Dept of Real Estate and Construction Management Master of Science Thesis no. 500 Div of Building and Real Estate Economics

Author: Supervisor:

Gustaf Rounick Hans Lind

Stockholm 2010

Energy Efficiency in Multifamily Properties: Drivers and Policies

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Abstract:

This thesis provides a critical review of the literature concerning energy efficiency in real estate

and investigates the main impediments that may cause a sub optimal investment in energy

conservation measures even though there are many simple investments that can be made with

high rates of return. It presents these problems within the context of multifamily properties in the

United States. It proposes an organizational and theoretical framework for understanding and

explaining the drivers of energy efficient improvements. Finally, it reviews policy measures that

are in place and that have been carried out in the past, taking into consideration the scientific

studies and investment analysis on energy efficiency improvements, in order to evaluate current

policy and propose certain recommendations. We found that policy initiatives aimed at

informing the public and mandating certain regulations appeared effective. On the other hand,

policy measures directing capital to certain “green” initiatives left a lot of room for potential

inefficiencies. However, having a more widely used objective standardized ratings system may

help in the effective administration of various subsidy programs designed to promote energy

efficiency.

Master of Science thesis

Title: Energy Efficiency in Multifamily Properties: Drivers and Policies

Authors: Gustaf Rounick Department: Department of Real Estate and Construction

Management Division of Building and Real Estate Economics

Master Thesis number: 500 Supervisor: Hans Lind

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Acknowledgement:

I would like to thank all the people at the Department of Real Estate and Construction

Management at the Royal Institute of Technology that helped me with my research and writing

my thesis. In particular, I want to thank my thesis advisor, Hans Lind, for sharing his valuable

time and expertise in matters pertaining to energy efficiency in real estate and academic writing

in general. I would also like to thank the Swedish State and fellow citizens who have made my

education in Stockholm possible.

Abbreviations

AC Air-conditioning

DHW Domestic Hot Water

DOE Department of Energy

DSF Double Skin Façade

ECM Energy Conservation Measure

EPA Environmental Protection Agency

FBC Florida Building Commission

IRR Internal Rate of Return

LEED Leadership in Energy & Environmental Design

NPV Net Present Value

PV Photovoltaic

USGBC United States Green Building Council

SEP State Energy Program

STE Solar Thermal Energy

Keywords:

energy efficiency, multifamily, market failures, public policy, real estate

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Table of Contents

1. INTRODUCTION .............................................................................................................................................. 5

1.1 SUSTAINABILITY ........................................................................................................................................... 5

1.2 ENERGY EFFICIENCY..................................................................................................................................... 5

1.3 RESEARCH QUESTIONS ................................................................................................................................. 6

1.4 AIM AND OBJECTIVE ..................................................................................................................................... 6

1.5 METHODOLOGY AND STRUCTURE ................................................................................................................. 7

1.6 PRACTICAL IMPLICATIONS ............................................................................................................................ 7

1.7 ORIGINALITY/VALUE .................................................................................................................................... 7

1.8 LIMITATIONS ................................................................................................................................................. 8

2. BACKGROUND INFORMATION ................................................................................................................... 9

2.1 ENERGY EFFICIENCY IN THE UNITED STATES ............................................................................................... 9

Historical Perspective ........................................................................................................................................... 9

Current and Future Expectations and Relevance ................................................................................................. 9

2.2 MULTIFAMILY (2010) ................................................................................................................................. 10

Multifamily Properties ........................................................................................................................................ 10

Subtropical/Tropical Climate ............................................................................................................................. 10

Real Estate Oversupply ....................................................................................................................................... 10

Energy Consumption ........................................................................................................................................... 12

3. FRAMEWORK FOR ACHIEVING ENERGY EFFICIENCY ................................................................... 13

Physical Improvements ....................................................................................................................................... 14

Property Management ........................................................................................................................................ 14

Rating Systems .................................................................................................................................................... 14

Government Initiatives ........................................................................................................................................ 14

Other Frameworks .............................................................................................................................................. 15

4. PHYSICAL IMPROVEMENTS ..................................................................................................................... 17

4.1 NEW CONSTRUCTION VS. RETROFIT............................................................................................................ 17

New Construction: Advantages and Disadvantages ........................................................................................... 17

Retrofit: Advantages and Disadvantages ............................................................................................................ 18

University of Hawaii and the Hawaii Community College ................................................................................. 19

4.2 RENEWABLE SOLAR ENERGY SOURCES ...................................................................................................... 19

Photovoltaic and Solar Thermal Systems ........................................................................................................... 19

4.3 CONSERVATION & EFFICIENCY ................................................................................................................... 20

Domestic Hot Water Consumption ..................................................................................................................... 21

Efficient Appliances ............................................................................................................................................ 22

Dynamic Ventilation Systems .............................................................................................................................. 22

Building Envelope and Solar Protection ............................................................................................................ 22

Advanced and Emerging Technologies ............................................................................................................... 23

Life-cycle of Major Energy Efficiency Improvements ......................................................................................... 23

Conservation and Efficiency vs. Photovoltaic Systems ....................................................................................... 23

4.4 CONCLUDING DISCUSSION .......................................................................................................................... 24

5. PROPERTY MANAGEMENT & MARKET FAILURES ........................................................................... 25

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5.1 INTRODUCTION ........................................................................................................................................... 25

5.2 EVALUATING ENERGY EFFICIENCY INVESTMENTS ..................................................................................... 25

5.3 THE EFFICIENCY GAP & ENERGY PARADOX ............................................................................................... 26

5.4 MARKET FAILURES ..................................................................................................................................... 27

Positive and Negative Externalities .................................................................................................................... 27

Lack of research due to public good nature of information ................................................................................ 27

Principal-Agent Problems within Property Management ................................................................................... 27

Solutions: Transparency & Contractual Agreements ......................................................................................... 28

Non Market Failure Barriers .............................................................................................................................. 28

5.5 OPTIMAL ENERGY EFFICIENCY ................................................................................................................... 29

5.6 FACILITY MANAGEMENT ............................................................................................................................ 31

5.7 CONCLUDING DISCUSSION .......................................................................................................................... 31

