Power Surge: Fueling Your Bottom Line with Energy Efficiencies
Jewell, Mark T., Journal of Property Management
Nearly 90 percent of the estimated five million commercial buildings in the United States are more than 15 years old. Consequently, during construction of these buildings, builders could not take advantage of the energy-efficient technologies now standard.
Today, builders, owners and property managers are paying close attention to the kind of value they can obtain by implementing energy-efficient strategies. They're considering everything from water conservation and wind energy to electrical product upgrades and solar panels. The Hines organization is one real estate firm committed to conserving energy in its owned and managed office buildings. Recently, it was recognized by Energy Star [R] for outstanding energy conservation in nine of its Houston-based office buildings and 33 properties in 18 other cities.
"When the Hines organization committed itself to energy conservation, we immediately set out to be a leader," said Jeffrey C. Hines, president of Hines.
Companies like Hines are recognizing that specific strategies must be developed and implemented to combat the growing demand for energy. According to the Energy Information Agency's Annual Outlook for 2002, higher demand for energy and increased production will characterize the United States' future.
The report predicts continued growth in electricity use through 2020. Growth rates are expected to reach 1.7 percent per year in the residential sector. In the commercial and industrial sectors, annual growth rates should reach 2.3 percent and 1.4 percent, respectively, between 2000 and 2020.
However, electricity isn't the only energy resource at issue. For many owners and managers of residential properties, water conservation has become a top priority. In order to encourage residents to use less water, an increasing number of owners are implementing water billing programs.
Robert Sherman, president of National Water and Power, noted that water usage programs can result in substantial savings. He estimated water consumption is reduced by 5 percent when using the Resident Utility Billing System (RUBS) method, while the sub-metering of individual residential units results in water usage reduction of between 20 and 30 percent.
"Water costs have nearly doubled in the last ten years, Sherman explained. "As the population increases, we need to conserve the water we have and place less pressure on our current water facilities."
Property managers and owners have begun to track increases in water costs and surges of use. "They're checking for leaks under the pool or around the building as they become aware that these are costs that can be reduced or controlled," Sherman said.
Given this emphasis on energy conservation, apartment renters are becoming more accepting of resident-based water billing systems. Sherman noted that "more than 2.5 million apartment units are involved in passing costs on to the resident separately from rent. Billing formulas based on square footage or unit occupancy are more equitable to the resident. Sub-metering allows renters to pay only for their portion of water usage.
In addition to water, energy experts are also pointing to alternative resources such as solar and wind energy. Thanks to rising natural gas prices, there is increasing demand for wind energy. The cost of energy from larger electrical output wind turbines used in utility-interconnected or wind farm applications has dropped from more than $1 per kilowatt-hour (kWh) in 1978 to less than $0.05 per kWh in 1998. Prices are projected to plummet to $0.025 per kWh when new large wind plants come online this year. In the past five years, the hardware costs of these wind turbines have dropped below $800 per installed kilowatt, under pricing the capital costs of almost every other type of power plant.
Examining Energy Efficiencies
Whatever the source of energy, one fact remains. Today's owners are expecting property managers to look carefully at the kinds of efficiencies and cost savings that can be incurred by implementing energy programs.
Imagine you're asked to evaluate two capital projects for your property management client. Each project requires a one-time investment of $100,000. Your engineer explains that an improvement to Building A would save twice as much energy as an improvement to Building B. He adds that the projects' simple payback periods (SPP) are 1.5 years and 3 years, respectively. Your client has directed you to find opportunities to reduce operating expenses but only has enough capital to fund one of these two projects. Should you recommend an upgrade to Building A, Building B or neither? If you think this is a trick question, you're absolutely right.
Owners often direct their managers not to spend time (much less capital) on projects with simple payback periods over 2 years. Your client may be much more interested in improving Building A because that project has a SPP of less than 2 years. Unfortunately, recommending that project could be a big mistake. When it comes to income-producing property, projected energy savings and SPPs don't tell the whole story. You need to know who should pay for, and who would benefit from, any proposed capital project.
