Passive House Construction Works Financially. Why Isn’t There More of It?
The environmentally friendly building methods face regulatory and training hurdles. Then there's the financing.
Developer A.J. Patton remembers when his mother received a $400 gas bill during a frigid Chicago winter in 1999. She worked in a cafeteria at the time, money was tight, and there was already a hole in the roof, so the bill went unpaid. The gas was shut off, and Patton spent a year heating his bathwater on the stove.
Today, the CEO of 548 Enterprise recalls that story when he evangelizes about a new pair of developments that will soon break ground in Chicago — at 3831 West Chicago Avenue in Humboldt Park and Galleria 89 in South Chicago — both of which will be all-electric, passive house projects. By choosing to build this way — an ultra-energy-efficient, tightly sealed building method that can cut heating and cooling bills in half, drastically lower carbon emissions, and improve air and environmental quality for residents — he believes he can provide tenants with a healthier, more affordable living situation than he endured as a child.
Patton is seeking to catalyze more of these kinds of sustainable projects, but taking a different path in a risk-averse construction industry isn’t easy. He can’t factor lower energy bills into his financing, and the process is relatively unfamiliar for construction crews in the region.
“There’s still a lot of work to be done to do this in the Midwest,” said Patton. “You got to hold their hand a bit and bring them into the game.”
Patton is a pioneer in helping passive house construction grow beyond early adopter status. Currently, there are approximately 275 such projects, ranging from single-family homes to massive housing complexes, encompassing about 15 million square feet of housing in the U.S., most of which have been built in the last five years. But it’s still a niche, accounting for just 1 percent of all multifamily projects done nationwide over the last decade, according to a new report from the Passive House Network, a training program.
While relatively new, passive house construction has already become cost competitive for large multifamily projects, with new projects requiring just a single-digit premium, averaging 3.7 percent, according to a Passive House Network survey of 45 such projects in New York City and Massachusetts. (Single-family homes and commercial offices still have healthy premiums.)
Going forward, state and federal incentives, including those contained in 2022’s Inflation Reduction Act, will likely make some projects cheaper than if they were done with traditional methods. That’s an appealing prospect during a period of financing challenges and rising costs.
But getting the whole construction ecosystem, including financing and builders, on board with a novel method will require investment in new technologies, building codes and lending practices, a cultural shift many experts say needs to be deliberate to truly accelerate this important shift.
Within the last decade, the push for passive house projects has slowly evolved, from initial projects led by developers with climate and sustainability philosophies to a broader support of such developments by local governments interested in high-performance buildings as well as the climate, cost and energy-conservation benefits. Roughly half of the existing passive house projects in the U.S. are affordable housing developments that tapped into the Low-Income Housing Tax Credit.
“It’s not like we’re creating an artificial mandate or inventing something,” said Passive House Network Executive Director Ken Levenson. “This is leveraging what the market is already producing.”
By lowering utility and energy costs — which make up 30 percent of operating expenses for multifamily buildings, and can be a pathway to more profitability, especially in rent-capped affordable housing — passive house construction can make buildings more productive assets over time. The lower energy load also makes electrification more cost competitive. Traditionally, though, most financing options for construction don’t incorporate those savings into underwriting loans. That’s a lost incentive for sustainable building.
“Whether it’s a private developer seeking an immediate profit, or it’s an institution that has fundraising and boards of trustees that have to authorize the funds, it’s very difficult politically to increase the upfront capital costs,” said Mark Teden, vice president of the multifamily program at MassHousing, which has funded more than 1,500 passive house units. “It takes a very forward-thinking institution or private developer to be willing to take the risk.”
One of the biggest drivers of cost parity discovered by Passive House Network research is experience, since using construction crews who have worked on these types of projects before lowers the overall cost. Building out a skilled workforce is key to success. In New York state, which boasts the largest footprint of passive house property in the nation, plans to measure building emissions and target reductions began appearing in 2009, and, in 2014, the state created a $500 tuition offset to train workers in new technologies. That has helped the nascent industry grow.