6. ENERGY RATINGS SYSTEMS ..................................................................................................................... 32

6.1 INTRODUCTION ........................................................................................................................................... 32

6.2 LEADERSHIP FOR ENERGY AND ENVIRONMENTAL DESIGN (LEED™) ........................................................ 32

6.3 ENERGY STAR™ ......................................................................................................................................... 33

6.4 OTHER SYSTEMS ......................................................................................................................................... 34

6.5 CONCLUDING DISCUSSION .......................................................................................................................... 34

7. GOVERNMENT INITIATIVES ..................................................................................................................... 36

7.1 INTRODUCTION ........................................................................................................................................... 36

7.2 INFORMATION PROVIDER ............................................................................................................................ 36

Government Agencies ......................................................................................................................................... 36

Assisting Development of Energy Ratings Systems ............................................................................................. 36

7.3 CAPITAL ALLOCATOR ................................................................................................................................. 37

Federal and State Subsidized Incentive Programs ............................................................................................. 37

Adjusting the tax code ......................................................................................................................................... 37

Government Buildings ........................................................................................................................................ 38

7.4 REGULATOR ................................................................................................................................................ 38

Mandating Minimum Standards.......................................................................................................................... 38

Code Restrictions and Enforcement .................................................................................................................... 38

Carbon Emissions Cap and Trading Schemes .................................................................................................... 38

7.5 RECENT STATE AND FEDERAL POLICY MEASURES ..................................................................................... 39

States Incentives .................................................................................................................................................. 39

Florida Energy and Economic Development Legislation (June 2008) ............................................................... 40

American Recovery and Reinvestment Act (February 2009) .............................................................................. 40

Integrating Energy Efficiency with other Housing Programs............................................................................. 41

7.6 CONCLUDING DISCUSSION .......................................................................................................................... 41

8. SUMMARY AND CONCLUSIONS ............................................................................................................... 43

REFERENCE: ........................................................................................................................................................... 45

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1. Introduction

1.1 Sustainability

Given the rapid pace of human development and the current and potential effects on the built

environment, it may be desirable to promote increased sustainability and a greater environmental

consciousness. What is sustainability? It is a term that is generally used to refer to the

environmental friendliness of a given object or development. An often cited definition is in the

Bruntland report of 1987 which states that sustainable development is „development that meets

the needs of the present without comprising the ability of future generations to meet their own

needs.‟ (Bruntland United Nations Commission, 1987)1 There are people at both sides of the

debate concerning human development‟s impact on the environment and how it might affect our

future prosperity and even survivability. We may be contributing to it through the burning of

fossil fuels which are releasing green house gases such as carbon dioxide that are being trapped

in the atmosphere. If this hypothesis is correct, then it is logical to examine the areas where

energy demand that is producing the CO2 is coming from. In the United States, 40 percent of

carbon emissions is caused by buildings. As a result, sustainability efforts have often given

significant attention to improving the built environment. According to the Environmental

Protection Agency (EPA), utility costs are the single largest controllable cost in an apartment

complex and on average accounts for approximately 20% of operating expenses (EPA, 2009). As

such, it may be worthy of investigation as to why such a small percentage of properties achieve

high standards in energy efficiency.

1.2 Energy Efficiency

Society as a whole may benefit substantially by improving sustainability and energy efficiency.

Achieving and promoting energy efficiency is a very complex issue given all the variables to

consider. Energy efficiency can defined as the level of energy consumption intensity. We will be

investigating the energy efficiency relating to multifamily buildings. We will also include

discussion pertaining to alternative energy sources such as photovoltaic systems and solar

thermal energy because they may help reduce energy costs and may provide other environmental

benefits. Our review of the current literature and research indicates that there appears to be

several energy saving measures and capital improvements that provide energy cost reduction

benefits which have financial returns in excess of the generally accepted cost of capital for most

types of real estate. (Masfield, 2009; Amstalden, Kost, Nathani, & Imboden, 2007; Koomey,

1 Cited from (Vos, 2007)

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Martin, Brown, Price, & Levine, 2008; Brown, 2001; Jaffe & Stavins, 1994; DeCanio, 1993; van

Hal, 2007) So why is there an apparent need for so much government involvement to promote

sustainability and compel energy efficiency investments by the private real estate sector?

Moreover, why are government incentives at times not even sufficient? Perhaps one reason may

be that the entity making the investment may not be the one that receives enough of the benefits.

Another explanation is that there are principal agent problems, which are difficult to solve. For

instance, most multifamily buildings in the United States are configured so that the tenants are

responsible for paying their own energy expenses. This may provide very little incentive, if any,

for landlords to make the required investments in energy efficiency unless they can somehow

charge higher rents or otherwise share in the future cost savings benefits that would result.

Investments in energy efficiency such as improvements in building insulation can be very

difficult to detect by anyone other than a professional property inspector. It would be very

difficult for the landlord to signal these potential benefits to tenants that would be one of the

direct beneficiaries of the investment. It is for this reason why it is so important that there are

recognizable and trustworthy energy efficiency and sustainability certification programs which

can provide some transparency and alleviate the asymmetric and imperfect information which

may inhibit prospective tenants‟ willingness to pay a higher rent for energy efficient properties.

It is important to recognize that every location has unique market conditions, environmental

attributes, and legal framework that may determine which policy measures are the most

appropriate. This research will attempt to determine the most effective application of this goal to

multifamily buildings within the current perspective of Florida.

1.3 Research Questions

What are the unique demands of multifamily buildings? What are the barriers to energy efficient

investments and potential market failures, especially with respect to multifamily buildings? May

it help to take a holistic perspective to better understand these stakeholder relationships and

determine how to effectively promote energy efficiency? Are government programs that are

supposed to help energy efficiency consistent with the conclusions of the literature?

1.4 Aim and Objective

The overall goal of this research is to determine effective energy conservation solutions to

multifamily dwellings and policies to promote them. We will concentrate on energy efficiency as

opposed to other important aspects of sustainability such as water conservation or other

environmental concerns. We will use a broad perspective to propose a holistic framework of the

various drivers of energy efficiency in order to propose the most sensible solutions. It will also

examine the current legislation relating to energy efficiency to see if it is consistent with the

findings in the literature.

