Financial Benefits

The Financial Analysis of a Deep Sustainable and Resilient Retrofit

PJ Pictureby Paul L. Jones, CPA, LEED Green Associate, Principal,
Emerald Skyline Corporation

According to a guide to the energy retrofit market entitled “Deep Energy Retrofits: An Emerging Opportunity” and published by the American Institute of Architects (AIA) in conjunction with the Rocky Mountain Institute (RMI), “Energy efficiency in existing buildings is most often addressed by upgrading dated engineering systems such as lighting and HVAC systems with better performing technologies… A design-centered, holistic approach to a retrofit, in which all the interactions in a building’s systems are considered can yield substantially higher energy savings. Retrofits of this type, called deep energy retrofits, aim for energy savings upwards of 50%.”

A green or sustainable building refers to both the real estate (land, building, fixtures, furniture and equipment) and its maintenance, or the use of processes that are environmentally responsible and resource-efficient throughout its life cycle (e.g., site planning, building design, construction, occupancy and operation including maintenance and renovation, and, finally, demolition. In our corporate brochure, we state that “A facility made sustainable by Emerald Skyline Corporation will have a small carbon footprint, high occupant comfort, limited environmental impact and conserved natural resources.”
Accordingly, a deep sustainable retrofit, hereinafter referred to as a “Deep Retrofit,” is designed to lower energy, water and waste disposal bills as well as operating, maintenance and insurance costs with increased marketability and higher long-term values due to a higher tenant capture rate resulting in premium occupancies and rental rates as well as reduced risk resulting in a lower cap rate upon sale. Other benefits include improved employee health, productivity and satisfaction from improved indoor environmental quality.

With recognition of the increasing importance of resiliency in the ability of a building to survive and recover from a catastrophic event, any Deep Retrofit should also include improvements that reduce a building’s vulnerability and risk due to stronger winds, higher storm surge, more frequent flooding, wild fires and other natural hazards that threaten our families, livelihoods, businesses and properties.

As a Deep Retrofit represents a significant modernization of a facility during which over 50% of the building is renovated, the optimum time to implement a Deep Retrofit is upon acquisition, to improve a building that suffers from significant vacancies, to reposition or repurpose a building, pursuant to a new lease (or renewal thereof) to a major tenant or timed to certain events in a property’s life cycle. A Deep Retrofit is a tremendous catalyst for a building’s comeback.

According to Jack Davis in a 6/14/2012 article entitled “Energy-saving Deep Retrofits published by the Urban Land Institute, “Deep retrofits are part energy efficiency project, part real estate project, and can be daunting in their cohesive nature. However, in a 2011 study the New Buildings Institute found that “in most projects, the cost of the efficiency portion was not distinguishable due to the renovation nature of the work.

Mr. Davis makes another valid point: “Psychologically, Deep Retrofits are simply more inspiring that a piecemeal approach. They they do not occur by accident; they imply the involvement of a capable team with a plan and the technical abilities to pull it off. They grab our attention in a unique way. In the competition to secure and retain tenants, with buildings certified under the LEED program becoming the norm in some markets, deep retrofits offer a gut-level indicator that this building is different.”

Study after study (see our Sustainable Benefits article “Welcome to Sustainable Benefits – Let’s begin with the benefits of doing a commercial building sustainable retrofit” February 2015) provides evidence that a LEED (Leadership in Energy and Environmental Design) or Energy Star certified building produces returns beyond those realized from energy savings alone. Therefore, it only makes sense that the financial analysis of a Deep Retrofit should extend beyond the capital budgeting approaches presented in our September eNewsletter.

RMI defines Deep Retrofit Value (DRV) as “the net present value of all of the benefits of a deep energy or sustainability investment.” In the case of a Deep Sustainable Retrofit, the analysis includes a calculation of the change in market value resulting from the implementation of the Deep Retrofit, which is based on the income approach to value in a full property valuation.

The first step in the analysis of a Deep Retrofit is to perform a diagnostic assessment of the Building. The assessment will include:

  • Gain an understanding of the building’s historical performance through an analysis of existing usage of, and expenditures for, energy, water, building maintenance and cleaning supplies as well as tenant behavior
  • Perform a sustainability audit of mechanical, electrical, plumbing and other building systems as deemed appropriate which includes an estimate of the capital investment required as well as a forecast of future utility, maintenance and operating cost savings,
  • Evaluate internal environmental quality, waste disposal practices, purchasing and other operating policies, procedures and practices which will also include a calculation of any savings or incremental costs realized as a result of the Deep Retrofit; and
  • Determine the resiliency of the property by ascertaining the building’s ability to absorb and recover from actual or potential adverse effects of stronger storms, higher storm surge, wildfires and more frequent flooding.

The next step is to complete what RMI refers to as a “Value Element Assessment” which is designed to identify the potential types of value that may be created by the Deep Retrofit. The four key elements of added value are:

  1. Retrofit Development Costs: As noted in the capital budgeting process in our article on the Capital Budgeting Analysis of a Sustainability Project, any direct and indirect savings are measured against the capital cost to be incurred. The Retrofit Capital Cost Equation is as follows: Gross capital cost less avoided capital costs less cost savings through design less cost subsidies, rebates and incentives equals Retrofit Capital Costs
  2. Energy and Non-Energy Operating Costs: The first financial benefit from a Deep Retrofit will appear in the utility bills as both the wattage consumed and the amount of peak-demand billing that is avoided will result in an immediate reduction in the electric and gas bills as well as the water bill. Non-energy operating cost savings are realized from new technology, improved performance information and operating savings from reduced maintenance requirements, and, including resiliency measures in the Deep Retrofit is anticipated to result in reduced property, flood and hazard insurance expenses. Also, a Deep Retrofit will enable a building owner to comply with current and future regulatory reporting requirements due to automated benchmarking data collection.
  3. Rental Revenues: According to a primer for building owners and developers published by the Appraisal Institute in conjunction with The Institute for Market Transformation, Deep Retrofits have the potential to improve tenant-based revenues which are those revenues generated when building owners are able to monetize enhanced demand resulting from the Deep Retrofit.
    • “In many markets, rental premiums are emerging in green buildings as many of today’s best tenants are increasingly willing to pay a premium for green spaces… National studies for commercial office buildings back up this trend on rents and occupancy, as certified green buildings outperform their conventional peers by a wide margin (According to recent studies, the premium can range from 2% to 17%).
    • “Occupancy premiums can lead the case for green investments. If it can be determined that the green features will result in higher occupancy (through market research) than an otherwise similar building, a significant argument can be built for increases in value (from a reduced vacancy factor). Further, a LEED-certified building will attract demand from governmental agencies, Fortune 500 companies, major banks and insurance companies and other tenants who have corporate sustainability guidelines.
    • “Savings may be experienced as a result of tenant retention and the corresponding reduction in lost rents, reduced retrofit costs upon releasing spacer, lower vacancy at turnover and improved lease terms.
    • “Along with this improved occupancy premium, quicker absorption may be experienced in new properties or those that have been repositioned as green.”

