Tuesday, December 16, 2008

Cutting Energy Expenses is Still Top Priority

I just finished reading the report by the Urban Land Institute and PricewaterhouseCoopers, Emerging Trends in Real Estate 2009 (which may be accessed and downloaded at the PWC web site: http://www.pwc.com/ and enter the title in the search box). The report represents a consensus outlook for the commercial real estate future and reflects the views of more than 700 individuals who completed surveys and/or were interviewed. The consensus of the participants was that the financial and commercial property markets would hit bottom in 2009, and experience slow recovery beginning in 2010. However, what was even more interesting to me was the report's discussion of the "green trend." In the midst of all the problems that currently exist in our industry, the report acknowledges that big tenants are still putting "green" on their priority checklists. They want good PR for occupying environmentally correct space, savings from more energy efficient systems, and improved working environments for greater productivity and to recruit and retain younger, up-and-coming employees. Rising utility bills continue to be a key driver and demand attention. Cutting energy expenses, the report contends, should be a priority in controlling rising operating expenses.
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There is no question that vacancy rates for all property types are increasing. This is already resulting in cut-throat competition for tenants. As such, building owners and managers will need every option available to them to attract tenants. The "green" option should definitely be in the quiver.

Wednesday, December 3, 2008

The Complexities of Carbon Trading

Wouldn't it be great if we had just a single acronym and definition for a tradable carbon offset! But alas that would make the world too simple.

Let's take a look at what we have today in the carbon trading market...

International

The cap-and-trade approach being used in the European Union (EU) Emissions Trading Scheme (ETS) is based upon the Kyoto Protocol and identifies a number of tradable carbon offsets. The underlying commodity being traded are European Union Allowances (EUA) which have been issued to approximately 12,000 energy-intensive installations with a cap on their emissions as covered by the EU ETS Directive. Each EUA grants a party the right to emit one metric ton of CO2. There also are Certified Emission Reduction (CER) units as another underlying tradable commodity. CERs are carbon credits arising from Clean Development Mechanism (CDM) projects. The CDM under the Kyoto Protocol allows parties from industrialized countries (referred to as Annex 1 countries) with a GHG reduction committment to invest in projects that reduce GHG emissions in developing countries as an alternative to more expensive emission reduction in their own countries. One CER is awarded for a reduction in GHG emissions equivalent in impact to one metric ton of CO2. To complicate matters, there are primary and secondary CERs. With primary CERs, the buyer is exposed to project risk. Secondary CERs isolate the buyer from project risk.

The trading market is directed at both EUAs and CERs, but also includes both futures and options contracts. The futures contract gives the holder the right and obligation to buy or sell the underlying instrument at a certain date in the future, at a pre-set price. In the case of an EUA Futures Contract, the underlying unit of trading is the EUA, with one EUA Futures Contract ("lot") representing 1,000 EUAs. In the case of a CER Futures Contract, the underlying unit of trading is the CER. The options contract gives the holder (buyer) the right, but not the obligation, to exercise the option on or before a future date. The other party (seller) has the obligation to honor the specified feature of the contract. The amount the buyer pays the seller for the option is the option premium. The owner of an options contract can exercise (buy or sell) on or prior to the pre-determined settlement/expiration date. Both parties of a futures contract must exercise the contract (buy or sell) on the settlement date. The underlying commodity for options contracts can be either EUAs or CERs.

United States

The underlying commody traded in the U.S., i.e., on the Chicago Climate Exchange(CCX), is the carbon financial instrument (CFI) contract, each of which represents 100 metric tons of CO2 equivalent. CFI contracts are comprised of Exchange Allowances (analogous to EUAs) and Exchange Offsets (analogous to CERs). Exchange Allowances are issued to emitting Members in accordance with their emission baseline and the CCX Emission Reduction Schedule. Emitting Members have made a voluntary, but legally binding committment to meet annual GHG emission reduction targets. Those who reduce below the targets have surplus allowances to sell or bank; those who emit above the targets comply by purchasing CFI contracts. There are also Exchange Offsets generated by qualifying offset projects. Futures and options contracts are also traded. In addition, the Exchange trades Regional Greenhouse Gas Initiative (RGGI) futures contracts. RGGI is made up of ten northeastern states participating under a cap-and-trade scheme that includes auctioning off permits for CO2 emissions