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1.5 Methodology and Structure

We will undertake a comprehensive critical literature review in order to investigate the current

and historical perspective of energy efficiency and the unique dynamics underlying multifamily

properties as they relate to energy efficiency. We will create a framework which divides the

promotion and achievement of energy efficiency into four main drivers, which will be

investigated in the following order:

1. Physical Improvements

2. Property Management

3. Energy Ratings Systems

4. Government Initiatives

This order is helpful because it moves from the more direct elements of the buildings structure

and operations to the more indirect drivers such as energy ratings and various government

initiatives. It also helps with presenting a logical order of defining the problems and then,

potential solutions. These drivers are further illustrated in Figure 2. The analysis of these

elements will be done through an extensive literature review for each component of the

framework. We will also attempt to assess how each of the four elements can and possibly

should interact with each other for a positive outcome. The report will then conclude each of

these chapters with added discussion and basic assessment and then, in the last chapter, it will

offer conclusions and a final summation. In addition, we will review the current legislative plans

that intend to stimulate energy efficiency, and give special attention to state programs in Florida

to see if they conform to conclusions found in the literature. We will then make a qualitative

assessment on how applicable these findings are and what the implications might be to future

policy considerations.

1.6 Practical Implications

By improving building energy efficiency, property managers may improve current profitability,

hedge against future energy price increases, reduce carbon emissions, and conserve natural

resources.

1.7 Originality/Value

Most of the current literature on energy efficiency has focused on buildings in colder climates

and many worthwhile studies have often overlooked various stakeholder interactions, theories,

and offered limited synthesis of all the aspects that may have a critical influence on energy

efficiency investment decisions. This work will attempt to fill some of those gaps by attempting

to apply the findings of the literature to the specific condition facing multifamily properties using

Florida as a backdrop.

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1.8 Limitations

While there may be significant environmental benefits towards reducing carbon emissions, this

research will not try to quantify or qualify all the external benefits but will just assume that

reducing net carbon emissions is a desired outcome. It will also assume that the individual

property owners are relatively indifferent to mitigation of carbon emissions or energy

consumption level and that the primary motivation for a particular investment is the

maximization internal benefits that can be monetized in the form of increased rents and/or

reduced operating expenses. Also, the focus will be on energy efficiency in existing buildings as

opposed to new construction for reasons outlined later in the physical improvements chapter.

Therefore, homebuilders will not be given as much attention in this research as part of the

framework for promoting energy efficiency.

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2. Background Information

2.1 Energy Efficiency in the United States

Historical Perspective

The industrial revolution dramatically expanded the energy consumption per capita in the United

States. However, the development of energy sources through massive energy projects such as the

Hoover Dam (1936) and the utilization of new energy sources such as nuclear power to generate

electricity (1951) created an environment where energy supply was usually ahead of demand.

Consequently, energy conservation was not seen as a priority. In fact, in 1954 the chairman of

the United States Atomic Energy Commission, Lewis Strauss famously spoke of electricity in the

future to be “too cheap to meter.” (Bodansky, 2004, p. 32) This perspective shifted after the oil

embargo in 1972 by Middle Eastern oil producers followed by the Iranian Revolution in 1979,

which caused surges in oil prices, rationing, shortages, and government price controls. It made

the U.S. more energy conscious until oil prices moved much lower in the mid 1980s to late

1990s. As a result, despite the energy crisis of the 70‟s most buildings were constructed in the

U.S. during times when energy and resource efficiency was not considered an important attribute

to consider.

Figure 1

Current and Future Expectations and Relevance

There has been a resurgence of debate on sustainability in the United States. Part of this can be

seen as a consequence of various environmental studies which have concluded that carbon

emissions have contributed to global warming which will lead to flooding of many highly

populated coastal areas and droughts in many agricultural regions. Another reason for the

increased debate has be the result of surging energy prices in 2008 and continued conflict and

39%

28%

33%

Energy Usage in the U.S.Distribution grouped by end-use sector in 2006.

(American Physical Society, 2008)

Buildings

Transportation

Industry

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instability in many oil producing countries. In response, U.S. President Obama has encouraged

and signed several legislative measures aimed at promoting energy independence and

sustainability in many areas including buildings, such as the American Recovery and

Reinvestment Act which is discussed in Section 7.4.

2.2 Multifamily (2010)

Multifamily Properties

Promoting sustainability is a complex process that must be tailored to fit the unique

characteristics of any given property. Disparate property types will require different solutions.

Over one third of American households rent and over 14% of households live in a rental building

with more than 5 units. (NMHC, 2009) Multifamily buildings will have different tenant energy

needs and configurations than a triple-net retail property. It is not the purpose of this paper to

compare the different property types but rather to focus on solutions that fit the specific nature of

multi-housing properties. Even so, there has been some energy efficiency research done with

respect to other property types that is deemed to have significant value in application to this

study.

One of the barriers to energy efficiency programs in multifamily properties as well as other

commercial properties that does not exist in owner-occupied single-family homes is that in

multi-housing properties, energy costs are often passed on to the tenants and, therefore, the

landlord does not have the incentive to make investments in energy conservation measures

because the benefits will get passed on to the tenant. However, this may be more a problem of

perception than reality if these savings to the tenant can somehow be reflected in higher rents.

Subtropical/Tropical Climate

Most of the research that has been done regarding to building energy efficiency has been directed

to colder climates where a large portion of energy usage is directed towards heating. However,

the advent of modern air-conditioning has helped facilitate growth in much hotter/humid

climates in the world. This provides a good reason for why there should possibly be increased

attention to addressing how best to improve energy efficiency in these hotter areas as well

because the same approach taken in colder climates will likely not be the most efficient. For

example, simply improving the thermal insulation will reduce the heating demand but would

likely increase the cooling demand holding all other factors constant. (Chlela, Hussaundii, Inard,

& Riederer, 2009, p. 982) The climate of Florida will primarily affect what will be discussed in

the section on physical improvements.