While the calculation of the increased income is the same as for a traditional building investment analysis, the determination of the key assumptions requires extensive market research to support the assumptions which are input into a discounted cash flow model, like ARGUS® Valuation DCF.

  1. Sales Revenue Premium: Increased property values are realized from the higher net operating income realized due to reduced expenses and increased tenant revenues, lower capitalization and discount rates which result from risk-mitigating protections sustainable and resilient buildings provide property owners and banks, higher quality tenants, and increased investor demand. Recent surveys show that green commercial buildings trade at a premium ranging from 6% to 35% depending on the certification and the market. Studies have shown that capitalization rates for Energy Star and LEED-certified buildings are between 50 and 100 basis points lower than those for brown buildings.

Since the analysis is to determine the premium due to sustainability and resiliency improvements made to a commercial building. To complete this analysis, it requires the creation of a Cash flow projection under two scenarios:

  1. Baseline: A baseline projection is prepared based on the property in its current operating condition and market position; and
  2. Post-retrofit: This projection incorporates the retrofit development costs, the reduced operating expenses, the premium rental revenue and the any anticipated reduction in cap rate.

The difference in net operating income and the reversionary value is discounted based on the risk profile of the property and the investment to determine the value add from completing the Deep Retrofit.

The benefits of a Deep Retrofit can be significant!

With over 30 years of experience in acquisition due diligence, property valuation and cash flow forecasting as well as the ability to conduct the diagnostic assessment and create a Deep Retrofit program and budget, Emerald Skyline is uniquely qualified to be your advocate in planning, analyzing and executing your sustainable and resilient retrofit project.

The Capital Budgeting Analysis of a Sustainability Project

by Paul L. Jones, CPA, LEED Green Associate, Principal,
Emerald Skyline Corporation

calcRegardless of whether you are building your ark and waiting for the sea level to rise or if you are a climate-change denier, the writing is on the wall: sooner or later, you will need to modernize your building to improve its sustainability and resiliency. Accounting for almost 40% of the world’s energy consumption and greenhouse gas emissions, buildings are considered a high-impact sector for urgent mitigation action on climate change.

Accordingly, building owners, managers and tenants need to assess the opportunities and possibilities for improving sustainability in order to optimize the benefits realized – both physically through reduced consumption and waste and financially through proper planning, budgeting and financing.

Let’s begin by recognizing that there is a robust business case for investing in sustainability and resiliency measures (see the Sustainable Benefits article “Welcome to Sustainable Benefits – Let’s begin with the benefits of doing a commercial building sustainable retrofit….”) which enables the stakeholders to improves profits, saves the planet and be socially responsible corporate citizen (the “Triple Bottom Line”).

The first step in creating a sustainable retrofit program is to benchmark the property. According to Ms. Clare Broderick in her article, Creating an Energy Efficient Plan – One Step at a Time, (GlobeSt.com, 3/4/2015), “There is much truth to the adage, “whatever you measure improves”.  Whether you are responsible for one building or a portfolio of properties you need to know your starting point in order to gather quantifiable results.”

Another step to facilitate the cooperation and sharing of costs and benefits between the landlord and the tenant is to align the interests through a Green Lease (for more on Green Leases, see the Sustainable Benefits article “Overcome Obstacles to Going Green with Green Leases“). Systematically including sustainability clauses at lease creation or renewal facilitates energy efficiency, sustainability and resiliency retrofit projects.

Sustainability and resiliency measures are not all capital-intensive. Many relate to building operations – like aligning operating hours with actual building occupancy or changing the time when cleaning crews work. Conventional wisdom states that the best way to start a sustainability program is to begin with free or low-cost measures which creates an environment where people who work or visit a building start thinking about reducing, reusing and recycling. (see the Sustainable Benefits article “Going green – Fifty free or low cost ways for commercial property owners, managers and tenants to begin.”).

While low cost measures and the replacement of energy-inefficient lighting and equipment occurs at the time of natural replacement as part of the annual capital budgeting process for property maintenance, the timing for a significant building sustainable retrofit is usually determined by the investment or occupancy cycle of the building:

  • To attract a new tenant or retain an existing one;
  • As part of the process to prepare a property for sale; and
  • Upon acquisition as part of a value-enhancement business plan.

Maximizing the benefits from investing in the modernization (sustainability) and risk-reduction (resiliency) of a building utilizes a capital budgeting approach and requires the diagnostic review of the building which provides an understanding of the current equipment in use and an assessment of the improvements that can be made to accomplish your sustainability goals and objectives. The key to stakeholder action is to use capital budgeting based on forward-looking investment plans that facilitates the decision-making process.

In addition to planned equipment replacement upgrades, the first type of upgrade which is typically analyzed and approved as part of the annual management plan involves low-impact initiatives which generally have a short payback and can be implemented in currently occupied/leased buildings. These measures include commissioning an energy audit, replacing lighting and installing occupancy sensors and mid-level building energy management and control systems with interval energy data monitoring among other programs. In the case of these types of improvements, the capital budgeting decision can be limited to the relevant costs and benefits as hereinafter described.

The second is referred to as a “deep refurbishment” or “deep retrofit” project that aim to achieve high energy performance of the whole building which may include upgrading the building envelope, replacing the base building lighting systems, installing next generation smart building automation systems, adding solar or other renewable energy systems that require significant capital investment that cannot be recovered solely through the energy savings of the first few years, and the financial analysis of investment opportunities needs to include the impact on asset values.

Simple capital budgeting measures that are commonly used by engineers and contractors in proposals are the Payback Period and the Return on Investment:

  • The Payback Period in capital budgeting is the amount of time necessary to recapture the investment in a retrofit project, or to reach the break-even point. For example, the cost to upgrade lighting to LED is $25,000 which is forecasted to generate $14,000 in energy and maintenance savings would have a 1.79 year payback period (Cost divided by annual savings or earnings).
  • The Return on Investment is the inverse of the Payback Period and calculates the percentage return on an investment relative to the investment’s cost. In our example, the Return on Investment would be 56% (annual savings or earnings divided by cost).