Further complicating the matter is the fact that in the U.S. there is also trading of Renewable Energy Certificates (RECs). RECs represent one megawatt-hour of electricity generated from a renewable source. They are used to comply with state-mandated requirements associated with the amount of a state's total electricity generation that must by a certain date in the future come from renewable energy. Currently, 28 states have such requirements. RECs are related to GHG reduction efforts because they constitute an alternative to fossil-fueled generation. However, there has been confusion between the REC trading and carbon trading markets, although the REC trading market has been designed for a completely different purpose than the carbon trading market. In the REC market, renewable energy itself is the goal. In the carbon market, the only goal is to reduce GHG emissions. While many renewable energy sources, such as wind and solar, will also reduce GHG emissions, that is not the case for all renewable energy sources. For example, wood is a renewable energy source, but using it to generate electricity will also result in GHG emissions. The problem is that projects generating renewable electricity can sell the associated RECs to voluntary or compliance buyers. Frequently, they also have the option of selling their RECs as carbon offsets on the voluntary market. Whether or not RECs would be acceptable as carbon offsets is a complex issue, with a challenging regulatory component.

EUAs, CERs, CFIs, RGGI, RECs...it can be quite confusing, but as the U.S. inevitably moves toward a cap-and-trade world under the new administration, a good understanding of the underlying tradable commodities will be essential. Think of the myriad of questions that an emitting party will likely need to answer. What are my allocated baseline emissions (are they truly baseline, or were there extenuating circumstances)? Where do I need to be (now and in the future)? How will I get there (internal emission reductions and/or purchasing allowances/offsets)? Do I have allowances to bank or sell, and if so, when and where should I? Does it make sense to trade allowances or purchase offsets created by GHG emission reduction projects? Are the offset projects legitimate? If I decide to purchase allowances/offsets, where should I go to purchase them? Should I think about hedging through the purchase of futures and/or options contracts? If so, when should I do it and for how far into the future? And these are just some of the more interesting questions! There is no doubt in my mind that an entire consulting industry will form to assist companies in getting answers to these complex questions. What an opportunity for consultants!

Carbon trading is not as simple as it may seem. As a wise person once said, the devil is always in the details!

Monday, November 10, 2008

Energy Tax Credits for Commercial Real Estate

Building owners, managers and investors can still qualify for credits of as much as 30% on federal taxes for investments in renewable energy technologies including solar, wind and biomass. Adopted as a rider to the $700 billion Emergency Economic Stabilization Act of 2008, the measure extends existing tax incentives for solar energy by eight years and wind energy by one year. Due to the high cost of solar panels, tax credits have become crucial to making solar installations financially feasible. For example, payback times in sunshine states can be reduced from 10 to 15 years to approximately 7 years. The lower cost of wind turbines as compared to solar panels already fuels investments in wind power. But the real incentive for commercial landlords in the tax measure is a deduction for investments in energy-efficient buildings. Investments equivalent to $1.80 per square foot can be deducted for buildings that achieve at least a 50% energy savings goal. This credit for energy-efficient buildings is available through the end of 2013.

If you are not already aware, the U.S. Department of Energy and the National Renewable Energy Laboratory (Commercial Buildings Section) have a focused initiative directed at achieving greater than 30% energy savings in commercial buildings. In fact, they just released two reports containing recommendations on achieving 50% energy savings (over ASHRAE Standard 90.1-2004) in grocery stores (www.nrel.gov/docs/fy08osti/42829.pdf) and medium-sized retail buildings (www.nrel.gov/docs/fy08osti/42828.pdf).

With financial challenges presenting the biggest impediment to achieving significant energy savings in commercial buildings, tax credits and incentives can do much to soften the impact.