Real Estate Oversupply

Any worthwhile discussion of sustainability and energy efficiency measures with respect to real

estate must take into consideration market conditions. What are the current preferences of

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consumers? How available is credit and capital for investment? What is the financial health of

the public sector or potential subsidizers of investment? What are the characteristics of supply?

Moving us to a more efficient consumer of energy will require investment. As with any

investment, it is important use an objective lens with which to measure the attractiveness of the

investment. Many people tend to be attracted to the shiny investments with all the bells and

whistles. We love to see the new houses utilizing all the latest technology and every square foot

scrutinized to produce the most green and environmentally friendly real estate possible. Perhaps

it is the perfectionist in us. However, as wonderful as those products are they may be self

defeating by producing much more waste than they claim to save simply by being built. If there

is the possibility of retrofitting the existing housing stock cost effectively to become more energy

efficient, then we must question if putting more weight on promoting energy efficiency in new

housing is prudent at this time. This becomes question become even more pertinent if there are

huge supply and demand imbalances in the market as is the case in Miami. Even if there were

generous subsidies to build new energy efficient homes, it would be extremely difficult for

builders to make a profit given that many buildings are being sold substantially below

replacement cost due to the oversupply of housing, lack of real estate investment demand,

challenging financing environment, and weak economy.

The oversupply of apartments is showing itself through an increase in the national vacancy rate

as of July 2009 to 7.6% (from 6.1% the previous year) which is the highest in 22 years and rents

dropped by the most in ten years during the end of the 2nd

quarter of 2009 according to real estate

research firm Reis Inc.2 Net absorption was the worst in at least ten years since Reis began

publishing quarterly absorption data in 1999 (Ries, 2009).3 Many cities in Florida are suffering

vacancy rates considerably higher in places such as Orlando (10%)4, Jacksonville (16%)

5

Making the supply imbalance even stronger is the finding by the University of Florida‟s Bureau

of Business and Economic Research that Florida‟s total population actually declined for the first

time since 1946. The researchers estimated that from April 2008 to April 2009 the population

declined by 58,294. Florida had been growing by an average of approximately 3,000,000 people

per decade since 1970 (University of Florida, 2009).

2 Cited from (Bloomberg, 2009) 3 Cited from (National Real Estate Investor, 2009) 4 Source: (CB Richard Ellis, 2009) 5 Source: (CB Richard Ellis, 2009)

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Energy Consumption

In order to determine where specific improvements in energy efficiency can be made, it is

important to examine the major usages of electricity in multifamily buildings in Florida. Other

than domestic hot water consumption, energy is typically not used to heat buildings but rather it

is used to cool and dehumidify through various AC systems. Cooling is one of the primary

objectives of buildings in the hot and humid climate of Florida. This can be done through a

number of different methods and combinations such as air-conditioning, ventilation, and solar

protection. In many cases, there are central AC systems which usually consist of a centralized

inside each dwelling that channels the cool air through various ducts to the different apartment

rooms. Other apartments have external or wall units that draw from the outside air in. Tenant

consumption of electricity through lighting and electrical appliances are also major sources of

energy use with refrigerators, washing machines, dryers, televisions, stereo, and computer

equipment being some of the largest appliances using significant energy6.

6 See (EPA, Where does my money go?, 2009) for more a more detailed breakdown of energy use in single family

homes.

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3. Framework for Achieving Energy Efficiency This study will outline a framework with which to organize and analyze the various factors

which may contribute to meaningful results in the realm of energy efficiency. An important

aspect of this framework includes assessing how these four factors can interact together in

effective ways. In fact, it seems that, occasionally, a combination of these factors must be present

in order for meaningful results to occur. Figure 2 below provides an overview of this framework.

Physical Improvements

Energy

Ratings

Tenants

Owners

Builders

New Construction Building Retrofit

Smart Buildings

Solar Energy Conservation & Efficiency

Systems Replacement STE System PV System Building Envelope

Federal

State

Agencies

Government

Initiatives Property

Management

International Mgmt. Co.

Figure 2: Conceptual framework for promoting energy efficient buildings

Info Provider

Regulator

Capital Allocator Communication

Facility Mgmt

Investments

Energy Efficiency Sustainability

Energy Star LEED

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Physical Improvements

The variation of physical improvements that can affect energy efficiency is almost limitless and

their complexities often require well trained technicians for consultations. As we review the

various types of improvements and examine certain case studies, we will attempt to compare the

cost and benefits of retrofitting or refurbishment and energy conservation improvements or

alternative energy improvements. Some of the aspects discussed in the Physical Improvements

chapter will allow us to understand some of the potential problems and solutions in the chapters

thereafter.

Property Management

We will define real estate management in a broad sense within the context of this framework.

Rather than look at it solely from the perspective of a management company we will consider it

as the field where all the actors interact. Property management strives to effectively manage real

property as well as the interests of the various stakeholders that are directly and indirectly

affected by the property‟s performance, in this case, energy efficiency. Sometimes it is difficult

to distinguish between the owners, property manager, developer, and even the tenant because

they often overlap. Property management can be an important component to any energy

efficiency strategy because it would be responsible for the direction of capital towards energy

efficiency investments, affects facility management, and must effectively communicate and

devise contracts that confront and overcome difficult principal/agent dilemmas which may

diminish the willingness to adopt more energy efficient strategies.

Rating Systems

Currently, ratings systems for buildings are still not widely adopted. In the United States, the two

most recognized programs are the United States Green Building Council‟s LEED™ rating

system and the Environmental Protection Agency‟s Energy Star™ label. It is an important step to

improve this area because it increases the transparency and signals to potential purchasers the

energy attributes of a property and allows for comparison with other buildings. These systems

could also be used in collaboration with various government incentives in order to possibly

increase the efficient allocation of resources.

Government Initiatives

Government can play a pivotal role in increasing the incentives of energy efficiency investments

in order to account for the potential positive externalities that could result from a cleaner,

healthier, and more sustainable environment. In addition, the government can utilize its ability to

collect information on a massive scale and provide information to investors regarding energy

efficiency that could be prohibitively expensive for the private sector to gather alone. This

information could also be used to devise and assist energy ratings systems. Another method in

which the government has an impact on energy efficiency is through regulation, which can take

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the form of building codes, carbon emission caps, and other requirements. There are many

strategies which the government can pursue if it wants to increase energy efficiency. We will

evaluate the literature and the recent developments and experiences which can relate to Florida

within our conceptual framework in order to determine which potential solutions may be the

most appropriate and effective or worthy of further study.