While both the Payback Period and Return on Investment provide a quick way to evaluate and compare capital projects, the next level of analysis is multi-year and involves the time value of money which are commonly used in analyzing real estate investments. They are the Discounted Cash Flow, Internal Rate of Return. Another method is the Profitability Index and, finally, the method that is recommended in evaluating alternative investments is Life Cycle Costing. For all of these measures, it is important to forecast anticipated savings, earnings and costs over the investment horizon (typically, the life of the equipment):

  • The Discounted Cash Flow (“DCF”) method “discounts” the estimates of future savings, earnings and costs using the cost of capital or other investment threshold to arrive at a present value estimate. The cost of the project is then deducted from the present value to arrive at the Net Present Value (“NPV”). The project is acceptable if the NPV is greater than zero. It can also then be used to compare to other projects.
  • The Internal Rate of Return (IRR) is the rate at which the NPV of cash flows of a project is zero (i. e, the rate at which the present value of the future cash flows equals the initial investment). This is a yield calculation and the project is acceptable if the project IRR is greater than the Cost of Capital or other investment return threshold.
  • The Profitability Index (“PI”) is calculated by dividing the present value of the project’s future savings, earnings and costs by the initial investment. A PI greater than 1.0 indicates that the profitability is positive while a PI of less than 1.0 indicates that the project will lose money (the NPV would be less than zero). It is a useful tool for ranking alternative projects because it allows for the quantification of the value created per unit of investment. Most of the time the PI will be consistent with the NPV methodology; however, they may be in conflict due to different project scale or different pattern of cash flows. Conventional wisdom is to use the NPV when the PI is in conflict with it.

In each of the NPV, IRR and PI, the future savings are determined using the difference in future consumption/expenditures based on the economy of the new equipment or process over the anticipated costs of continuing use of the existing equipment.

  • Life Cycle Costing (“LCC”) is a tool to determine the most cost-effective option among different competing alternatives to purchase, own, operate, maintain and, finally, dispose of an investment in property, plant, equipment or process. According to BusinessDictionary.com, it is the “Sum of all recurring and one-time (non-recurring) costs over the full life span or a specified period of a good, service, structure or system. It includes purchase price, installation cost, operating costs, maintenance and upgrade costs, and remaining (residual or salvage) value at the end of ownership or its useful life.”

Consider the following example in the selection between two air handling units (from “Sustainability/LEED and Life Cycle Costing – Their Role in Value Based Design and Decision-Making” by Stephen Kirk, PhD, and Alphonse J. Dell’Isola, PE, date unknown):

Consider the selection between two air handling units. A 10% discount rate, a 24-year life cycle and a differential energy rate escalation of 2% per year are assumed. Other relevant data (NOTE: For all capital budgeting decisions, only incremental cash flows are included. Accordingly, sunk costs – those costs that have already been incurred – cannot be a part of the incremental cash flows used in the financial analysis of a capital project.) are:

Type of Cost Alternative 1 Alternative 2
Energy Efficient Economy
Initial cost $15,000 $10,000
Energy (annual) 1,800 2,200
Maintenance (annual) 500 800
Useful life 12 years 8 years

 

The solution begins by converting all annual or recurring costs to the present time. Using the present worth annuity factor, the recurring costs of maintenance would be:

Alternative One: maintenance (present worth) = $500 x (8.985) = $4,492

Alternative Two: maintenance (present worth) = $800 x (8.985) = $7,188

According to the discount rate tables, the present worth of the energy costs for each alternative would be:

Alternative One: energy (escal. @ 2%) = $1800 x (10.668) = $19,202

Alternative Two: energy (escal. @ 2%) = $2200 x (10.668) = $23,470

 

Replacement or nonrecurring costs are considered next. When one or more alternatives has a shorter or longer life than the life cycle specified, an adjustment for the unequal life is necessary. If the life of an alternative is shorter than the project’s life cycle, the item continues to be replaced until the life cycle is reached. On the other hand, if the item life is longer than the specified life cycle, then a terminal or salvage value for the item is recognized at the end of the life cycle. This treatment using the present value factors is illustrated as follows:

 

Alternative Two: replacement (n = 8) = $10,000 x (0.4665) = $4,665

Alternative One: replacement (n = 12) = $15,000 x (0.3186) = $4,779

Alternative Two: replacement (n = 16) = $10,000 x (0.2176) = $2,176

The salvage value for both systems equals zero since they both complete replacement cycles at the end of the twenty-four year life cycle. A summary of present worth life cycle costs follows:

 

Type of Cost Alternative 1 Alternative 2
Energy Efficient Economy
Initial cost $15,000 $10,000
Maintenance (recurring) cost 4,492 7,188
Energy (recurring) cost 19,202 23,470
Replacement (nonrecurring), year 8 0 4,665
Replacement (nonrecurring), year 12 4,779 0
Replacement (nonrecurring), year 16 0 2,176
Salvage, year 24 0 0
Total present worth life cycle costs $43,473 $47,499

 

The first alternative would be selected on the basis of this LCC analysis.

Of course, any analysis should reflect the rebates that are available from manufacturers, utilities and governmental agencies.

As you can tell, the simple Payback Period and ROI analyses may be appropriate for small projects, like replacing the lighting, but using the DCF, IRR and PI methods provide better information while Life Cycle Costing Analysis provides the best basis for evaluating a project, or alternatives among projects, in making the capital budgeting decision.

As a CPA, I know that these analyses require time and skill to accurately prepare, but making sound capital budgeting decisions when improving a property using these techniques is the lynchpin of profitability. Emerald Skyline Corporation is uniquely qualified to be your advocate in planning, analyzing and executing your sustainable and resilient retrofit project.

In my next article, I will present the investment analysis of a “Deep Retrofit” as pioneered by Rocky Mountain Institute.

When assessing risk and reward in acquiring commercial real estate – be sure to cover all your bases including sustainability and resiliency

PJ Picture

 

by Paul L. Jones, CPA, LEED Green Associate

It is a great day – you have just put a property you like under contract. Now the work begins…conducting your acquisition due diligence. You know the program:

  • Obtain the deliverables from the seller
  • Research title for exceptions and obtain insurance binder
  • Ensure compliance with building and zoning codes
  • Engage the appraiser
  • Hire an engineer to conduct a property condition assessment
  • Hire an environmental engineer to prepare a Phase I environmental site assessment
  • Abstract leases and agree to the rent roll, check expense pass-through calculations and conclude on in-place and prospective income
  • Analyze the market and assess the property’s competitive profile including Green certification, utility expenses (electricity, gas, water and waste) and resiliency
  • Review all existing contractual relationships and obligations, including property maintenance, service and other agreements, warranties (equipment, roof, elevator, etc.)
  • Obtain property insurance quote and coverage binder
  • Establish the veracity of the operating statements and establish an operating budget
  • Update the cash flow forecast and yield assessment to evaluate the purchase price and desirability of the investment

What if I were to tell you that with all this work, you may not have covered all your bases. Let’s go back to the purpose of your acquisition due diligence: to ensure that you are getting what you thought you were getting and to assess, eliminate or quantify the risk and rewards in the investment.

Just like your market analysis which looks at both current conditions as well as the pipeline of future competition and the affordability of new competitive construction; In a rapidly changing environment, it is important for purchasers and investors in real estate to evaluate the property’s operating and energy efficiency, indoor environmental quality and resiliency as well as anticipate future environmental, regulatory and operating conditions.

