RATING and RAT-TING

Building tenure, that is how a building is owned and operated greatly affects the risk that a building owner investing in an energy efficiency retrofit will not be able to recoup his capital expenditure costs.

RISK AND ENERGY EFFICIENCY RETROFIT

Building tenure can be described in terms of the following the supply chain (between firms) or value chain (within firm) linkages:
a) Developer/owner/occupant – where a company develops a building it plans to own and occupy.

b) Owner/occupant – where a company purchases a building and occupies it

c) Landlord-tenant – where the building owner purchases the building and leases it out to tenants.

d) Landlord-WorkplaceAsAServices(WAAS)-tenant

CHANGE IN USE RISK

One source of risk for energy efficiency retrofit which varies with the different forms of tenure comes from “change in use” and associated change in energy demand.  Under developer/owner/occupant tenure any change in the use of the building over of the long period of building tenure is limited in scope to the change in activities of the one company.  This risk is similar in owner/occupant tenure where the building has been purchased from a developer or previous owner and held for a long period of time.  Under landlord-tenant tenure the risk is greater.  With each change of tenant comes the greater risk of a change in energy demand. Investments with a discounted payback period greater than the length of a tenant’s lease carry the risk of a mismatch between the energy efficiency investment and a future tenant’s energy requirements.

Risk aversion has contributed to the steady increase[1] in the number of large “generic” office buildings held in landlord-tenant tenure under a triple net lease[2]. To maximize the expected returns the developer designs for the maximum number of potential owners. In turn the owner wants a building which is in high demand and appeals to the maximum number of potential tenants.  The result has been the increasing number of “generic” buildings designed in the international style:  high energy use, sealed, fully air-conditioned, high-rise with central service core, identical facades, and leased under a triple net lease – one style fits all.  This type of building appeals to the widest range of tenants and in doing so reduces the risk involved in leasing but increases the risk involved in an energy efficiency retrofit which requires a more nuanced fit between building and occupant use.

THE RISK OF TECHNOLOGICAL CHANGE

Another source of risk for the investor in energy efficiency retrofit is that of technological change. Any retrofit involving energy efficiency technology must account for the risk that the technology will become obsolete or inappropriate before its payback period is complete. The length of that payback period is affected by the type of building tenure. The developer/owner/occupant has the whole lifecycle of the buildingto consider. While he has a long period of time in which to recoup his costs due to lower energy costs he has to still consider payback periods which will be shorter than the technological obsolescence of the energy efficiency retrofit.

GREEN BRANDING RISK

Another significant source of risk is the changing usefulness of green branding: how much an investor is prepared to pay for being seen to be “green.” This form of green branding is an intangible but real way in which a building occupant can add value to his corporate brand and be prepared to pay more for it. However green branding also carries its risks. Firstly there is the risk that appearance of technological obsolescence will change.  An energy efficient technology hard-wired into a building may still function, but if it so much as appears to be out-moded it will bestows less value on the brand of the building’s occupants.  In addition there is the risk of that a change of tenant may mean a change in the usefulness of green branding.  For example an investment in an energy efficiency retrofit may be able to command extra rent if the space is leased to a head office of Greenpeace but have the opposite effect if the next tenant is Maserati.   There is also the risk that green branding may be self limiting. As more of the worlds building stock become green, these buildings will, by virtue of their numbers, move out of the top percentiles.  In doing so “green” buildings will, include not only Class A buildings but also Class B or even C buildings.  This would erode the extra rent a building could enjoy by virtue of its exclusivity and significantly shorten the payback period for energy efficiency retrofit. At first this appears to be a good problem to have: green branding will have become self limiting only when a significant number of buildings can be seen to be green.  However if green branding is only a relative measure then the point will be reached where it is not a cost effective investment for the remaining majority of building stock.  This additional source of risk raises the investment threshold is still higher.

