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Taking Energy to the Bank

Some things just seem simple. Greater energy-efficiency means smaller energy bills. For some organizations reduced energy costs are incentive enough to pursue energy-efficient technologies and operation strategies. For others, it may take a stronger incentive, and that next step is being slowly developed today. By David Kozlowski.

Energy-efficiency is being converted into dollars in a lot more ways than facility executives ever thought it could. Energy-efficient buildings are attracting a growing number of savvy tenants providing building owners a market advantage. Some Wall Street investors are looking for it in the properties they invest in. Even a few lenders, which have been prodded by building owners, have begun to recognize energy-efficiency as a physical asset, such as Italian marble or a fitness center.

While many challenges exist before the real estate and financial sectors recognize energy-efficient building technologies and operations as an asset, the framework for its acceptance is being built, and slowly facility executives and industry professionals are beginning to pay attention.

A Safe Investment

Wall Street has gotten a lot of attention for its tremendous boost to the economy, including the financial health of real estate. While risk-taking movers and shakers may make the news, most investors are rather conservative. They prefer pragmatic, practical choices and as much assurance in a reasonable return on investment as possible. And investors in commercial buildings are beginning to recognize that energy meets those criteria.

As a result, says Michael Steele, COO of Equity Office Properties, the nation’s largest office real estate investment trust (REIT) with 99.1 million square feet of office space, Wall Street is getting interested in how real estate is managing energy use. In the last couple of years, he says, investors have begun scrutinizing REIT portfolios for buildings that can show energy cost savings.

“There are two things that Wall Street looks at: revenues and expenses,” Steele says. “On the expense side, energy is our number one expense, when you exclude property taxes, and may take up to 25 percent of operating costs. So it is a benchmark that Wall Street looks at closely.”

Energy use is important to shareholders because it is an indication of their return on investment. Better energy efficiency means operating expenses are kept down, and the building is making more money — and so are shareholders.

Arden Realty has 18.7 million square feet of property, mostly in southern California. Its first vice president of asset management, Robert C. Accomando, says, “Wall Street looks at us like any other business; we are expected to keep our costs down, and a major portion of our costs is operating costs.” This makes sense, Accomando says, because market rents are relatively static, fixed by the competition in the marketplace. The only thing that is dynamic, he says, is operating expenses.

Deregulation’s Impact

So far the plan seems clear: Cut costs, raise ROI and attract investors. But the real world could confound the formula. Enter electric deregulation.

The impact of deregulation on real estate investments is uncertain in Wall Street’s mind right now, Steele says. A few years ago investors believed, perhaps naively, that deregulation would drive energy costs down by as much as 20 percent. No one in the real estate community or Wall Street believes this now, he says. Energy use has come to be seen as a much more important ingredient in a successful property.

A strategic tool of an energy efficient operation is the ability to get accurate load profiling and to use that to shift loads to eliminate costly demand spikes, says Doug Walker, president of Harwood Management Services, a division of Harwood International that has buildings in California and Texas, which is on the threshold of deregulating its electric power industry.

“Load profiling will be a real benefit when deregulation comes,” he says. “Because if you can show a utility how well you can level your load and how much you can control it, you can generate better pricing,” lowering operating costs.

And don’t think investors aren’t watching. Last month, Accomando says, he received 30 to 40 calls from investors asking him how Arden was dealing with the energy problems in California, as that state struggles to cope with its version of deregulation. “Energy is really important to them,” he says.

Beyond deregulation, also uncertain are the perspectives of lenders. For the most part, they ignore it, and question how it can be recognized as anything other than a non-permanent feature of a facility such as good indoor air quality.

“I don’t know how to assess it,” says Jonathan L. McKetney, director of the Mortgage Bankers Association of America. If it’s not hardware, he says, there doesn’t seem to be any provable value.

In addition, McKetney says, lenders are nervous about over leveraging a property based on something that might be expensive or difficult to maintain. At the very least, he says, lenders would have to see three or four years of electric bills.

Walker says he recognizes that proving value to the bank is an uphill battle, but building owners can be successful if they are persistent.

Using a common appraisal method, building owners can show the value of energy efficiency. Energy efficiency saves money, increasing the net operating income. Since building value as determined by the income capitalization method is the product of the cap rate and NOI, building values can increase significantly.