Friday, October 24, 2008

Global Recession's Impact on the Green Movement and Sustainability Initiatives

The true test of how strong a foothold the green movement and sustainability initiatives have will become evident in the global recession we are now experiencing. In the commercial real estate industry when things are going well investment capital always seems to be available. However, from past experience in the last two commercial real estate downturns, investment capital in such difficult times always seems hard to find. The prevalent attitude appears to be to preserve what we have as best possible to get through the tough times. As rental growth deteriorated and property valuations dropped, significant investment was often put on hold and cost cutting became the norm.
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Unfortunately, there are already signs that the green movement and sustainability initiatives may temporarily move to a back burner. The U. S. Department of Energy's Zero-Net Energy Commercial Building Initiative (CBI) was part of the Energy Independence and Security Act of 2007. The goal of CBI is to make zero-net energy buildings broadly achievable by 2025 through a combination of energy efficiency and renewable power. Federal funding for the program was authorized at more than $1 billion over the next 10 years. The private-public partnership involved some major players in our industry, including CB Richard Ellis, Hines, ProLogis, Simon Property Group and Tishman Speyer. It also involved some major players in retail, including Best Buy, JCPenney, Macy's, SuperValu, Target, John Deere, Toyota and Whole Foods Market. But alas, in his 2009 budget request, President Bush proposed a 27% cut in funding for DOE's Energy Efficiency and Renewable Energy Office, the agency arm overseeing CBI. Clearly, the impact of the massive, taxpayer-funded bailout recently approved by Congress is becoming evident and will restrict spending.
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Even Europe's leadership in tackling climate change may be weakened by the credit crisis and slumping global economy. Just last week at an EU meeting, Italy, Poland, Latvia and others threatened to veto Europe's carbon plan unless it was softened. They urged the rest of the EU to recognize the economic difficulties being experienced. In fact, today more and more world leaders are discussing the possibility that the world might even fail to agree on new targets for when the Kyoto Protocol runs out in 2012. This would be a disastrous response to progress already made in addressing global warming.
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There is a lot of fear running around and anxiety about commercial real estate fundamentals in a global recession is at an all time high. There is no doubt in my mind that any investment in property improvements will be carefully scrutinized. However, there is one thing I know for sure: investments that can reduce building operating costs will be given priority, so long as the return is reasonable. Reducing energy costs certainly fits this bill!

Friday, September 26, 2008

Which Green Certification System?

Today there are three green building certification systems. The recognized leader, and one we are all familiar with, is the U.S. Green Building Council's signature Leadership in Energy and Environmental Design (LEED) certification, applicable to both new and existing buildings. An alternative to the LEED standard is Green Building Initiative's Green Globes certification. Green Globes' roots go back to Canada in 1996 when the Canadian Standards Association published the Building Research Establishment's Environmental Assessment Method (BREEAM) as a guideline for existing buildings in Canada. It became an online assessment and rating tool for existing buildings under the Green Globes brand in 2000. At about this same time, they expanded their footprint into the development of standards for new building design. Practically, it is clear to me that Green Globes is more of a Web-based assessment tool than a standard. Amazingly, Jones Lang LaSalle acquired the business this past July, presumably because they saw the marketplace begging for a tool that could enable a quick, less expensive assessment of a building's overall performance. Jones Lang LaSalle believed that this would be particularly attractive to owners of large portfolios of existing buildings, such as themselves.
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Finally, there is the National Association of Home Builders' National Green Building Standards. However, these focus principally on single-family residential construction and remodeling and multi-family construction.
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In my opinion, the likelihood that a single certification will overwhelmingly dominate the market is low. Rather, competition among certification systems will accelerate over the next few years. In fact, it is much more likely that each certification system will find its own niche in the market. For example, LEED certification is not cheap and can be prohibitively expensive for small commercial buildings, portfolios of existing commercial buildings and low-price-point residential properties. But working through all this will take time.
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Where does this leave the owner or manager of an existing building or a portfolio of existing buildings, particularly in the tough real estate market we are living in today? In my view, the most important element of establishing a "green" building is reducing energy consumption. This is a winner no matter what the economic climate and the place to start. There are things that can be done that are relatively inexpensive (refer to an earlier blog of mine) and things that require a capital investment. I believe the spiraling cost of energy in all its forms and government tax incentives and credits will continue to support at least moderate capital investment levels with excellent ROIs. Lower energy cost will also mean a greater NOI and therefore, enhance a property's value. No matter what "green" certification you may ultimately choose at some point in the future (probably following market drivers), the investment in reducing energy will never go to waste!
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Would anyone like to share with our community their experience with "green" certification of existing buildings? I am sure we would all be interested.