Regardless of your personal position on climate change and sea level rise, commercial real estate is going to be affected – and because of real estate’s primary characteristic – it is immovable – the effects can be significant.

  • According to the report, “Risky Business: the Economic Risks of Climate Change in the United States” which was published last summer, “If we continue on our current path, by 2050 between $66 and $106 billion worth of existing coastal property will likely be below sea level.”
  • FEMA is anticipating a 45% growth in the areas susceptible to flooding due primarily from sea level rise by the end of this Century – just 85 years away.
  • According to the Institute for Market Transformation, “fourteen cities, two states and one county in the United States have passed laws requiring benchmarking and disclosure of energy use in buildings.” To learn more about where and under what conditions benchmarking is required, go to org. (FYI – these requirements are soon to affect over 5 billion square feet of space AND the EPA estimates that buildings that are benchmarked save an estimated 7% in energy over three years).

PJ Building Benchmarking

I live in Miami. Last week, we were in the cone of TS Erica which looked like it could grow into a hurricane. Businesses and people in South Florida began making preparations by buying staples like gas, batteries, non-perishable food supplies and reviewed their disaster plans. Thanks God the storm did not materialize and all we had was a hard rain which did cause flooding throughout our community. Climate change and sea rise are similar – you prepare for the worst and hope for the best. It does not hurt that in preparing for the worst, we actually are able to delay the time for the rise to occur (through a reduced carbon footprint). Accordingly, prudent investors are well advised to include the following additional due diligence procedures to assess the sustainability and resiliency risk inherent in the property.

  • Obtain information on the risks the local community experiences due to climate change which could range from increased storm intensity and flooding due to sea level rise, wild fires and water restrictions due to drought conditions, or increased utility usage due to higher average temperatures.
  • Obtain information on new or prospective municipal environmental requirements and evaluate the property leases and operations to determine the ease and cost of compliance.
    • For instance, if benchmarking is going to be required, do the leases in place require the tenant to share utility usage information (if, as is the case with many properties, the tenant pays utilities directly).
  • In an era of increasing utility costs and more efficient lighting, HVAC and other systems, do the leases provide for a proper sharing of the cost of replacing the equipment if it results in a reduction in utility usage? See my article on Green Leases in the Sustainable Benefits archives.
  • Obtain current and prospective FEMA flood maps to ascertain the risk and timeline the property will be in a flood zone in the future.
  • If the property is not a Green-rated building (LEED, EnergyStar, etc.), have the engineer assess the age and efficiency of the building systems.
  • From your insurance agent, obtain information regarding anticipated future availability and rate increases.
  • In evaluating the competitive leasing market, evaluate the relative absorption, rents, occupancies and tenant quality of Green buildings vs. traditional buildings to determine the market demand for sustainable buildings.
  • Evaluate the building’s ability to absorb and recover from to actual or potential adverse effects of stronger storms (wind and rain), higher storm surge and more frequent flooding in coastal areas or tornados, wildfires and dust storms in other areas. Each location has its own set of risks. Some resiliency due diligence questions to ask are:
    • Is the building site and entrance flood-proof?
    • Is the landscape design hazard-resistant?
    • Does the building have back-up power systems including HVAC and water)?
    • How secure is the interior environment from damage due to higher storm intensity?

The checklist of due diligence items and questions to be answered with regard to a property’s sustainability, resiliency and ability to comply with ever evolving government, insurance company and tenant requirements needs to be customized based on the location of the property as well as its class and quality.

In a November 2014 article, “Do-or-Die Due Diligence, Auction.com Vice President Andre Cuadrado warns “The due diligence process is one of the most important, yet challenging aspects of investing in real estate. If it’s not conducted thoroughly with a keen eye, an investor could end up with bad deals and lose millions of dollars.”

Cuadrado advises investors to spend the time and resources necessary to conduct due diligence thoroughly. “Some people try to save money on the process,” he notes, “but it’s expensive to be cheap when conducting due diligence, as your investment may end up not being what you thought it was.”

Remember, as Sun Tzu is quoted from The Art of War: “Every battle is won before it is even fought.” This is true for real estate investing as well – complete and thorough due diligence is the key to risk reduction and profit enhancement.

The breadth and depth of our experience and understanding of commercial real estate due diligence, sustainability and resiliency, Emerald Skyline Corporation is uniquely qualified to be your advocate in planning and executing your due diligence needs.

Welcome to Sustainable Benefits – Let’s begin with the benefits of doing a commercial building sustainable retrofit….

2/12/15

PJ Picture
By Paul L. Jones
, Founder,
Director, Financial Advisory Services for Emerald Skyline Corporation

 

“Who is more foolish: The child afraid of the dark or the man afraid of the light?” (Maurice Freehill, British WW I flying ace).

Figure 1 Empire State Building - LEED Gold

Figure 1 Empire State Building – LEED Gold

Throughout my 36-year career in commercial real estate, commercial buildings have generally been classified from A to C based on location, construction quality and tenancy. Class A buildings represent the cream of the crop. They secure credit-quality tenants, command the highest rents, enjoy premium occupancies, are professionally managed and have a risk profile that supports lower cap rates and higher values. Class B buildings are similar to Class A but are dated yet not functionally obsolete. Class C buildings are generally over 20 years old, are architecturally unattractive, in secondary or tertiary locations and have some functional obsolescence with out-dated building systems and technology. NOTE: No formal international standard exists for classifying a building, but one of the most important things to consider about building classifications is that buildings should be viewed in context and relative to other buildings within the sub-market; a Class A building in one market may not be a Class A building in another.

Based on years analyzing investments in income properties, it appears to me that in the recovery from the Great Recession the commercial real estate market has evolved to include energy efficiency and environmental design as a requirement for improving the marketability of a building – not to mention optimizing its operating income and value.

COMMERCIAL OFFICE BUILDINGS

On December 1, 2014, Buildings.com, in an article entitled “GSA Verifies Impact of Green Facilities,” reported that a study conducted by GSA and the Pacific Northwest Laboratory conducted a post-occupancy study of Federal office buildings, which varied in age and size and had been retrofit to reduce energy and water consumption. The following results were based on a review of one year of operating data and surveys of the occupants which was compared to the national average of commercial buildings: High performance, green buildings:

  • cost 19% less to maintain
  • Use 25% less energy and water
  • Emit 36% fewer carbon dioxide emissions
  • Have a 27% higher rate of occupant satisfaction.

One of the most famous sustainable retrofit projects undertaken was the updating of the 2.85 msf Empire State Building whose ownership directed that sustainability be at the core of the building operations and upgrades implemented as part of the $550 million Empire State ReBuilding program. According to Craig Bloomfield, of Jones Lang LaSalle (JLL), “After the energy efficiency retrofit was underway, JLL led a separate study of the feasibility study of LEED certification” which “showed that LEED Gold certification was within reach at an incremental cost of about $0.25 psf.

