Building Energy Use Disclosure Impacts Deals

As more and more prospective purchasers of commercial real estate incorporate building energy use into their property due diligence, it is becoming evident that this building characteristic is fast emerging as a legitimate consideration in the acquisition process. After numerous discussions with investors and prospective purchasers, five key reasons appear to be driving this trend.

(1) Less energy efficient buildings are likely to be less competitive in the marketplace and may result in lower rent growth (as compared to what is currently being experienced) or even a rent discount. Below-market rent growth can impact a property's pro forma and valuation, and ultimately may impact the financing.
(2) With the growth in popularity of "green buildings," buildings with relatively poor energy performance will likely be viewed as less valuable. Without investment to make the building more energy efficient, the building can soon become outdated, with the consequent adverse impact on the investment.
(3) Buildings with relatively poor energy performance may experience a reduced prospective tenant pool as tenants under their triple-net leases today are more concerned about energy costs that continue to escalate.
(4) More and more communities are including energy efficiency requirements in their building codes for new building construction and major renovations to existing buildings. More often than not, these requirements will result in higher capital costs. For unwary prospective purchasers intending to eventually make major improvements, this can cause an unexpected increase in capital expenditure.
(5) As more and more building owners choose for a variety of reasons (such as shareholder pressure, tenant pressure, public relations, etc.) to become "carbon neutral," this is becoming a consideration when property is acquired. For example, making a building "carbon neutral" will often necessitate the purchase of carbon offsets (after the building is made as energy efficient as reasonably possible) to offset residual building energy consumption. Such offsets cost money and need to be factored into the deal.

There can be little doubt that a building's energy use can impact a real estate transaction and that energy efficient buildings are fast becoming "politically correct." As such, the time to start investigating your building energy use is now.

ASTM Forms Building Energy Performance Disclosure Task Group

The ASTM E50 Executive Committee approved the creation of a new Task Group to develop a standard on Energy Performance Disclosure for Buildings Involved in Real Estate Transactions. The European Union’s Energy Performance of Buildings Directive, legislation in California and the District of Columbia, and recently proposed legislation at the federal level (Waxman-Markey Bill) and in a number of other states and cities for building energy use disclosure prompted the request to ASTM for development of the standard. The goal is to standardize the way that building energy use numbers are determined and reported in commercial real estate transactions, with particular focus on how they have been normalized, i.e., over what period of time, the heating and cooling degree days, occupancy, etc. In this way, prospective purchasers of properties will understand the numbers when they are disclosed, either voluntarily or in response to regulatory requirements.

Today, a building’s energy consumption is playing an increasingly important role in real estate transactions. It can impact the transaction because less energy efficient buildings are becoming less competitive in the marketplace and can reduce the prospective tenant pool. To attract tenants may even necessitate reducing rents and impact planned rent growth built into the pro forma provided to the lender. Also, the growing number of cities and municipalities now adopting energy efficiency requirements in their building codes can impact the capital needs of any building involved in a real estate transaction in these locations, and therefore its valuation.

It is anticipated that the standard would be used principally by professionals conducting due diligence for prospective property purchasers and lessees, e.g., an addendum to a property condition assessment. The standard is expected to take into consideration factors such as property and building characteristics, electrical and heating fuel consumption, benchmarking information against peer buildings, the building’s carbon footprint and energy audit history, whether the building has any “green” certification, rating or labeling, applicable energy efficiency codes, and available economic incentives, credits and grants.

The Task Group chair, Anthony Buonicore, P.E., CEO of the Buonicore Group and publisher of the daily newsletter, Building Energy Performance News, is now seeking individuals interested in participating on the Task Group. He can be reached at 800-238-1841 or ajb@bepinfo.com.

Significant Debate Over NAIOP Building Energy Savings Study

In December 2008, ConSol (an energy modeling firm), working under contract to NAIOP (the Commercial Real Estate Development Association), released it study, Achieving 30% and 50% over ASHRAE 90.1-2004 in a Low-Rise Office Building. Much controversy followed over the conclusions reached in this study. Rather than take a position, permit me to present the facts as I see them and you can draw your own conclusion.