Tuesday, September 23, 2008

New Initiatives Deal with Energy Reduction in Existing Buildings

The commercial real estate industry spends approximately $24 billion annually on energy and contributes approximately 18% of U.S. carbon dioxide emissions. It is also well known that energy represents the single largest controllable operating expense for buildings, typically a third of variable expenses, and this expense continues to increase! No prudent building owner or manager would argue that a re-evaluation of energy use in their buildings is a high priority. Unfortunately, to-date the principal focus has been on new buildings or buildings undergoing significant renovation, not on existing buildings, of which there are orders of magnitude more. Only the United Kingdom has focused on both new and existing premises with expansion this past summer of its energy performance requirements to commercial property over 26,900 square feet when built, sold or rented.

Energy retrofits to existing buildings in the U.S., although a growing priority, have often been complicated by numerous financial and contractual barriers. However, BOMA this past summer unveiled its Energy Performance Contract (EPC) Model. Developed in collaberation with the Clinton Climate Initiative (CCI), the BOMA EPC Model allows building owners to perform major energy retrofits to existing buildings by removing key barriers and providing a turnkey solution. The Model provides a standardized energy performance contract, similar to the American Institute of Architects' construction contract. The key legal and technical provisions in the contract have been vetted by top real estate and energy service companies, along with BOMA legal counsel and numerous experts in the field. The BOMA EPC Model provides a market mechanism that every building, regardless of age, location and type, can use to significantly improve efficiency.

As part of the EPC Model, BOMA and CCI teamed up with USAA Real Estate Company to generate an energy reduction pilot project to test the Model. The pilot project clearly demonstrated the business case, including development of a financial structure to fund the costs. Working with an investment bank, Hannon Armstrong, a financial structure was developed using the assets in the building as collateral, not the building itself, and using the guaranteed energy savings from the project to pay for the loan.

The BOMA EPC Model is a significant industry event. The industry finally has a streamlined, industry-vetted, cost effective and time efficient model contract that can be used to implement major energy retrofit projects in existing buildings.

It is also interesting to note that BOMA also has released a new lease guide, the BOMA Green Lease Guide, for writing "green language" into a commercial real estate lease. Terms of the lease actually incentivize tenants to reduce energy consumption. The Guide offers an alternative to the typical triple net lease, where the landlord pays for capital improvements to reduce energy consumption, but the tenants, who pay the utility bills, reap the benefits of these measures.

While much has been written and done about reducing energy in new buildings, it is clear that the greatest impact will be achieved by reducing energy in existing buildings. Fortunately, this is becoming a much higher priority in the industry.

Tuesday, June 3, 2008

Electricity Conservation Conundrum in Commercial Buildings With Multiple Tenants

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 do not pay for the electricity they use individually. Furthermore, it is not unusual to find that some tenants are subsidizing others who are wasting electricity. This does not make sense.

One answer to this conundrum might be to install submeters (connected to the building's master meter) to each tenant space. These meters can monitor electrical consumption in kilowatt-hours and demand in kilowatts. Each tenant can then be responsible for their actual usage. If they use less electricity because of conservation measures, they will pay less. This is a much better system than allocating total building electricity cost by square footage.

Another conundrum is related to investment in energy conservation measures. Since electricity cost is often a pass-through cost directly to tenants, there is little financial incentive for building owners to invest in technologies to reduce electricity costs. Until tenants complain about high energy costs and threaten to move to more energy efficient space, building owners really have little incentive to act. This also does not make sense. Fortunately, the government is helping with tax credits and other financial incentives.