Graphics on financial benefits of high-performance buildings

Source: Institute for Market Transformation: Studies consistently show that ENERGY STAR and LEED-certified commercial buildings achieve higher rental rates, sales prices and occupancy rates.

Source: Institute for Market Transformation: Studies consistently show that ENERGY STAR and LEED-certified commercial buildings achieve higher rental rates, sales prices and occupancy rates.

According to the report “Green Building and Property Value” published by the Institute for Market Transformation and the Appraisal Institute, a trend is emerging where green buildings are both capturing higher quality tenants and commanding rent premiums. As indicated by the above graph summarizing four national studies for commercial office buildings back up this trend on rents and occupancy, as “certified green buildings outperform their conventional peers by a wide margin.”

  • According to the EnergyStar.gov website, “Transwestern Commercial Services, a national full-service real estate firm, has generated impressive returns through sound energy management. In 2006, Transwestern invested over $12 million in efficiency upgrades, for an average 25% energy savings. The Company estimates that dedication to energy management has increased the portfolio’s value by at least $344 million.”
  • According to John Bonnell and Jackie Hines of JLL – Phoenix, “In Phoenix, owners of LEED-certified buildings can capture a premium of 29 percent over buildings without this distinction.” The premium for Green buildings had disappeared during the Great Recession and reemergence in the first quarter of 2014 as a result of improving Phoenix market dynamics which is being realized in other major markets as well.

RETAIL

For retail buildings, the tenants are driving the shift to sustainability with green building as consumers become increasingly aware of the environment and the need to reduce, reuse and recycle. According to the “LEED in Motion: Retail” report published by the USGBC in October 2014, “LEED-certified retail locations prioritize human health: among their many health benefits, they have better indoor environmental quality, meaning customers and staff breathe easier and are more comfortable. In a business where customer experience is everything, this is particularly valuable.’ Green retail buildings also out-perform conventional buildings and generate financial savings:

  • On average, Starbucks, which just opened their 500th LEED-certified store, has realized an average savings of 30% in energy usage and 60% less water consumption.
  • McGraw-Hill Construction, which surveyed retail owners, found that green retail buildings realized an average 8% annual savings in operating expenses and a 7% increase in asset value.

It is noteworthy that, according to the third annual Solar Means Business report published by the Solar Energy Industries Association, the top corporate solar user in the United States is Walmart. In fact, almost half of the top-25 solar users are retailers (the others are Kohl’s, Costco, IKEA (9 out of 10 stores are solar powered), Macy’s, Target, Staples, Bed Bath & Beyond, Walgreens, Safeway, Toys ‘R’ Us, and White Rose Foods). Other Top-25 solar users with a significant retail footprint include Apple, L’Oreal, Verizon and AT&T.

In the competitive retail market, the study also noted that being distinguished for pro-active and responsible corporate social responsibility attracts customers and investors.

MULTI-FAMILY BUILDINGS

In a study of 236 apartment complexes conducted by Bright Power and The Stewards of Affordable Housing released last July, 236 properties in two programs, HUD’s nationwide Green Retrofit Program and the Energy Savers program available from Illinois’ Elevate Energy and the Community Investment Corp. One year of pre- and post-retrofit utility bills were analyzed. The researchers found the following:

  • Properties in the Green Retrofit Program had realized a 26% reduction in water consumption – or $95/unit annually.
  • The energy consumption in the Green Retrofit Program was reduced by 18% representing an annual savings of $213/unit.
  • Surveyed buildings in the Energy Savers program had reduced gas consumption by 26% and had reduced excess waste by an average of 47%.
  • The water saving measures in the Green Retrofit program reflected a simple payback period of one year while the energy savings measures had a simple payback period of 15 years.

In an article be Chrissa Pagitsas, Director – Multi-family Green Initiative for Fannie Mae, reports that 17 multifamily properties have achieved Energy Star® certification with two of them, Jeffrey Parkway Apartments in Chicago and ECO Modern Flats in Fayetteville, Arkansas, receiving financing from Fannie Mae.

  • The Eco Modern Flats complex is over 40 years old. With the goal of reducing operating expenses, the project was retrofit in 2010 with energy and water efficiency improvements including low-flow showerheads and faucets, dual flush toilets, ENERGY STAR® certified appliances, efficient lighting, closed-cell insulation, white roofing, solar hot water and low-e windows. As a result of the retrofit, the property achieved a 45% reduction in water consumption, a 23% drop in annual electricity use including a 50% savings in summer electricity consumption while increasing the in-unit amenities, obtaining LEED Platinum certification and increasing occupancy by 30% resulting in a significant increase to Net Operating Income.

Multi-family properties made sustainable gain a competitive advantage in marketing to young professionals and other target audiences who prefer to live in an environment that is healthy and energy-efficient which saves money on utilities.

HOTELS

In a 2014 study conducted by Cornel University, researchers compared the earnings of 93 LEED-certified hotels in the US to 514 non-certified competitors. The study included a mix of franchised, chain and independent facilities in urban and suburban markets with three-quarters of the properties having between 75 and 299 rooms.

The results show that green or sustainable hotels had increased both their Average Daily Rate (ADR) and revenue per available room (RevPAR) with LEED properties reporting an ADR that was $20.00 higher than the non-certified properties (prior to certification, they reported an ADR premium of $169 vs. $160).

The researchers noted that these premiums were realized in price-competitive markets and that the amount of the premium was unexpected. From the results, they concluded that Eco-minded travelers were willing to pay a modest premium to stay at a verified green facility.

Further, the savings realized in electricity and water usage as well as reductions in waste disposal fees and costs as well as reduced maintenance costs go straight to the bottom line resulting in increased Net Operating Income. Here are some examples:

  • The Hampton Inn & Suites, a 94-room facility in Bakersfield, had REC Solar install carport-mounted solar panels which is offsetting 44% of the electricity costs, or up to $8,800/month – adding over $100,000 to the property’s bottom-line.
  • The 80-room Chatwall Hotel in New York completed an LED lighting retrofit project mid-year 2014 which will result in a first year savings of almost $125,000. The cost: just about $1.00 per LED light after rebates.

According to Flex Your Power and ENERGY STAR® statistics, the hospitality industry spends approximately $4 billion on energy annually with electricity, including the HVAC system, accounting for 60% to 70% of utility costs. In fact, excluding labor, energy is typically the largest expense that hoteliers encounter and the fastest growing operating expense in the industry (www.cpr-energy.com). The EPA has concluded that even a 10% improvement in energy efficiency is comparable to realizing a $0.62 and $1.35 increase in ADR for limited service and full service hotels, respectively.