An increase in value due to cuts in energy costs was something that was at first difficult for the bank to buy when Harwood refinanced a property.

When the bank began to run its analysis for refinancing of a Harwood building using various data, the bank initially kicked out the operating costs for being too low compared to other buildings in the area. When Walker convinced the bank representatives that the operating costs were indeed accurate, the bank redid its analysis. The result was a couple hundred thousand dollars more added to the loan.

Still many bankers are doubtful about any broad recognition of this. “You would need to show some durability, some kind of track record,” McKetney says. The lender needs to know that the added value — the energy cost savings — is part of the building, stays with the building, and is not part of an operational strategy.

Offering Comparisons

Helping them understand that energy efficiency is part of the building is where Energy Star Buildings can help, says Robert Sauchelli, program manager for Energy Star Buildings, a U.S. Environmental Protection Agency voluntary program that allows building owners to compare their building’s energy performance to others in the United States.

Sauchelli agrees that mortgage brokers and appraisers don’t really understand energy efficiency. That is in part because they have no basis for comparison. With the Energy Star Buildings program, building owners can enter in some basic data including the size, location and energy costs, and get an energy efficiency score that ranges from one to 100 — 100 being the best.

With the score, building owners then can compare their buildings’ energy performance vis-à-vis other buildings in their area or across the country. The program adjusts for geography and other variables. The database contains more than 4,000 buildings and is growing.

This kind of database can provide the comparables that lenders and appraisers are looking for, Sauchelli says.

“An inefficient building is a risk factor, just like a leaky roof, that banks have to pay attention to when they’re doing their due diligence,” he says. “You can compare one building with high energy costs and one with low energy costs just like you can one building with a questionable roof and one with a solid roof.”

Bringing appraisers and lenders together to help them understand the asset value of energy efficiency is the goal of a program being developed by the San Francisco-based Institute for Market Transformation. Appraisers who participated in pilot projects in San Francisco and New York were very positive about the assessment value of energy efficiency. These pilot programs, however, just scratched the surface of a large, conservative industry, says Mark Chao, senior program director.

Owners and Tenants Benefit

In a competitive marketplace, energy efficiency can provide an advantage to owners of leased space as well. When owners increase their net operating income through energy cost reductions, they have essentially three options on how to “spend” the savings. Owners can keep it, increasing margins. If they are using full-service leases, they can lower the rents to improve occupancy. If the energy costs are passed through, an owner can use the lower utility costs to attract or retain tenants.

“It’s still location, location, location,” Accomando says. “But if you have the location and your neighbor has the location, and if he’s not as energy efficient as you, his base-year calculation for escalation rates is going to be different. Tenants notice that right away. All other things being equal, you have the edge.”

Arden has made a habit of energy efficiency and uses the Energy Star Building label to promote it. Of the 86 Energy Star labeled buildings in California, Arden owns 80 of them. Given California’s current energy costs, Accomando says, “their tenants are liking us a lot.”

Energy efficiency also is helping to keep Harwood’s buildings fully occupied, Walker says. “Tenants want to renew,” he says. “That saves us time and money since we don’t have to market the buildings.”

But energy efficiency means more than utility costs to some tenants, Steele says. Within Equity Office Properties and within the marketplace in general there is an increasing pool of high-end tenants sensitive to environmental issues and saving natural resources. Having an energy efficient building gives the owner an opportunity to win over that customer — especially when that is the difference between two otherwise similar buildings, Steele says.

And for Accomando, the environmental benefits of energy efficiency have marketing potential. He can cite chapter, book and verse on how energy reductions relate to acres of trees, number of cars, and tons of sulfur dioxide and nitric oxides, and some tenants and potential tenants are responsive to that.

What seems like a simple equation of energy saved equals cash in the pocket can really be much more. Is that something that even an Energy Star Building owner can go to the bank on tomorrow? Not likely, but the commercial marketplace is beginning to understand the extended economic impact of energy retrofits. Like anything good, this will take time.


By David Kozlowski, senior editor, Building Operating Management magazine. This article © 2001 Trade Press Publishing Corporation, all rights reserved.

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