The new skills and knowledge involved in passive house construction revolve around understanding how to work with traditional materials in a different way, says Aaron Gunderson, executive director of Passive House Massachusetts, which has helped the state develop more than 10,000 passive house units.
“There’s a misplaced perception that comes from larger general contractors, or larger developers or home builders associations, that this is going to be a larger change,” he said. “We need to have this massive amount of workforce development training programs in place before people start taking these projects on.”
Familiarity isn’t an issue just for construction crews, but the supply chain as well. Special materials and mechanical systems, like advanced HVAC and triple-pane windows, aren’t made domestically for the most part. It’s therefore a matter of building out a more robust flow of those needed products.
Arif Quraishi, chief growth officer at Legence, an energy transition accelerator, compares the growth of more sustainable residential construction methods to the uptake of electric vehicles. There will be that hockey stick of growth when it hits the mainstream, but it’ll take longer for passive house apartments to catch on.
Better policy and more incentives can accelerate the shift that’s already happening in the market. Early-mover states such as Pennsylvania, New York and Massachusetts boast numerous funding and financing programs that kick-started the ambitions of private developers.
Pennsylvania reworked its affordable housing credit formula to give more points to passive house projects via what’s called the Qualified Allocation Process, creating a mini-boom in such developments. Massachusetts and New York both offered design challenges to incentivize developers and architects to experiment with the concept and showcase the advantages of passive house construction.
“The market is adopting things for its own self-interested reasons, like keeping energy costs low,” said Mark Attia, MassHousing’s director of capital formation. “Massachusetts is smart to embed these incentives in a number of different ways.”
On a federal level, the Inflation Reduction Act offers a bevy of tools, including $4.5 billion in rebates and tax credits up to $5,000 per unit for all-electric, passive house projects, as well as $1 billion for state and local governments to adopt new energy codes. Patton is counting on incentives to cover the cost of installing solar panels on his Chicago projects.
These public programs are adding to shifting norms around financing and the incorporation of sustainability and ESG measurements. Attia believes the Inflation Reduction Act will ultimately create institutional awareness and capabilities for community lenders and even green banks to make more loans for better buildings.
In finance, a newer vehicle for making these kinds of investments, C-PACE, has slowly become more institutionalized. It allows lenders to align financing with the cost savings over a longer time horizon. For example, C-PACE allows a 20-year financing period that aligns with the expected payback time from sustainability investments. In many situations, borrowers would otherwise need to take mezzanine debt with floating rates to add sustainability investments to existing capital stacks.
“Building owners can find cost-effective, commonsense ways to finance cutting emissions and making buildings more environmentally friendly,” said Joe Pursley, Nuveen’s head of insurance in the Americas. “With the choices millennials and younger people are making today — they only want to be in green buildings — it’s starting to become more of a need-to-have than nice-to-have.”
Changing codes, which tend to be old and to have little room for new energy technology, can also help nudge developers. Boston just adopted a code requiring passive house standards for new multifamily. Currently, 25 U.S. states have utility-funded energy-efficiency programs, with 13 requiring investment to support low-income customers or communities of color, both ideal fits for passive house projects.
Levenson, of Passive House Network, sees more construction uptake coming in California and Colorado as well, two large markets that have embraced electrification and new building codes. This underscores his belief that regulation should aggressively award and encourage this shift, if the government and industry truly want to make more sustainable practices widespread in an appropriate time frame.
“It has to be regulated,” said Levenson. “If it’s not mandated by the government, if it’s not code, it’s not going to be widespread enough.”
Patton argues that what ultimately matters is deals. Real estate is a follower’s market, and as soon as more developers in more places see success, they’ll replicate it.
“If what we’re saying about passive house is true, there will be a lot of success to celebrate,” he said. “That’s why I’m going to be transparent about the cost and process. If you’re going to be the blueprint, you need to share the blueprint.”