Many studies show that hotels do not realize the full benefit of many energy efficiency measures as guests feel no obligation to employ sustainable practices and wastes the opportunity for savings afforded by the hotel’s energy efficiency measures; however, almost half realize savings in excess of 20% reflecting that many operators have found ways to enlist guest cooperation in saving electricity and water.

According to the US Energy Information Administration (EIA) 2012 Commercial Buildings Survey, the United States had approx. 87.4 billion square feet of floorspace in 5.6 million buildings that were larger than 1,000 sf which also excluded heavy industrial manufacturing facilities. Ninety percent of the buildings that will exist in2035 have already been built – and buildings consume 80% of energy used in cities worldwide and represents almost 20% of all energy consumption in the United States.

Source: US Department of Energy 2013 Renewable Energy Data Book, 1/22/2015

Source: US Department of Energy 2013 Renewable Energy Data Book, 1/22/2015

 

The evidence is clear – building and operating sustainably pays dividends – in improved NOI from cost savings and increased revenues. Attracting higher quality tenants, improving market perception and reducing risk indicates that going Green is becoming a key for maintaining the Class of a building – keys to improving long-term values through lower cap rates.

So, why aren’t more building owners and managers going green? We will seek to discern this matter in our next Sustainable Benefits.

The Invisible Hand

6/10/14

PJ Picture

 

By Paul L. Jones, Founder,
Director, Financial Advisory Services for Emerald Skyline Corporation

 

 

Adam Smith, author of The Wealth of Nations, gave definition and meaning to the economics and laid out the foundation for the economic system on which the U.S. was based. As noted in the introduction to the Condensed Wealth of Nations published by the Adam Smith Research Trust, “It took the outdated, received wisdom about trade, commerce, and public policy, and re-stated them according to completely new principles that we still use fruitfully today.” (http://www.adamsmith.org/sites/default/files/resources/condensed-WoN.pdf)

The economic system we have come to know as capitalism facilitates a free market economy built on the concept that both sides benefit from trade and that the market had an “automatic mechanism that allocated resources with great efficiency” which we know as the Invisible Hand. According to Smith,

“Every individual… neither intends to promote the public interest, nor knows how much he is promoting it… he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” The Wealth of Nations, Book IV, Chapter II, p. 456.

It is the invisible hand on which we continue to rely as we count on the developers, owners, managers and tenants of commercial real estate to act in their own best interests – which, undoubtedly, is to improve operating cash flow and maximize the value of their properties.

In my first two posts, I highlighted some of the economic benefits to eradicating functional obsolescence in an existing building and avoiding it in a new building.   The studies that have been performed all indicate that a sustainable retrofit puts money into the pockets of all of the stakeholders in a property.   Now, here are some more statistics that hopefully get your attention (as reported by Rob Roth, , Ph.D., Chief Executive Officer, EnergyActio, in the recently released “2014 INSIDER Knowledge” published by Environmental Leader (www.environmentalleader.com) :

“In the United States, the average commercial building wastes approximately 30% of the energy that owners and tenants pay for. On an annual basis, energy waste costs owners and tenants more than $60 billion which is equivalent to:

  • $60 billion in lost business profits
  • $857 billion in lost capitalized asset value (at a 7.0% cap rate)
  • Funding for 1.3 million jobs (at the 2013 average wage of $45,790).”

In an article posted by NREI/Green Real Estate Strategies yesterday (6/9/2014), John Bonnell and Jackie Hines of Jones Lange LaSalle in Phoenix, report that “LEED-certified buildings can capture a premium of 29 percent over buildings without this distinction.” They further report that “It appears that a green building is no longer a luxury, but a requirement here to stay.”

As more owners, investors, managers and tenants pursue the Sustainable Benefits to be derived from remediating functional obsolescence through a sustainable retrofit, the invisible hand will enable us to achieve the societal goals of reducing our carbon footprint, minimizing our contribution to climate change and extending the life of our natural resources.

Remember, reuse, reduce and recycle.

Be well and be blessed, Paul

Monetizing Sustainability Investments for Business Decision Making

Tod Christenson, John Platko, Antea Group, 5/27/2014

View the original article here

Today’s sustainability investment options are extensive and broad ranging, including relatively straightforward efforts (e.g., energy conservation projects) to multi-year/multi-stakeholder initiatives (like those that target social and environmental improvements deep within an organization’s supply-chain). While doing any or all of these could yield significant benefits, it is often unclear which will generate the greatest, most enduring value. Faced with this dilemma, leaders often struggle to understand which choices are best and how they should evaluate the many alternatives to ensure the most effective, efficient and sustainable decisions are made.

One way to improve would be to encourage better, more quantitative analyses that examine the full costs and benefits associated each investment in sustainability, combined with an analysis of which could make the greatest contribution for the business, the environment and society simultaneously.

While most understand that “when the economics work, the social and environmental benefits last,” many barriers remain for those wishing to accelerate the pace and effectiveness at which sustainability initiatives are funded and implemented, including:

  • the lack of a demonstrated link between sustainability and business value;
  • failure to communicate the strategic potential of such efforts in a way investment decision-makers can understand and appreciate; and
  • not leveraging proven, familiar processes (that other company functions have applied) to accelerate decision-making and scale solution implementation.

Accenture’s 2013 CEO survey (UN-Global Compact – Accenture CEO Study 2013: Sustainable business and the pace of change) seems to agree, reporting that 37% of 1,000 top executives feel that the lack of a clear link to business value is a critical factor in deterring them from taking faster action on sustainability. It should be noted that this percentage is increasing: in 2007, just 18% reported a failure to trace such a link and in 2010, this figure rose to 30%.

Our experience confirms this trend, as we regularly note good projects that do not receive sufficient (or any) investment as these initiatives are perceived as failing to deliver competitive business value.

From our vantage point, there are two principal challenges that need to be overcome for sustainability to be viewed as a more critical contributor:

First, the “equations” for presenting business cases do not sufficiently include all the benefits of investing in sustainability – specifically, these efforts should include an accounting of potential contributions such investments could make in terms of:

  • Offsetting of risk (brand risk, reputation risk, supply/commodity risk, regulatory risk, etc.);
  • Delivering efficiency gains; and/or
  • Adding revenue/market share (via innovation and/or building brand/reputational equity).

Without accounting for and quantifying all these dimensions, sustainability investments risk appearing less important than other business investments and hence are perceived as not carrying as much “strategic weight.”

Second, sustainability departments are generally not equipped to build and pitch multi-dimensional business cases – this requires a combination of strategic, financial and political skills rarely found among these practitioners. Challenging questions are being posed, and few confident answers are being provided:

  • Are we realizing value expected from existing, funded sustainability initiatives?
  • We have many sustainability investment choices, but which ones are the best for our business?
  • How confident are we that our actions will yield the tangible and intangible benefits promised by the business case?
  • Do we understand the true business impact and cost of doing nothing?
  • How do we increase the reliability and credibility of our business case analyses, and therein, how can we increase the confidence of our sustainability investment decision-making?

