commercial mortgages: an underutilized channel …...commercial mortgages: an underutilized channel...

Commercial mortgages: An underutilized channel for scaling energy efficiency investments? Paul Mathew Lawrence Berkeley National Laboratory Nancy Wallace University of California Berkeley Elena Alschuler U.S. Department of Energy Leonard Kolstad Institute for Market Transformation Presenter: Jeff Deason, Lawrence Berkeley National Laboratory ACEEE Summer Study on Buildings, 2016

Outline

•  Premise and context: why commercial mortgages?

•  Current practice

•  Impacts of energy factors

•  Potential interventions

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Premise and Context: Why Commercial Mortgages?

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Wide array of EE financing instruments

Green Bonds Energy Performance Contracts Capital Leases On-bill Financing

Revolving funds

…. 4

What about commercial mortgages?

•  Commercial mortgages currently do not fully account for energy factors in underwriting and valuation…

•  …energy efficiency is not properly valued and energy risks are not properly assessed and mitigated.

•  Commercial mortgages are a large lever and could be a significant channel for scaling energy efficiency.

5

$ 2.5 trillion market

6

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015

$ B

illio

n

Commercial Banks Insurance Companies CMBS Other

Key CMBS sectors: Office, Retail, Hotel, Multi-family

7

Current Practices

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Current Practice

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Evalua&onofUnderwri&ng

Criteria:LTV,DSCR,OE

Ra&o,etc

Appraisal:Verifica&onof

Price

Borrowerinput:ProFormatoestablishnet

opera&ngincomeandbuildingprice.

PropertyCondi&onAssessment(PCA)forReserves

FundingDecision

CurrentUnderwri,ngSequence

Appraiser LoanUnderwri/ng

EngineeringFirm

CreditCommi6ee

Energy Factors in Current Practice

•  Appraisal typically includes little/no information on energy efficiency of assets –  Although there are current efforts to address this

•  Energy costs may not be properly represented in NOI –  Usually based on historical data, if available –  Does not account for energy consumption and price volatility

during mortgage term

•  PCAs do not normally include information on energy efficiency

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Green features and property value: DOE ‘meta analysis’ of > 50 studies

Higher rental rates LEED: 15-17%

ENERGY STAR: 7-9%

Higher occupancy rates LEED: 16-18%

ENERGY STAR: 10-11%

Increased sales price LEED: 10-31%

ENERGY STAR: 6-10%

Lower utility costs ENERGY STAR: 13%

http://www.imt.org/finance-and-real-estate/green-building-and-value

Impact of Energy Factors on NOI and Valuation

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Energy factors that directly affect NOI

•  Energy use volume –  Electricity kWh/kW, fuel therms –  Driven building features, operations, weather

•  Energy use volatility (+/- %) –  Driven by operations, weather

•  Energy price –  $/kWh, $/kW, $/therm

•  Energy price volatility –  e.g. forward curves

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Year-to-year weather impacts

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-12.00%

-8.00%

-4.00%

0.00%

4.00%

8.00%

12.00%

annu

alsiteene

rgycompa

rison

toTMYda

ta

Weatherimpactonsiteenergy

Largeoffice Mediumoffice Smalloffice

San Francisco, CA (Warm-marine)

Atlanta, GA (Warm-humid)

Chicago, IL (Cool-humid)

Baltimore, MD (Mixed-humid)

A host of operational factors

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Occupant behavior Lighting controls Window operation Thermostat setpoints/setback Local heating/cooling equipment Plug in equipment

Facilities management Economizer settings VAV box minimum flow setting Supply air temperature reset Static pressure reset Chilled water/Hot water supply

temperature reset Condenser water temperature

reset Chiller /boiler sequencing …

Maintenance Damper/ valve check Filter change Coil cleaning …

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-25%

0%

25%

50%

75%

100% s

ite e

nerg

y %

cha

nge

from

avg

pra

ctic

e San Francisco

-25%

0%

25%

50%

75%

100%

HVAC

com

bined

(L)

All c

ombin

ed (L

)

HVAC

com

bined

(M)

All c

ombin

ed (M

)

All c

ombin

ed (S

) site

ene

rgy

% c

hang

e fr

om a

vg p

ract

ice

Baltimore

PoorPrac'ce GoodPrac'ce

Energy price risk and valuation

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Wholesale (Energy-Hub) Pricing Augmented Valuation Model

Traditional Commercial Mortgage Valuation Model (CMVM)

MarketFundamentals

OptionPayouts

CashFlows

MortgagePrices

Interest RatesBuilding Prices

Vol. RatesVol. Build-

ing Price

Default andPrepayment

ProjectedCash Flow

ExpectedValue

•  5% reduction in mortgage value in due to energy price risk. •  Higher initial loan-to-value and larger loans are more mispriced. •  Greater mispricing in hot-humid climates or hot-humid-cold climates. •  Reducing energy use increased mortgage value

MarketFundamentals

OptionPayouts

CashFlows

MortgagePrices

Drift Dynamics:

Interest Rates,

Rent, Elect.

Forwards, Nat.

Gas Futures.

Vol. Dynamics:

Interest Rates,

Rent, Elect.

Forwards, Nat.

Gas Futures.

Default andPrepayment

ProjectedCash Flow

ExpectedValue

Source: Jaffee, et al. Energy Efficiency and Commercial-Mortgage Valuation, Fisher Center for Real Estate, UC Berkeley

Potential Interventions: Results from a Scoping Study

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Challenges and opportunities…1

● Energy efficiency is generally not a motivating factor for lenders.

● Very limited awareness and analysis of energy cost impacts in underwriting.

● Underwriting is not standardized across the industry.

● The Property Condition Assessment (PCA) generally does not include information on energy efficiency.

● Most appraisals do not consider existing or planned energy efficiency features in property valuation.

Challenges and opportunities…2

● Many owners have not been able to see impact of energy factors on building value in their own portfolios.

● Context matters: all real estate is local. The impact of energy factors on valuation varies significantly by location, building type, quality, and market conditions.

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Potential interventions and outcomes

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Rentalincome

Vacancyrates

U1litycostvola1lity

U1litycosts

Energy/“Green”ImpactsonMortgageValua8on

Appraisals

Underwri1ngmethods&requirements

PropertyCondi1on

Assessments

Poten8alInterven8onPoints

PropertyValua1on

Interestrates

DebtServiceCoveragelimit

Loan-to-Valuelimit

Poten8alOutcomes

Efforts currently underway

1.  Demonstrate to lenders why, where, and how much energy factors “move the needle” - Initial results in September 2016

2.  Incorporate energy efficiency information in Property Condition Assessments (PCAs)

3.  Incorporate energy efficiency routinely in appraisals - DOE working group – see poster session

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Acknowledgements

Holly Carr (U.S. DOE)

Cindy Zhu (U.S. DOE)

Philip Coleman (LBNL)

Paulo Issler (UCB)

Bob Sahadi (IMT)

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Thank you

Paul Mathew

pamathew@lbl.gov

https://cbs.lbl.gov/energy-factors-commercial-mortgages