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ConSol responded to an RFP from NAIOP asking for an analysis of a recently constructed low-rise office building, and the practicality of building it 30% and 50% above the ASHRAE 90.1-2004 Energy Standard in three locations: Newport Beach, CA, Baltimore, MD and Chicago, IL. For its analysis, ConSol used EnergyPlus v2.2, the U.S. Department of Energy's building energy simulation program for modeling building heating, cooling, lighting, ventilation and other energy uses. The methodology was based on a modified version of ASHRAE 90.1-2004 Appendix G. Modifications included the exception of non-regulated loads, baseline glazing and energy savings, not energy cost, as the metric. It was deemed appropriate to focus solely on regulated loads as only they could be affected by jurisdictional energy codes. Baseline glazing was set at 50% to most accurately maintain architectural similarity to the actual building as constructed. The baseline building was a recently completed Class A, low-rise, office building with 95,000 square feet in 4 stories (each of average height at 14 feet) having an HVAC system that consisted of VAV with terminal reheat and a gas fired boiler.

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While there are 7 climate zones in the U.S., the simulation building locations included in ConSol's scope of work were in only three climate zones: 3, 4 and 5. ASHRAE's 90.1 standard has separate requirements (for insulation, glazing, HVAC and lighting) associated with each climate zone, and these were used in the ConSol simulation.

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The energy efficiency measures above ASHRAE 90.1 that ConSol assessed included: better roof and wall insulation, varying levels of exterior window glazing, reduced air infiltration (via the installation of an air barrier), reduced lighting power densities and higher efficiency HVAC equipment. Cost information was obtained using the RSMeans Green Building Cost Estimating Database, published data and personal correspondence with equipment manufacturers. State average utility (electricity and natural gas) prices were used as compiled by the Energy Information Administration (retrieved in December 2008). The payback period in years was determined by simply dividing the marginal cost of the energy conservation measures above ASHRAE 90.1 by the annual utility savings. Peak kilowatt savings were not included in the analysis.

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ConSol determined that the Newport Beach model building achieved 15.8% energy savings over ASHRAE 90.1 at a marginal cost of $169,900 corresponding to a 12.2 year payback. The Baltimore model building achieved 21.5% energy savings at a marginal cost of $165,150 corresponding to an 11 year payback, and the Chicago model building, a 23% energy savings at a marginal cost of $188,500 corresponding to an 8.8 year payback. The conclusion was that achieving 30% - 50% energy savings in a newly-constructed, low-rise, Class A, office building over ASHRAE 90.1-2004 would be difficult to achieve.

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A number of issues have been raised to question the validity of this study and its conclusions. These include:

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(1) Actual utility rate schedules were not used in the analysis and pricing associated with peak demand periods was therefore not factored in (and it should have been since buildings normally operate during periods of peak energy demand). This would have significantly increased the energy savings.

(2) Utility rate increases were not factored into the analysis. This would have further increased the energy savings.

(3) Financial incentives and rebates were not factored into the analysis, which would have reduced marginal costs for the energy saving measures above ASHRAE 90.1-2004.

(4) The same building model was used for all three climate zones, rather than fitting the design to the location. For example, it would have been appropriate to use operable windows for ventilation in the Newport Beach model. Also, window design alternatives that could take advantage of natural light for daylight and sunlight for heating were not considered.

(5) The study only considered a limited number of energy saving measures (above ASHRAE 90.1-2004). For example, use of an energy management control system (with occupancy sensors to turn off lights, etc.) was not considered, and it would be today. Rather than merely "bolting-on" energy efficiency measures, today such measures would likely be considered as part of an integrated building design. (ConSol did indicate that certain energy efficiency measures, such as evaporative cooling technologies and light emitting diode (LED) lighting systems, were not included in the study due to lack of modeling capability, insufficient data or that they were outside the project scope.)

(6) The study failed to consider, even conceptually, other factors that may be associated with energy efficient buildings, including the possibility of these buildings commanding higher rents and experiencing higher occupancy. These dollars could also be used to offset the marginal costs for energy saving measures above ASHRAE 90.1-2004.

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Clearly, a strong case can be made that the NAIOP/ConSol study has a number of significant limitations and should not be generalized. What do you think?

National Building Energy Performance Disclosure?