Value Creation: Business & Sustainability

Linking sustainability to value creation is becoming a new imperative for business leaders. As such, investments in sustainability must be more connected to both business and societal benefits, improving management of risks/costs and stimulating growth and/or innovation, while simultaneously helping companies better meet societal and environmental expectations and obligations. When building the case, leading organizations are increasingly articulating associated sustainability benefits within a clear and simple framework, one that illustrates how these investments can better protect, strengthen, and/or advance the business.

Frequently, benefits of this sort are intangible, uncertain and generally difficult to quantify in ways that are credible and agreeable to all decision-makers. Determining the appropriate level of analysis, who must be engaged, what input is required, etc., is often a challenge requiring innovative, clever leadership, clear process and strong cross functional engagement to ensure success. Commonly, those that pursue such efforts ensure they always ask:

  • Am I using the right vernacular, do I understand, and more importantly, use terminology and methods familiar to financial and other decision-makers, or am I only talking in “sustainability speak?”
  • Have I considered all relevant costs or benefits (tangible or intangible) in my analysis?
  • Have I engaged the appropriate internal domain or functional experts to gather data, experience and methods needed to build a credible, monetized investment analysis?
  • Have I accommodated and considered future variability and other possibilities that could impact decisions or outcomes?

Innovators Are Creating the Case for Sustainability Today

Ultimately, value-adding sustainability investments protect, strengthen and/or advance business endeavors while simultaneously improving the environment and society’s well-being. Clearer demonstration of such value creation capability is becoming more common as innovative organizations repurpose standard management and strategic tools to deliver a more compelling case for sustainable investment and action.

As a consultant to private industry for more than 30 years, Tod Christenson partners with clients to develop and implement fit-for-purpose and innovative solutions to drive sustainability across the entire value chain. He has unique skills and expertise in the areas of strategic thinking and planning methods, sustainability, corporate social responsibility, organizational diagnosis and coaching, and benchmarking.

John Platko has nearly 30 years of business, sustainability, environmental, health and safety leadership experience. His client engagements involve the development and implementation of strategies, plans and programs that emphasize simultaneous creation of business, environmental and social value for private sector clients operating domestically and internationally. John has led projects in more than 40 countries in North America, Latin America, Europe and the Pacific Rim. He is a founding member of the company’s sustainability practice; a leader in Antea Group’s Accounting For Sustainability – AA4S decision-support service; and the primary architect of iEHS, the company’s web-based environmental, health, safety and sustainability information management platform.

‘Green’ Federal Facilities Save $42M

Environmental Leader, 05/27/2014

More than 400 federal facilities achieved $42 million in cost savings and environmental benefits last year as part of the Federal Green Challenge (FGC).

A national effort under the EPA’s Sustainable Materials Management Program, the FGC allows federal offices or facilities to pledge participation in reducing the federal government’s environmental impact and recognizes outstanding efforts that go beyond regulatory compliance and strive for annual improvements in selected target areas (waste, electronics, purchasing, water, energy and/or transportation).

Within these areas, additional accomplishments by participants included: diverting more than 500,000 tons of municipal solid waste and construction and demolition waste from landfills, and reducing fleet distance traveled by 16.5 million miles.

Data collected from the challenge show that FGC participants sent 1,765 tons of end-of-life electronics to third-party certified recyclers, minimizing environmental impacts — including water and energy use, releases to air and water, greenhouse gas emissions, and land use impacts.

The US General Services Administration’s new standards for its federal buildings, published in March, focuses more on outcomes, or performance, and less on technology.

The Facilities Standards for the Public Buildings Service, also known as the P100, is a mandatory standard that outlines how facilities will be managed, designed and built to achieve higher performance levels and save energy in the 9,200 buildings the GSA owns and leases across the country. The P100 applies to all new construction projects including additions to existing facilities.

Incentives Aim to Green Up New York, Reduce Operating Costs for Building Owners

By Joshua Ayers, Senior Editor, 5/20/2014
View the original article here

New York—A recent study found that 75 percent of greenhouse gasses in New York City are being generated by buildings, a majority of which are multifamily residential buildings. The alarming figures have prompted an assortment of companies and organizations, ranging from major utility companies to the mayor’s office, to develop programs that incentivize green upgrades in an effort to entice multifamily building owners to curb emissions.

A panel of industry experts explored the fiscal perks of these programs at FirstService Residential’s Third Annual Green Expo & Symposium May 15 in New York, stressing the importance of participating in the programs before they are no longer available.

“What’s packaged inside of this is not only trying to operate your building more efficiently, cleaner, greener, but also as a major opportunity to save money,” said FirstService Residential President Dan Wurtzel as he opened up the discussion. “Ultimately if at the end of the day that’s where we end up then we’re all in a better place. We save money, we’re contributing to a greener environment and probably our property values are going to go up because of the reputation of the building. So it’s a win-win all the way around.”

One of the largest incentive programs currently available to New York building owners is NYSERDA’s flagship program, the Multifamily Performance Program (MPP), which allots building owners $500 to $1000 per unit to help reduce energy usage by 15 percent. To qualify, owners must work with one of about 90 NYSERDA-approved partners, which include engineering firms, energy consultants and non-profit organizations. That chosen partner then assess and recommend improvements that will help them achieve the reduction. Owners become eligible for an additional $300 per-unit bonus if they are able to meet the criteria.

“The good news is that the way that all this is calculated and the way that electricity rates work, 15 percent energy reduction is about a 15 percent cost reduction,” says Michael Colgrove, director of NYSERDA’s New York City office, who directly oversees the multifamily programs. “If you know how much you spend annually on energy usage, you take 15 percent off of that, and that’s about what the program [can do to] assist you.”

Colgrove said that most buildings in the program end up reducing usage by 20 to 25 percent and that there have been some buildings that have cut energy use by as much as 40 percent. In addition to the initial incentives, owners can qualify for an additional $300 per unit if they are able to reduce usage.

But the panelists stressed the importance of taking advantage of these programs, as most of them do have set term limits.

For example, Con Edison has created a new program aimed at curbing peak summer demand energy uses. The program, called the Demand Management Program, provides a certain amount of money for every kilowatt of energy saved via a variety of methods such as lighting upgrades, While owners can potentially save thousands of dollars through these incentives, the program will end promptly in June 2016.

Con Edison also has other programs that reward energy reduction such as the four-year Commercial and Industrial Program, which features components that provides rebates for energy efficient equipment and other incentives that can help fund up to 50 percent of a green capital improvement project.

“Some programs have quadrupled the amount of programs and funding available,” said panelist John Skipper, business development for Energy Efficiency & demand response, Con Edison

While these incentive programs allow for building owners to save thousands of dollars in operating costs and give buildings a greener footprint, proper research in rare cases can lead to an additional source of income.