Returning to our example, let's assume that Building A's leases have been in place for a while, and that operating expenses per square foot both before and after the upgrade are greater than the expense stops in most of the leases. In other words, most tenants will continue to pay escalations even after the energy expenses are reduced. On the other hand, Building B contains a combination of gross leases (which require the landlord to pay all energy expenses) and fixed-base leases that were signed fairly recently (so operating expenses have not yet exceeded the expense stops).
Who would benefit from the energy-saving improvements in each building? Building A's leases would allocate most of the savings to the tenants, while Building B's would allow the owner to capture most of the savings. If you let your client fund the upgrade in Building A, he would receive little or no return on his investment. Investing $100,000 in Building B, however, would lower the owner's share of operating expenses, boost the property's net operating income, and support a higher asset value (given the income approach to appraisal and a stable capitalization rate).
Better Math, Better Decisions
You can't determine whether the owner, the tenant or both would benefit from a contemplated energy upgrade unless you know the capital to be invested in each tenant and common-area space; the savings projected for each of those spaces; how the leases would allocate those projected savings and which leases allow the landlord to recover capital expenditures that reduce operating costs for the property.
At the end of the day, the owner's return on capital invested will consist of any savings the leases allocate to him by default or by amendment; capital amounts he can recover from his tenants; and rebates he collects for doing the upgrade.
This math can be daunting, especially if a building has a significant number of leases, or if energy and other operating expenses were combined into a single base year or expense stop. Fluctuations in various operating expenses over time, renewal probabilities and many other factors can further complicate the analysis. Nonetheless, it has to be done. Without good numbers, owners and managers are left making decisions based on myths, such as, "We should only fund projects that have SPPs of 2 years or less," or "Upgrades to tenant spaces in mid-lease would only benefit the tenants."
Last year, more than $1.5 billion in rebates and other financial incentives were offered by utilities, government agencies and other sources to motivate energy-efficiency improvements to buildings. That figure was twice the amount offered in the previous year.
Grubb and Ellis Management Services (GEMS) is one firm which takes advantage of such rebates. Speaking at IREM's 19th Annual Asset Management Symposium in San Diego last March, Jim D'Orazio, vice president and national director of engineering for GEMS, explained his firm pursues rebates and other incentives. "All of our recent capital expenditures have been screened for retroactive rebates," he said. "We make sure the paperwork and other requirements are handled properly so we collect our rebate dollars."
GEMS also takes steps to make sure it funds the best upgrades, those that will net the most value for its owners. "We fund a capital project if it exceeds our required rate of return," D'Orazio said, "whether there are rebates to help pay for the upgrade or not. Our decision making goes beyond simple payback period and considers the leases, appraised value and other factors.
There are many opportunities to make your properties more energy efficient. Any rebate dollars you collect can only improve the return on investment, which makes it even easier for the owner to say "Yes!" to a proposed upgrade.
RELATED ARTICLE: Focusing Time and Resources
As management guru Peter Drucker said, "Value is created by the compression of time." To better focus your efforts and come to a faster realization of which opportunities to pursue, try ranking each property using the following criteria:
* Anticipated holding period, Is the owner willing to hold the property at least long enough to do an upgrade and realize the benefits?
* Availability of capital. How much capital is available for the property, and what is the owner's required rate of return?
* Technical potential. Do the type and/or vintage of installed equipment (or a low energy-performance benchmarking score) suggest energy could be saved?
* Utility costs. Is the utility rate high enough to make energy-efficiency improvements cost-effective?
* Lease provisions. Is it likely the owner would receive the economic benefit of energy savings, either with or without recovering money from the tenants?
* Rebates. Are there financial incentives available to help pay for the study and/or installation of the contemplated upgrade(s)?
Mark T. Jewell (215-732-4480, ext. 227, firstname.lastname@example.org) is CEO of RealWinWin, Inc.…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Power Surge: Fueling Your Bottom Line with Energy Efficiencies. Contributors: Jewell, Mark T. - Author. Magazine title: Journal of Property Management. Volume: 67. Issue: 3 Publication date: May 2002. Page number: 54+. © 1999 National Association of Realtors. COPYRIGHT 2002 Gale Group.
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