard to these issues—both in the U.S. and globally. Certainly in the U.S., virtually nothing of any importance happens in the world of real estate without the involvement of one or more ULI members. This puts ULI in a perfect position to provide leadership in innovation, policy, and implementation on the energy and environmental issues surrounding the development, ownership, and operation of and investment in real estate.
Where do you see the combined issues of climate and energy affecting the ULI agenda in years to come?
I believe that these issues will continue to increase in importance for ULI for the foreseeable future. How we effectively deal with rising energy costs and increasing demand for certain natural resources, especially water, is one of the major issues of our time. Because of the breadth and depth of experience and knowledge held by its members, ULI is the natural source for the development of an economically viable model for how to reconcile the social, environmental, and economic issues involved in real estate.
ULI has taken a number of actions over the past few years to begin this process. The creation of the Responsible Property Investment Council, which is focused on these issues, and the formation of the Climate, Land Use, and Energy Advisory Group were good first steps. Now, ULI is working to expand the discussion to include more members and all of the product and district councils. I believe that as more members become engaged in advancing the thought leadership on these issues, we will begin to see the enormous power of ULI to influence and implement positive changes in the energy and environmental profile of real estate and, by extension, our communities.
Payne’s Project Review
Project Name
Yorktown Club Apartments
Location
Durham, North Carolina
Number of Units 236
236Property Description
Yorktown is a 236-unit community originally completed in 1970. The property is composed of 30 buildings on 24 acres (9.7 ha). Units are large, averaging 1,452 square feet (135 sq m), with most units being two-story townhouses. Facades are a combination of brick and various forms of siding.
Condition at Purchase
At acquisition, the property was close to being derelict, with nearly 25 percent of the units uninhabitable. A partial list of issues upon acquisition included the following: leaking roofs; 40-year-old, nonfunctioning, single-pane aluminum-frame windows; 40-year-old electric heat-strip furnaces combined with a mixture of variously aged R-22 electric air-conditioning systems; a mixture of 3.5- and 5-gallon (13–19 liter) toilets; mold inside many units and on the exterior of buildings; rotten exterior siding; seriously overgrown landscaping; water penetration throughout the property with standing water under four buildings; several buildings with rotted floor joists and band boards and collapsed floors; severe drainage problems; plumbing failures; nonfunctioning pool; three nonfunctioning laundry rooms; air leaks; inadequate insulation; and inadequate exterior lighting. The property was suffering from the accumulated impact of years of general neglect.
Scope of Retrofit Work
All new roofs, siding, and windows (Energy Star–low-emissivity) installed. New kitchens and bathrooms with new low-flow fixtures, bathtubs, showers, and toilets installed. New Energy Star appliances put in. Water submeters installed through the property. New 14-SEER, 410-A (a chlorine-free refrigerant) heat pumps with programmable thermostats and new duct work installed in attics and crawl spaces. New Energy Star, low-water washing machines and dryers installed in every unit. All structural issues repaired and all drainage issues addressed. New energy-efficient interior and exterior lighting added. Blower door tests performed on all units, followed by air sealing and adding insulation.
Delivery Challenges
There was the issue that is a given with all rehab projects: surprises. Some surprises were good; some were bad. No matter how much due diligence and planning one does, there are always surprises. Experience and an ability to adapt are critically important. I am fortunate to have a very experienced and able team working on this project. They did a very good job of identifying and estimating the cost of the required work and have done a remarkable job of dealing with the surprises in innovative and cost-effective ways. While we are going to end up slightly over our original budget, a substantial portion of the overage was the result of changes to the scope of work that we decided to make after the project began. All in all, I am extremely pleased with where we stand from a final-cost-to-original-budget perspective.
In addition to the standard surprise issue, these projects have another form of delivery challenge: our goal is to produce an apartment that is affordable to a wide range of middle-market residents, is energy efficient, has an improved environmental profile, and will produce financial returns that are sufficient to attract the capital to undertake this type of project. This balancing of the social, environmental, and economic interests of the project is an ongoing process.
At every stage of the project, there is a cost/benefit analysis that examines every aspect of the project for its impact on rent, resident utility costs, operating and maintenance costs, net operating income (NOI), value, and investor returns. We are a for-profit enterprise. We have investors without whom we would not be able to undertake these projects, and those investors have return expectations that we must meet in order to attract their capital. The challenge is to balance the needs of our investors with those of our target residents in a win-win solution.
Finance Strategy
Because of the scope of work being done, this project is more like a new construction project. As such, we are using a 65 percent loan-to-cost construction loan. The equity is combination of Ginkgo and investor capital.
Financial Performance
Our goal in undertaking this project was to produce a finished property that was attractive and affordable to a wide range of middle-market residents while still producing returns that would be sufficient to attract investor capital; and we wanted to do so without any form of government assistance or subsidy.
We acquired the property for approximately $24,000 per unit and are scheduled to spend $34,000 per unit in retrofit capital. When it is completed, we will have a total cost of approximately $40 per square foot (average size of 1,452 square feet [135 sq m] per unit) for a property with new roofs, new siding, new windows, new doors, new HVAC systems, new appliances, new bathrooms, new kitchens, new floor coverings, new parking lots, etc. The result is a substantially new property for far less than replacement cost. The combined effect of a substantial increase in occupancy, an increase in rental rates, and reduced operating costs is a very substantial increase in NOI and value. We have not completed the project, but initial indications are that we will exceed the original forecast presented to our investors.
From the residents’ point of view, there is a substantial increase in rental rates, but our focus in undertaking the project was on the total cost of occupancy (i.e., rent plus utilities). Our goal is for the savings created by reduced energy costs associated with the new windows, air sealing, insulation, and new HVAC systems to substantially mitigate the increase in rent.
Energy Performance
Our original target for the project was to reduce both energy and water consumption by a minimum of 30 percent. We have not fully completed the project at this point, but preliminary indications are that we will meet or exceed our targets. We recently entered a joint venture with Duke Energy to do a comprehensive review of the energy savings produced by the project; the results will be made available as a ULI case study.