Other Frameworks

While the framework proposed here tries to define the driving forces on a macro level, other

frameworks found in the literature focus on the decision making process on a more micro level.

The Conceptual Industrial Energy Efficiency Policy Framework (CIEPF) (Hasanbeigi, Menke, &

du Pont, 2009) illustrated below divides the process into states: Awareness, Motivation, and

Action.

While the perspective on the model is different, many of the drivers are the same, just worded

differently. For example, “fiscal incentives” would be translated as “capital allocator” in our

model. The “awareness” and “technical information” would be covered in our model by the

government subsection, “info provider” and the “energy ratings.” It seems that the important

concept to take away from the CIEPF framework is that it is not enough to be aware of the

benefits; there must also be the motivation and the ability to act on it. In this respect, the models

are very similar because the purpose of our model is to show that all three drivers may need to be

present in order for increased energy efficiency investments to occur. It also stresses that

motivation is a crucial factor which is also similar to our model in that an important source of the

Awareness for top

management

Awareness for

staff

Demonstration

projects

Voluntary

Agreements

Fiscal incentives

Technical

Information

Research &

Development

Benchmarking

data, tools and

software

Energy Management

System

Regulations and

standards

Awareness Action Motivation

Figure 3: Conceptual Industrial Energy Efficiency Policy Framework

(Hasanbeigi, Menke, & du Pont, 2009)

16

lack of investments is found in the chapter, Property Management where many of the market

barriers and incentive problems are discussed.

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4. Physical Improvements Physical improvements to real estate can take the form of entirely new construction or

rehabilitation of an existing structure. It is also important to distinguish between projects that are

meant to conserve the amount of energy used and those that develop add a new renewable source

of energy such as photovoltaic systems. Figures 3, 4, and 5 help to show some of the theoretical

distinctions between these different measures and how they would interact together.

4.1 New Construction vs. Retrofit

As discussed in the previous sections, we can see that there are many different methods to

increase energy efficiency while maintaining the same level of comfort and in many instances,

greatly improving personal comfort levels. However, because there are so many different

methods and infinite number of variations it becomes very difficult to determine the right mix of

these improvements or even categorize them. One of the categories which this paper attempts to

outline is that of energy efficient buildings that fall into either new construction or retrofit. To

some, a completely retrofitted and enhanced building could be considered new construction for

purposes of marketing the property.

New Construction: Advantages and Disadvantages

There are many benefits to new development. One potential benefit is that certain building

design elements to limit energy use such as building position and orientation can be carefully

considered beforehand. One case study of Deventer Hospital in the Netherlands supported the

idea that by being able to incorporate energy efficiency and sustainability measures in the

planning stages, the extra costs were limited (Hal 2004)7. A different study to California‟s

Sustainable Building Task Force concluded that and initial investment of lower than 2% of

construction costs produced life-cycle savings of more than 10 times the upfront investment

(Cats et al. 2003)8. In addition, employing the latest technology in the building process may

lower the operating cost through the course of its useful life in comparison to a property built in

the 1980s. (Goodman, 2004)

However, it is important to consider whether or not the new building‟s construction requires the

demolition and disposal of a structure at the development site prior to construction of the new

facility. This requires a substantial amount of resources and energy and may be highly wasteful if

7 Cited from (van Hal, 2007) 8 Cited from (van Hal, 2007)

18

the prior building could have been adequately retrofitted to provide environmentally friendly and

sound housing. Another important consideration is that the actual construction of new housing

requires large amounts of materials that need to be produced and transported and then

constructed at the site. It is not just the operating costs and the end product that one must

contemplate. It is for these reasons among others why it may be sensible to take a whole life-

cycle approach when determining sustainable and energy efficient investments (van Hal, 2007).

Retrofit: Advantages and Disadvantages

New construction offers builders an opportunity to integrate sustainability in the widest range of

possibilities. However, the reality is we have to also deal with the built environment that we

already have. Nevertheless, as indicated by Mansfield (2009) retrofitting and refurbishment can

have numerous advantages:

Efficiency gains due to reduced construction time.

Lower total project cost relative to new construction.

Less demolition and construction waste.

More efficient use of urban land by retaining existing stock.

Recycled components are often higher in quality and what is currently available.9

Traditional construction quality often surpasses the current standards due to economic

optimization.10

Refurbishment projects can be more attractive to prospective tenants due to their historical

attributes, closeness to amenities, and unique architecture.

On the other hand, Mansfield (2009) cautioned that retrofitting can also have some disadvantages

that must be considered when making deciding whether or not to retrofit or start from scratch:

Refurbishment may not be economical when the extended life of the building is not sufficient to

enjoy the full benefits of the investment.

Ongoing maintenance costs may be higher for an older building

The criteria cannot be met trough the refurbishment alone.

Might not be feasible to equal the environmental performance of new construction.

By recognizing the advantages and disadvantages of both methods, real estate practitioners can

make informed, case specific decisions as to what is the right course of action. In order to

investigate these issues more deeply we can review examples of previous cases and some of the

findings in the literature regarding specific improvements.

9Original Source: (Pearce, 2004) 10Original Source: (Pearce, 2004)

19

University of Hawaii and the Hawaii Community College

By committing $2.9 Million in initial capital investment in energy efficient equipment, installing

a variable speed chilled water pump and energy management system, and replacing the lighting

system, chiller, AC system, ventilation system, and cooling tower, the University was able to

achieve tremendous results. It saved 1.8 million kWh annually, which amounted to an annual

energy cost savings of $450,000. In total it saved $6.6 million in energy and other cost savings

over a 10 year period (1997-2007) (Shelton, 2000)

4.2 Renewable Solar Energy Sources

Photovoltaic and Solar Thermal Systems

In general, there are two types of active solar energy systems. One technology, photovoltaic

systems (PV), uses solar panels to capture sunlight and radiation in order to convert it directly to

electricity. The other type, solar thermal energy systems (STE), captures the heat energy from

the sun and transfers to places in need such as a swimming pool, building heating ventilation

system or water heater. In some cases, the heat can be concentrated on an STE and converted to

electricity.