The real question still is who pays for all this. I believe that investments in submeters (which can cost as much as a few thousand dollars each) and other energy conservation measures should be viewed today as a cost of being in the real estate business. These investments will increase the value of a building and make a building more attractive to tenants, particularly as energy costs continue to spiral upwards. Moreover, if tenants can be convinced these investments can save them money, it may even be possible to have them pick up some of the cost.

While today such investments are still voluntary, in the next few years you can expect that they will probably be required by some form of government regulation. Sitting back and doing nothing does not appear to be an option!

Sunday, April 27, 2008

How GHG Emission Cap and Trade Will Impact Existing Building Owners

There appears to be little doubt that the next administration in Washington, D.C. will bring about federal GHG emission reduction legislation and that it will be based on a cap and trade program. In the absence of federal GHG legislation, however, many states and local governments have already adopted ambitious plans for reducing GHG emissions. Twenty-two states have entered into regional pacts that impose mandatory GHG emission caps and over 800 cities have adopted GHG programs calling for reductions in GHG emissions. The Regional Greenhouse Gas Initiative (RGGI), for example, which includes Connecticut, Delaware, Maryland, Massachussetts, New Hampshire, New Jersey, New York, Rhode Island, Vermont and Pennsylvania (as an observer), will implement a regional cap and trade program in January 2009. The first auction of carbon dioxide allowances is planned for this September. Another example is the Western Climate Initiative (WCI) which includes six western states (Arizona, California, New Mexico, Oregon, Utah, and Washington, with Colorado, Kansas, Nevada and Wyoming as observers) who have agreed to reduce aggregate GHG emissions by 15% below 2005 levels by 2020. It is clearly evident that the use of cap and trade programs for the reduction of GHG emissions is the direction in which the U.S. is moving.

Why should existing building owners be concerned about this? Commercial buildings account for 38% of the carbon dioxide emissions in the country. As cities and states begin to implement their aggressive GHG reduction goals, it is highly likely they will realize that they will be unable to achieve their goals simply by imposing green building standards on new construction projects. As a result, existing building owners should anticipate that local government will move to impose energy reduction measures on their properties as well, at the very least on building renovation.

What can existing building owners do about this? In my view, the time is now to conduct an energy audit of all facilities to learn where and how much energy is being used, and where energy savings might be realized. With the spiraling cost of energy, the energy savings will be an attractive operating expense reduction. Also, if you are located in a state with GHG reduction plans, it would be prudent to keep abreast of the discussion, particularly how it may impact you.

Two Recent Studies Show Value of Green Buildings

Two recently released studies have confirmed the energy savings and increased value associated with green buildings.

The first study was conducted by the New Buildings Institute (NBI) for the U.S. Green Buildings Council (responsible for LEED certification), with support from the U.S. EPA (which has the Energy Star program). The March study measured the energy performance of 121 newly constructed LEED-certified buildings that had been occupied for at least one year. Measured energy savings on average were 28% over non-certified buildings. These savings were close to the 25% savings predicted.

The second study also published in March was conducted by the CoStar Group. CoStar analyzed over 1,300 LEED-certified and Energy Star buildings and compared them to non-certified buildings of similar size, location and tenancy. The findings showed that the LEED-certified buildings commanded a rent premium of $11.24 per square foot and had a 3.8% higher occupancy rate compared to their non-LEED certified peers. Energy Star buildings were also able to command a rent premium of $2.38 per square foot and had a 3.6% higher occupancy rate than non-Energy Star buildings. The CoStar study also showed that Energy Star buildings were selling for approximately $61 per square foot more than their non-Energy Star peers. Leed-certified buildings, however, were bringing in approximately $171 more per square foot than non-LEED certified buildings.

While more study is still needed, the results of these studies are substantiating that green buildings can save significant energy (typically 25-30%) and command a premium valuation.

