Tuesday, June 23, 2009

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 Without investment to make the building more energy efficient, the building can soon become outdated, with the consequent adverse impact on the investment.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.


sabrina.prieus said...

You believe that tenants will ask for a discount when the building is not energy efficient. Do you believe tenants will pay more for an energy-efficient building? Or will it be the current price? How then do building owners retrieve their investments?

Tony said...

Sorry for not getting back to you sooner, but I have been on vacation and just returned to the office last week.

In today's commercial real estate climate, tenants routinely are asking for rent reductions and concessions, and getting them. It's clearly a tenant's market.

The issue of a tenant paying higher rent today for an energy efficient building depends on a number of factors that are for the most part based on economics, the type lease and how utility costs are allocated among tenants. If the tenant is signing a triple net lease (as is common today), the tenant is assuming responsibility for utility costs. As such, if the utility costs are lower for the building, the tenant will ultimately be paying less. The fact of the matter today is that tenants know they do not have to pay more for energy efficient space because the high vacancy environment makes owners do whatever is necessary to attract tenants, and this usually means discounting.

With respect to building owner's getting a return on energy investment, it depends on the type lease. For triple net leases, the owner makes the investment, but the tenants get the advantage - not the most favorable scenario for an owner. However, in the newer "green" leases, the allocation is more favorable for an owner to get a return on the energy efficiency investment.

The mantra in today's challenging commercial real estate environment is to conserve cash. So capital investment for anything is at a premium. If it's not absolutely necessary, it likely will not be done, at least not be done now.