THE ALLOCATION OF RISK BETWEEN PARTIES ACROSS THE BUILDING LIFECYCLE

Building tenure also affects the allocation of risk.  The developer/owner/occupant enjoys a long period of time in which it can both accept the risk and reap the reward of the discounted value of the lower energy costs and green branding.  Under owner/occupant tenure there is similarly a long period of time with the one party accepting the risk and receiving the return.  However under landlord-tenant tenure with a triple net lease, the owner pays for the energy efficiency retrofit but the tenant pays the energy bills. Risk is “split[3]” from return and cost from beneficiary.

METHODS OF ALIGNING RISK WITH REWARD

The innovative Model Green Lease[4] addresses the split between and reward by shifting all risks except that of excessive energy use, back to the landlord.  The Model Green Lease is essentially a gross lease[5] modified to contain escalation clauses and expense stops to reduce the moral hazard of excessive energy use by the tenant.  Such a lease must stipulate the collection of specific energy consumption information. This information is best collected at source, in real-time and correlated with building lifecycle information system reports.

Another way of reducing risk is to provide specific data about energy usage and share it between parties across the building lifecycle.  Building information systems, based on AEC industry wide graphic alpha-numeric information standards[6],  provide the data required to populate the sophisticated options based Whole-life costing Model.[7] Operating in real time as “smart meters,” these systems can also provide energy usage data which enables behavior modification by a greater range of building users.  And these same systems also can signal to both parties across the landlord-tenant divide providing historic energy use data to landlord, and current and prospective tenants, enabling these risks to, in theory, be fully ameliorated in the terms of a perfect leasing contract.

Recent policy has mandated information transparency to improve energy efficiency. In the UK the EU directive on the Energy Performance of Buildings[8] mandated the production of a simple energy certificate at the time the building is sold or leased. Much more recently, on June 30th 2009 in the US the Californian state government passed Assembly Bill 1103[9] which required that by January 1st 2010, now by 2011, building owners upload information about building type and performance in accordance with the US Environmental Protection Agencies ENERGY STAR[10] protocol and disclose this information to existing and potential buyers, lessees and lenders.

energySPACE furthers information transparency between parties across the building lifecycle. Rather than providing formal commentary this website is a space for informality. It provides a forum for frank exchange of the efficacy of green retrofit with the aim of further reducing the risk and so encouraging a decision to carry out an energy efficiency retrofit.

Ann Godfrey, 2010 @All rights reserved.


[1] Invologie 2004 “Who Plays and Who Decides: Chapter 5 The Office Submarket” Report was completed for The U.S, Department of Energy, Office of Building Technology, State and Community Programs under contract number DE-AF26-02NT20528.

[2] Triple Net Lease A Triple Net Lease (NNN) – A lease under which the building tenant pays, in addition to the rent, utilities, insurance, maintenance, real estate taxes, and common area maintenance (CAM).

[3] This has been referred to as the “split incentives” for energy efficiency retrofit in publications including notably:

Mills, Evan: May 2004 “Amplifying Real Estate Value through Energy and Water Management” in Proceedings of the 2004 ACEEE Summer Study on Energy Efficiency in Buildings, and

The Pew Center for Global Climate Change Brief,  November 2006: “Building Solutions to Climate Change”

[4] “Model Green Lease” Prepared by a US consortium of the Corporate Design and Management Institute. Released on July 13th 2009. Its stated purpose is to “encourage landlords to compete for tenants by designing, building and managing sustainable buildings without sacrificing comfort or service while maximizing the landlord’s return on investment.”

[5] Gross Lease – The Landlord pays for building operating expenses: building insurance, building maintenance, utilities, and real estate tax charges.

[6] Systems International Alliance for Interoperability http://www.iai-na.org

National CAD Standards (NCS) and BACnet: An American national standard, a European pre-standard, and an ISO global standard Building Automation and Control Networks under development by ASHRAE.

[7] Ellingham, I., and Fawcett, W., “New generation Whole-life Costing: Property and Construction Decision-making under Uncertainty. Taylor & Francis, 2006

[8] 2002/91/EC EU directive on the Energy Performance of Buildings

[9] Assembly Bill No. 1103, State if California. .Approved by the Governor of California June 30th, 2009.

[10] ENERGY STAR introduced in 1992 by the US Environmental Protection Agency (EPA) awards the Energy Star rating to the 25% most efficient residential, commercial and industrial buildings

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