Photovoltaic systems typically require a substantial upfront investment but can greatly reduce the

ongoing energy needs from traditional sources by providing “free” renewable energy through

sunlight. Figure 4 illustrates the monthly cost savings that can result from installing an

alternative energy sources such as photovoltaic panels.

As we can see from Figure 4, the utility function begins to slope inward indicating a negative

marginal utility because of excessive cooling, making the occupants increasingly uncomfortable.

What this figure shows is simply a conceptual illustration of how it is less costly per month to

achieve maximum utility as well as a given comfort level at $0 monthly cost. In the following

Comfort & Utility

Monthly

Cost

Alternative Energy Maximum Comfort

Decrease

in Cost at

Maximum

Utility

Building with investment

in PV system

Traditional Building

Fig. 4. Monthly Energy Savings: PV System

20

section, we will use this graphical interpretation to help explain the distinction between energy

efficiency and alternative energy sources and how the combination of the two can have a

compounding effect.

4.3 Conservation & Efficiency

Based on much of the legislation that has recently passed, it seems as though there is a lot of

attention to procuring new clean energy sources for homes, however, there does not seem to be

quite as much attention to making more efficient use of the energy that we already have. As we

review the literature, we can see that substantial savings and benefits can be enjoyed by

improving conservation and efficiency of the built environment.

Perhaps one way to break down conservation and efficiency improvements within a building

would be to separate those measures which focus solely on improving the integrity of a building

envelope and those which improve mechanical systems. Building envelope improvements could

include such things as roofing and wall insulation and facades. Mechanical systems would

consist of such things as AC systems, domestic hot water, lighting, and other important

appliances on the other hand. This distinction, however, becomes increasingly difficult to make

as buildings become more high-tech by using electronic sensors integrated in the structural

components (Fernandez, 2007) and some facades use active ventilation with multiple layers

(Haase, Marques da Silva, & Amato, 2009).

Evaluating which improvements to make a building more efficient with its energy use can be

very difficult. One of the reasons why it is difficult is that a building is not just the sum of its

parts but a working system where each part can feed off of another, especially when it concerns

energy efficiency. For example, replacing the AC system will likely have less effect if there is a

significant leak within the building envelope allowing the cool air to escape and the warm,

humid air to penetrate the building. This would be similar to the experience of turning up the AC

in a car while the windows are open, instead of just closing the windows.

Comfort & Utility

Monthly

Cost

Maximum Utility

Decrease in

Cost at

Maximum

Utility

Building with

investment in improved

energy efficiency

Traditional

building

Fig. 5. Monthly Energy Savings from ECMs

21

In Figure 5 we can see that the main effect of the energy efficiency improvements is that they

decrease the slope of the curve resulting in a higher marginal utility at the early part of the curve.

Therefore, the point of maximum utility is reached at a lower cost. Because energy is used more

efficiently, the same comfort level can be reached by expending less energy and monthly cost.

By examining Figure 6, we can see how the monthly cost becomes even lower at the point of

comfort maximization. The important concept to take from this is how at the point of zero

monthly cost, the comfort received from alternative energy is greater than with no efficiency

improvements. The two types of improvements are not mutually exclusive and interact with each

other to provide a compounding effect, even though there may be some diminishing returns with

respect to reduced energy costs. Therefore, it is important that one considers the positive effects

of combining the two measures as opposed to simply giving a side by side comparison. That can

be a complicated process which is beyond the scope of this paper but it is an important concept

that should not be ignored. This visual representation of potential complex interactions of

different improvements may help to explain why, at times, it may require experts in the field of

energy efficiency in order to properly assess the benefits of energy efficiency investments. It also

highlights how building systems should be treated as a whole integrated system that is not just

the sum of its parts.

Domestic Hot Water Consumption

One of the primary areas of energy consumption in multifamily buildings that may not be as

significant in other commercial spaces such as office buildings is domestic hot water (DHW)

consumption. (Ndoye & Sarr, 2008, p. 1222) They can be gas or electric powered. If they are

powered by electricity then they may be integrated with external power sources such as PV

systems or STE systems.

Comfort & Utility

Monthly

Cost

Efficiency Gains in

Alternative Energy Maximum Utility

Decrease in

Cost at

Maximum

Utility

Fig. 6. Monthly Energy Savings from PV system & ECMs

Building with both PV

system and energy

efficiency

Building with only

investment PV System

Traditional

building

22

Hot water heaters can be individual units placed inside each respective apartment or larger units

that service multiple units or the entire building. If they are centralized, then tenants may not

have the same incentives to conserve hot water usage, however, at least the landlord would be

incentivized to have an efficient system. If the hot water heaters are placed in each unit, then

tenants may have incentives to use efficiently however the landlord may not have the incentive

to upgrade to a more efficient system because the energy cost is passed on to the tenant.

Efficient Appliances

Appliance use represents a significant source of energy consumption in buildings. In Florida, it is

common practice for the landlord to include the largest appliances within the dwelling. Typically

the only appliances that tenants bring to the unit are computer and communications equipment,

appliances for entertainment. The landlord would be responsible for appliances relating to food

storage, washing/drying equipment, and air cooling11

, and water heating. The ratings system

Energy Star employs a fairly well recognized label for appliances that landlords may benefit,

from a marketing perspective, by offering Energy Star appliances within their rental units.

Dynamic Ventilation Systems

Because cooling is one of the primary sources if not the most important source of energy use,

any improvements that would minimize the heat transfer. One method which attempts to limit

the transfer of heat is a double skin façade (DSF). There several different variations of a DSF. A

ventilated DSF is one of the more effective methods of insulating a building. However it can be

quite costly to implement but if done efficiently it can yield substantial results that justify the

cost. For example, by taking to consideration which side of a building is most exposed to the

suns strongest rays, it may be most effective to place the ventilated DSF there and not on the

others. (Haase, Marques da Silva, & Amato, 2009)

Building Envelope and Solar Protection

One area where there appears considerable room for improvement is the building shell, which

helps insulate the structure from the undesirable outdoor elements such as heat, solar rays,

moisture, and wind. If the building envelope is not properly sealed, then much energy can be

wasted. An estimated 20-40% of home heating and cooling energy escapes via leaks throughout

the structure‟s shell. (Florman, 1991) (Heede, Bailey, Baynham, Cureton, & Yoon, 1995)12

.