Thursday, March 13, 2008

Energy Use in Commercial Buildings

Today we are at an “energy nexus” directed at global warming taking center stage, green buildings becoming fashionable, and fuel and electricity costs spiraling upwards. It is an “energy nexus” because energy is at the heart of each. Energy [production] is a major contributor to global warming. Energy [efficiency] is a major component of “green” buildings and [the cost of] energy is unquestionably at record high levels.

This nexus has commercial real estate at a financial crossroads. If steps are not taken to improve the energy efficiency of buildings, the government will undoubtedly do it for us. Already it has created considerable concern at the political level with a stream of legislation either passed, planned or in the works. At last count, 27 states, 15 counties and 87 cities have either passed or are in the process of introducing legislation that incorporates energy efficiency is some form as a key component.

While it is impossible to stem the tide of this legislation, such legislation should not really be necessary considering the obvious benefits of increasing building energy efficiency and going “green.” A recent study by CoStar found that “green” buildings can have as much as 30% more value upon sale, experience higher asking rents ($2 or more per square foot), have higher occupancy rates (2% or more higher), and lower operating costs (resulting from lower energy cost, reduced insurance cost and often, tax credits). Tenants also benefit by reduced absenteeism and increased productivity. This has resulted in a number of major players in our industry, including CBRE, Jones Lang LaSalle, Transwestern, GE Real Estate, Hines and ProLogis, committing to move aggressively in this direction. It also adds considerable credibility and momentum to the movement.

Making new commercial buildings energy efficient is not difficult since the owner is starting with a clean slate. Unfortunately, new buildings pale in number compared to existing buildings. For existing commercial buildings, the industry must focus on energy conservation measures and diligent creative management practices.

Typical energy conservation measures thoughtful property managers have applied are identified below. Heating and cooling are generally the single biggest energy cost component (representing about 30% of energy use), followed closely behind by lighting (representing about 25% of energy use).

Typical tactics to reduce energy use in an existing building include:

(1) HVAC System
  • use of programmable thermostats
  • checking that all thermostats are functioning and properly set
  • time-clock controls that can turn systems, such as space cooling and space heating devices, hot water pumps, heat exchanger circulation pumps, and supply, return and exhaust fans, on and off according to building occupancy requirements
  • use of outside air economizers
  • leak testing air supply and return ducts
  • repair any hot water, steam or chilled water line leaks
  • air dampers, damper controls and linkages should be working properly
  • insulate heating and cooling ducts and plenums, hot water, steam, condensate return and chilled water piping
  • make sure combustion systems are cleaned and tuned regularly and replace filters in accordance with the manufacturer’s recommendation
  • clean and tune chiller systems regularly

(2) Service Water System
  • set a temperature limit on the hot water used for purposes other than comfort heating
  • insulate water heater, storage tank and piping
  • time-clock control of hot water recirculation pumps
  • use of low volume shower heads and low flow model toilets

(3) Lighting Systems
  • reduce interior and exterior lighting load with high efficiency lighting
  • use interior and exterior lighting controls to turn off lighting when it is not necessary

(4) Commercial Refrigeration
  • clean and tune refrigeration equipment on a regular basis, particularly the condenser coils and evaporators

(5) Motor-driven equipment
  • repair any leaks in air and water lines
  • clean or replace filters according to the manufacturer’s recommendations

(6) Building
  • install insulation, if possible, in the space between the ceiling joist and roof rafter
  • install individual electricity use meters in tenant space to encourage energy conservation (rather than allocating electricity cost solely on a square foot basis)
  • require the Energy Star rating for any new equipment purchased 

In the final analysis, there really is little choice for building managers but to “jump on the train that is leaving the station.” The alternative is a building that will quickly become obsolete.

Would you like to share what you are doing, and the results you have obtained? My hope is this blog will become a forum for the exchange of great cost effective ideas and strategies to increase building energy efficiency. We want to know what works and what doesn’t and don’t hesitate to provide reviews on your experience with new equipment.

Tony Buonicore, P.E.