Recent action in the House of Representatives made some significant strides in advancing proposals for energy efficiency policy. Representatives Henry Waxman (D-CA) and Ed Markey (D-MA) released a their bill, called the American Clean Energy and Security Act, containing climate change legislation and a variety of energy efficiency provisions, but most notably for the commercial real estate industry:

(1) A new Retrofit for Energy and Environmental Performance (REEP) program to promote comprehensive efficiency retrofits to commercial buildings (and also to homes), reducing energy consumption by an average of 20% or more.

(2) A provision directing that building codes be strengthened to reduce energy use in new buildings by 30% starting in 2010 and 50% starting in 2016.

(3) A provision establishing a building labeling program so that owners and prospective purchasers and tenants can compare energy use of a particular building to similar buildings in their local area.

With building energy performance disclosure already underway in California (required under AB 1103), and Ohio, Minnesota, Denver and New York City considering similar measures, the "train clearly has left the station." You have to be blind not to see the handwriting on the wall! There can be no question now that energy efficient buildings will have a competitive advantage in the commercial real estate market.

Four T's for Quick Energy Savings in Existing Buildings

In my experience with existing buildings, if you follow the four T’s for saving energy: Tune it up, Turn it down, Turn it off and Track it, you should be able to reduce energy consumption by at least 10-15% without significant cost.

Tune it up would include optimizing your ventilation rates (you want to condition the least amount of outside air necessary to maintain proper air quality inside your building) and your conditioned air distribution system, calibrating your thermostats and sensors (because inaccuracies can cost energy), and performing periodic maintenance of all building systems including regular boiler tune-ups and filter changes, cleaning heating and condenser coils, and window and light fixtures.

Turn it down would include night setbacks to ensure lighting and HVAC shutdown during unoccupied periods, and reducing heating and cooling temperature controls (for example heating to 68-70 degrees F, and cooling to 74-76 degrees F).

Turn it off would include shutting down office equipment when not in use (e.g., computers, printers, monitors, coffee makers should all be turned off overnight and on weekends). Occupancy sensors, time clocks and automatic controls can easily accomplish this.

And finally, Track it would involve monitoring and recording daily energy use by category, comparing it to regional or national energy use benchmarks for similar buildings, and finally, making sure that an energy conservation ethic is maintained over time.

If you follow these simple four T's, you will get the greatest bang for your buck. All of these steps can be done relatively quickly and have an excellent ROI.

Making an Office Building Carbon Neutral

The question of making a building carbon neutral is coming up more and more frequently today, particularly since CB Richard Ellis committed to be carbon neutral by 2010. CBRE joins HSBC, Barclays Bank, the World Bank, salesforce.com, Nike and many other well known names that have made a committment to having carbon neutral facilities.

But what does being carbon neutral for a building really mean? Well, the precise answer is “it depends on who you ask.” Simply, a building that is carbon neutral has no “net” carbon dioxide (CO2) emissions to the atmosphere. (N. B. While it is common to focus on CO2 emissions since they are the major component of greenhouse gas emissions, other greenhouse gas emissions (such as methane and nitrous oxide) are also included, but typically are wrapped into the CO2 number by referring to CO2 or CO2 equivalent emissions.)

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Having no net CO2 emissions to the atmosphere does not necessarily mean that the building itself does not emit any CO2 to the atmosphere. In fact, a building can release CO2 into the atmosphere and still be carbon neutral, but the building’s emissions must be balanced (or offset) by a CO2 reduction elsewhere on the planet. How are these offsets generated? Well, offsets are typically generated by carbon reduction projects financed by industries governed under cap-and-trade limits or by entrepreneurial carbon offset providers. Offset projects might include for example, installation of renewable energy facilities – particularly solar and wind, the collection of methane (a powerful greenhouse gas) generated by farm animals or landfills, or even reforestation such as currently taking place in Central America, Brazil, Indonesia and parts of Africa.

The first step for a building to become carbon neutral is to identify the building’s carbon footprint, or where CO2 is being emitted as a result of building operations, e.g., from the electricity consumed by building operations (assuming of course the local utility uses fossil fuels to generate electricity), or from fossil fuel combustion at the building itself, for example, burning fuel oil or natural gas for space heating.

Unfortunately, identifying a building’s carbon footprint is not as easy as it sounds. It is complicated by the fact that a building’s carbon emissions can be direct or indirect. Direct carbon emissions (such as electricity and fossil fuel consumption) are directly associated with building operations. Indirect carbon emissions, however, are not, and may, for example, take into consideration carbon emissions resulting from employee or tenant automobile travel to and from work, and even employee business travel. So the first step has to be to decide which carbon sources (direct and/or indirect) are to be included in determining the building’s carbon footprint.