11 In lower rent apartments it is not uncommon to have tenants be responsible for providing their own wall or

window unit air conditioner. 12 Cited from (Pimental, et al., 2004)

23

A growing area of interest in the realm of sustainable buildings is green roofs. There are many

different types of green roofs but they typically consist of roofs which have partial or complete

covering of plants and soil within a sound construction framework that have a number of

different parts. This is a very new field of study but research has been done indicating that these

types of roofs provide substantially more insulation from solar heat. (Simmons, Gardiner,

Windhager, & Tinsley, 2008)

Advanced and Emerging Technologies

John E. Fernandez of Massachusetts Institute of Technology provides a very helpful summary of

all the promising new technologies that may help to make buildings more energy efficient and

improve their life-cycle. One example is the development of “smart buildings” which contain

sensors within the concrete frame that communicate moisture, stress, and temperature levels.

With such an accurate reading of a buildings health, owners can have a better understanding of

what areas may need repair or preventative care. (Fernandez, 2007)

Life-cycle of Major Energy Efficiency Improvements

Energy efficiency investments can be very different in form as well as their estimated useful life.

The following are a list of possible assumptions for estimated useful life of various common

energy investments (Fairey & Vieiria, 2009):

30 years for envelope energy conservation measures

30 years for solar hot water systems

15 years for HVAC equipment

10 years for major appliances

5 years for CFL lamps

These estimates are certainly debatable. One study (Stazi, Di Perna, & Munafo, 2009) that

investigated the durability of 20-year-old insulation retrofits and found that they were still

effective in guaranteeing the heat transmission rate values and elimination of thermal bridges.

Information on useful life should be an important consideration when evaluating investments and

is required information for certain discounted cash flow valuation methods, which will be further

discussed in section 5.2.

Conservation and Efficiency vs. Photovoltaic Systems

Yalcintas and Kaya (2009) examined several case studies from Hawaii in order to determine

which the most effective energy strategy was: conservation or renewable energy. (Yalcintas &

Kaya, 2009) They concluded that most of the “low hanging fruit” with respect to gains in energy

efficiency are found in conservation measures and not renewable energy. They found that

renewable energy such as photovoltaic systems required a significant initial investment and took

many years to be paid back for this investment even after taking into consideration the generous

incentive programs offered for such systems. Other research done also suggests that among the

24

measures to improve energy efficiency, solar collectors and solar photovoltaic systems are not as

cost effective as improving building insulation. (Verbeeck & Hens, 2005)

4.4 Concluding Discussion

One of the main points of contention in the literature is whether or not it is better to promote

energy efficiency in new housing or improve the existing housing stock. One of the reasons for

this debate is that a lot of research and government programs focus on new construction

(Mansfield, 2009) while there is considerable evidence that suggests that the immediate

cumulative effects of improving new construction techniques on energy use and carbon

emissions will be limited and there are many possible improvements to the existing stock that

could have high returns and more total savings with respect to energy efficiency (Mansfield,

2009). Based on conclusions found in the literature concerning this topic and taking in

consideration the current residential real estate over supply within Florida, it seems that the

arguments in favor of focusing efforts first on improving the energy efficiency of the existing

housing supply are overwhelming.

Another point is that, for the time being, it appears that there are opportunities for improving

building efficiency that provide greater returns on investment than solar energy such as

Photovoltaic systems. The high initial cost of PV panels is a reason for this. Over time, this cost

will likely decrease and energy prices may rise, however, for the time being, the high cost is a

significant barrier to profitability in the near-term that would likely need strong government

incentives in order to overcome.

25

5. Property Management & Market Failures

5.1 Introduction

Property management pertains to the allocation of resources to help achieve the goals of the

property owner. It may be that one of the reasons why more energy efficiency investments are

not made is because of investment barriers and market failures within this field. We look at

property management from a very broad perspective. It can include facility management, which

is responsible for effectively maintaining the building and minimizing energy costs. Property

management can also include the management of tenants and leases, which may be an area

where energy efficiency can be stimulated, for example with respect to “green leases.” Property

managers and owners should also accurately evaluate potential energy efficiency investment

decisions and possibly communicate with property owners in an effective way. Therefore, there

are several aspects of property management that should be considered if a property is to achieve

its energy efficiency potential.

5.2 Evaluating Energy Efficiency Investments

There are many ways for managers and owners to evaluate energy efficiency investments. The

discounted cashflow (DCF) model is a common approach. With respect to energy efficiency

investments, one would determine the discounted value of the expected energy cost savings over

the life of the improvement minus the initial investment in order to determine the net present

value (NPV). A positive net present value would indicate a worthwhile investment according to

this method. The Internal Rate of Return (IRR) method for determining investment profitability

calculates a more comparable percentage measurement by determining the hypothetical discount

rate that would make the NPV of a given investment equal to zero.

Another method for valuing a potential investment is a simple payback method, where a

calculation would be made to determine how long it would take for the energy cost savings to

payback the cost of the investment. There are several disadvantages to this method. One is that it

does not factor in the life of the improvement. It may neglect investments that generate

substantially larger savings but take a while to do so. Another limitation with this form of

evaluation is that it does not take into consideration the cost of capital or attempt to discount the

risk involved with the future benefits. Despite this being one of the more simplistic methods, it

is often used by property managers because of their myopic inclination to prefer investments that

have immediate and visible results. (DeCanio, 1993)

Another potential reason why property managers may prefer the simple payback method for

energy efficiency investments is that some property owners may consider it important to recoup

the investment during their ownership of the property due to the perception that such investments

may not have a net positive effect to the resale of the property. Thus the reasoning may be that:

26

the shorter the payback period, the more likely the owner will capture some of the profits before

the property is to be sold.