Panelist William C. Ragals, Jr., board president of The Strand Condominium in Manhattan says his board took advantage of now-expired NYSERDA and Con Edison oil-to-gas conversion incentives to help fund the installation of a Combined Heat and Power (CHP) that has allows the building to produce energy at below Con Edison rates.

“With the money that they gave us and the efficiencies that we received in operating expenses by switching from oil to gas, the balance of our out-of-pocket was recovered by us in about five months,” Ragals said.

Despite all of the available programs, qualifying for incentives does not come without a set of challenges. Ragals says that researching the program and educating board members or property managers is the first step to addressing these challenges.

“I had to educate my board and that is something you have to face,” he says.

Another key step to reeling in incentive money is to identify what upgrades need to made and which ones will have the best effect on operating costs.

This can be determined several ways. One way is to utilize information collected through annual benchmarking reports (a requirement of Local Law 84) to identify how much energy a building uses and how that figure compares to other similar buildings in order to determine whether an upgrade is warranted. The second involves conducting an Energy Efficiency Report, something that is already required every 10 years for larger building thanks in part to Greener, Greater Buildings Plan efforts, specifically Local Law 87, which that mandates such an inspection for “covered buildings” with 50,000 or more gross square feet.

“Basically you have a qualified contractor come in and analyze the system that’s in your building and tell you where you can save energy,” said Jenna Tatum, NYC Carbon Challenge Director, New York City Mayor’s Office of Long-Term Planning and Sustainability.

Tatum says that the building owners can get credit for the audits up to four years in advance of the 10 year deadline, and that while the audit does cost money, there are no requirements necessary to commit to any projects.
Colgrove clarified, however, that work has to already have started before NYSERDA incentives will be paid out.
“NYSERDA won’t actually give you an incentive until you’ve installed at least 50 percent of that work,” he said, adding that “NYSERDA’s MPP program has a clause in it that says ‘we will recognize any work that a building has done up to a year of applying to the program,’ and that can qualify toward your 15 percent target.”

Change Your Perception of Financing and Reap the Energy Savings

An overview of funding options for your next project
By Eric Woodroof, Ph.D., CEM, CRM
Click to view original article

Psychologically, when most people hear the word “financing,” they have a quick and negative reaction about cost. I understand the perception. If you look at the total financing cost on your home, you pay an amount over 30 years that can be twice the purchase price!

But most energy projects are different from your home mortgage. The savings is greater than the finance cost (especially with today’s low interest rates). Yet lack of capital and financing cost are the most common reasons why good energy projects are delayed or cancelled.

An energy project can have a rate of return over 30% – higher than most investment opportunities and many companies’ profit margins. Even with a 10% financing cost, you are still 20% ahead compared to doing nothing.

Lack of capital is solvable for many projects. I will outline solutions, some old and some new. I hope this article inspires you to challenge anyone who tries to block a good project based on the premise that money is not available and the financing cost too high. The truth is, you are probably throwing bags of money out the window – and that money cannot be recovered, even if you do a conservation project at a later date.

Innovative Options

Among recent financing innovations are Utility Energy Service Contracts (UESC), Power Purchase Agreements, on-bill financing, and Property Assessed Clean Energy (PACE) financing.

Utility Energy Service Contracts are basically performance contracts that are developed and implemented by utilities. The contracts offer some streamlining because utilities can provide the project funds and make deals with neutral cash flow.
Power Purchase Agreements (PPAs) are commonly used for solar PV and wind generation. In a PPA, solar is put on the roof at no upfront cost to the building owner, who agrees to purchase the kWh produced over a long-term contract. The PPA is typically structured so that the building owner is paying about the same price for the solar kWhs as they would for power from the grid. This works well when the grid price is high, the utility is cooperative, and local incentives are available.

On-bill financing is offered by some progressive utilities, typically as part of a Demand Side Management Strategy that benefits the utility. As the name implies, building owners repay the installation costs with an extra charge on their future utility bills. The deal is structured so that the monthly savings is larger than the extra charge. The improvement can be linked to the meter, so that if the owner sells the building, the savings and the repayment are taken over by the new owner.

PACE is very similar to the on-bill financing concept except that the savings and repayment are linked to the property tax, so that if an owner sells a property, the new owner would assume the property tax amendment (i.e. extra payment). However, any new owner also reaps the savings cash flow. In recent years, PACE has become very popular. This financing vehicle has now been enabled by legislation in 31 states.

Traditional Financing

There are also many traditional financing options available to facility managers. If you decide to finance a project with a loan, bond, true lease, capital lease, or other leasing variation, you may have some new vocabulary to learn. You may also need an accountant to evaluate such things as depreciation. (And note that there are some new tax regulations for depreciation in 2014.) Take a little time to understand this information as well as the view from the CFO (or whoever signs the contract). To get approved, the CFO has to say “yes.” Try to make it easy – or even irresistible – for him.

Performance contracting has been around for decades and allows projects to be developed by an Energy Service Company (ESCO) that offers a performance guarantee on the savings in which the savings are greater than the finance payment, which is usually handled by a third-party financier. This approach can be attractive because, in theory, the savings are risk free due to the guarantee.

Performance contracting is more common with government, institutional, and educational facilities because financiers are more comfortable lending money to organizations that are likely to survive a recession and other difficult business cycles. Contracts can become complex (for both the ESCO and the facility) and it takes time to understand them as well as get legal endorsement, which adds time and cost.

Local incentives and rebates from utilities can be substantial and improve the return on investment if you are willing to do some before/after documentation. For example, my utility will give a $10 rebate on LED lamps that cost $20. A list of free rebates, tax credits, and other incentives is available at www.dsireusa.org. Also ask your local government, chamber of commerce, and economic development office because they may have special grant money. Because the local community benefits, I have seen funding available to help pay for solar, energy efficiency, and water conservation projects.

Additional Resources

It is clear that energy financing options have increased, leaving more choices for the facility manager – a great situation if you know where to look and how to leverage your options.

If you want some basic information about financing and performance contracting, I have a free webinar entitled Financing for Engineers that is available here. There is also information on the energy.gov and EPA websites.
For career-focused individuals that want to earn accreditation, you can look at a new certification program from the Association of Energy Engineers, the Certified Performance Contracting & Project Funding Professional. I think this type of training will help many facility managers and ESCO professionals navigate their options and accelerate project approvals.

Eric A. Woodroof, Ph.D., is the Chairman of the Board for the Certified Carbon Reduction Manager (CRM) program and he has been a board member of the Certified Energy Manager (CEM) Program since 1999. His clients include government agencies, airports, utilities, cities, universities and foreign governments. Private clients include IBM, Pepsi, GM, Verizon, Hertz, Visteon, JP Morgan-Chase, and Lockheed Martin.