It should be evident that even before determining a building’s carbon footprint, it certainly makes sense to get all building operations as energy efficient as possible to result in the smallest carbon footprint. This will save money because to become carbon neutral, it is highly likely that offsets will have to be purchased to offset the building's carbon footprint, and these offsets could in the U.S. at today’s pricing cost anywhere from $8-17 per metric ton of CO2 offset. To provide perspective, if you have just a single coffee pot in your office and it operates all day for a year, the electricity it consumes will be equivalent to almost half a metric ton of CO2 that will need to be offset!

So it should be evident that making a building carbon neutral may not be as simple as it sounds, and will most likely cost money (to improve building energy efficiency and purchase offsets). But more and more companies today are committing to be carbon neutral and more and more tenants are indicating a preference to move into carbon neutral space. There is no question, this is the direction we are heading and is something all of us in the commercial real estate industry will soon be facing!

"Green" Leases Growing

As we all know, during the last 30-plus years, there has been a steady shift in the marketplace from the all-inclusive gross lease to the net lease. Gross leases, although they commonly contained rent escalation clauses, for example, to cover inflation, are not very protective when building operating costs, such as energy costs or property taxes, increase faster than the inflation rate. The advantage of the net lease is that it effectively transfers all risks for building operating costs to the tenants. So it is easy to understand why the majority of the leases today are net leases.

The downside of the net lease, however, is that the landlord gets none of the benefits from reducing operating costs, since this has no impact on the building’s NOI, and as we all know, it is the NOI that impacts the building’s value. Net leases also create an unnecessary hurdle for green buildings, particularly with respect to investment for energy savings projects.

The complicating issue is who pays for an energy savings project and who benefits. In the ideal case, he who pays should benefit. Under the triple net lease, the tenant pays rent plus a pro-rated share of taxes, utilities, maintenance and insurance. Since electricity cost is a pass-through directly to tenants, there’s little financial incentive for building owners to invest in technologies to reduce electricity costs. In fact, until tenants complain about high energy costs and threaten to move to more energy efficient space, building owners do not have much incentive to act. This makes little sense in today’s world.

Also interesting today is that there is little incentive for tenants to implement energy conservation measures. In most existing commercial buildings, a single meter measures the power fed to the entire building and the building pays for it at a bulk rate. The electricity cost is then included in the monthly maintenance or common charges, in the same proportion that other costs are allocated, typically on the basis of a tenant's square footage. Hence, tenants don’t pay for the electricity they use individually. And it is not unusual to find that some tenants can be subsidizing other tenants who are wasting electricity. This way of doing business provides no great incentive for the tenant to reduce energy consumption. Clearly, this also does not make sense.

The fundamental problem is getting the benefits of an energy savings investment into the hands of those who paid for it, or the benefits of energy conservation measures into the hands of those who implemented them. This is where the “green” lease comes into play. In a “green” lease, both the tenants and landlord can benefit.

While green leases are relatively new on the landscape, they generally are a form of modified gross lease. Yes, so it entails going back to gross leases. The “green lease” or modified gross lease, with the appropriate language, transfers the fiscal responsibility for controlling operating costs back to the landlords, who are far more qualified to control operating costs than the tenants. The leases allow the landlord to reasonably amortize the cost of energy savings projects that will reduce operating costs and treat that amortization as an operating cost – as long as the amortization does not exceed the savings. To account for after-hours use or prevent excess energy consumption by any tenant, the lease provides for the sub-metering of each tenant’s energy use. Green leases may also address a building-wide recycling program and sustainable product purchase requirements.

Because of the many complexities of preparing a “green lease,” last year BOMA released its Green Lease Guide, for writing "green language" into a commercial real estate lease. Terms of the lease incentivize tenants to reduce energy consumption, water use, produce less waste, recycle as much as possible, and choose environmentally-friendly products, furnishings and office equipment. The language included in the document gives owners the right as standard procedure to pass thru to tenants any capital costs that result in lower total operating costs. The lease guide can be purchased on BOMA’s web site, at http://shop.boma.org.