One of things which many property manager and owners may overlook when evaluating energy

efficiency investments is that they do not take into consideration all the benefits that a particular

investment directed towards energy efficiency may have. For example, improving building

insulation by renovating a wall or a roof may also improve the structural integrity of a building

and add to its useful life. (Martinaitis, Kazakevicius, & Vitkauskas, 2007). Martinaitis et al

proposed that there could be a “two-factor” method for valuing building renovation and energy

efficiency improvement projects. Such a method would attempt to place a building rehabilitation

coefficient in present value calculation that would attempt to factor in some of the other benefits

(or lack thereof) of a specific energy efficiency investment.

Another problem with evaluating investments is the difficulty in choosing the right assumptions.

Amtalden et al. (2007) found that changing the expected price had a significant effect on the

outcome of their results using the discounted cashflow method of analysis. As the expected price

of energy increased, energy efficiency investments became more profitable in their result

(Amstalden, Kost, Nathani, & Imboden, 2007). It may be incorrect to assume that the rate of

inflation of energy prices will remain subdued. The dramatic increase in the monetary base and

exploding deficit in the United States and potential energy demand increases from China and

India could make the past two decades a poor indication of the future. While the case for

inflation is certainly debatable, the point is that it is unclear how property managers would

evaluate such possibilities or if they would even be considered at all.

5.3 The Efficiency Gap & Energy Paradox

The question of why the application of profitable energy efficiency investments is so low or slow

to catch on is not original. It can be described by the term, “efficiency gap” which means the

disparity between the real amount of energy savings investments and the higher amount that

would still be cost effective from the consumer‟s point of view. (Brown, 2001)

There are many striking examples of this efficiency gap. One notable example is that of the

experience with efficient magnetic ballasts for fluorescent lighting in the United States. This type

of lighting was commercially available since 1976 and was well-tested with performance that

was on par or better than standard ballasts and paid back its investment in less than two years on

almost all commercial buildings. However, the application of this technology by building owners

was very low. By 1987 five states had prohibited the sale of standard ballasts but the remaining

27

population chose the less efficient ballasts over the newer technology at a rate of 10-1. (Koomey

et al.)13

This paradox may be explained by certain market barriers that inhibit energy efficient

investment. If the barrier can be removed effectively by government intervention, one can label

the barrier as a market failure (Jaffe, Stavins 1994).

5.4 Market Failures

Positive and Negative Externalities

Another potential market failure could be from the positive and negative externalities

surrounding energy efficiency that are enjoyed or suffered by the investor. For example, if there

are substantial benefits to society for resulting form reduced pollution or other environmental

benefits resulting from increased energy efficiency (positive externality), then the investor may

not receive the total benefits from making the investment. In other words, the cost savings that

the investor receives would not be reflective of the total benefit to society. Therefore, the market

would not be setting the proper signal through prices, which may strengthen the case for market

intervention by for example, the government. This, however, does not explain why a given

energy efficiency investment that is already seemingly cost effective without outside influence,

ignoring externalities, is not undertaken.

Lack of research due to public good nature of information

While it is certainly not necessarily unique to the property market, firms may be unwilling to

invest in proper research and development because the fruits of their potential discovery will leak

out to the competition. Nevertheless, it may be reasons suggest that there should be a greater role

for the government to intervene and stimulate R&D. (Brown, 2001)

Principal-Agent Problems within Property Management

The literature predominantly indicates that there are certain energy efficient measures which

have high rates of return. So why is it that these investments are not undertaken? DeCanio (1993)

suggested that there are several barriers to energy efficient investments. One of them is that firms

do not behave as individuals. “The presence of public goods, externalities, and the clash between

individuals‟ private incentives and the good of the whole all combine to produce outcomes that

fall short of what could be obtained if all the resources of the group were deployed by a single

guiding intelligence.” (DeCanio, 1993) DeCanio further hypothesized that due to the asymmetric

13 Cited from (Brown, 2001)

28

information in the field of property management as well as the short sightedness of property

managers, energy efficient saving technologies often suffer from underinvestment. Because

owners have difficulty in quantifying the work done by property managers, managers are often

forced to produce quick results that are most immediately visible to owners. (DeCanio, 1993)

Another principal agent problem relates relationship between the tenant (principal) and the

landlord or management company (agent) in which the tenant has imperfect information about

the property‟s energy efficiency. It is most likely too costly to for a residential tenant to get an

expert assessment of a potential dwelling‟s energy efficiency considering their turnover is likely

higher compared to other types of tenants, therefore the residential tenant may require a risk

premium in the form of a reduction in the base rent in order to account for this uncertainty.

Solutions: Transparency & Contractual Agreements

One potential solution to this dilemma is through the attainment of an energy or sustainability

rating from Energy Star or LEED, whereby potential tenants are able to ascertain the greenness

of a habitat and, thus, willing to pay a premium in rent due to a reduction in risk of adverse

selection among other factors. Another method is by devising contractual agreements whereby

the owner shares some of the utility expense, which will, in turn, signal to potential tenants the

likely savings which may make them willing to agree to a higher contract rent. However, this

may lead to other problems such as an over consumption of energy which may negate the gains

in efficiency.

Green leases are leases that contain certain legal provisions that are designed to improve the

sustainability of the property by delineating certain required actions on the part of the tenant or

landlord. Green leases are a relatively new phenomenon that is becoming increasingly

widespread in the office and retail spaces (Nakashima, 2008). However, green leases in

residential real estate are very rare perhaps because tenants are not willing to sign legally binding

agreements restricting their energy consumption without knowing with some degree of

confidence how efficient a building is.

Non Market Failure Barriers

Maybe there are some barriers that are not market failures per se but costs that may be

unaccounted for in ordinary net present value calculations. These may also explain paradox since

these other costs or uncertainties would need to be added into a cost benefit analysis and might

change the results. For example, maybe the uncertainty about future energy prices would require

the use of a much higher discount rate for energy efficiency investments than for other types of

building improvements. Another is that the qualitative attributes may not be identical and could

be worse than the existing technologies. For instance, some people may prefer the quality of

traditional light from an incandescent bulb than a fluorescent. Also, there are many information

29

costs of adopting a new technology that may be overlooked in traditional investment analysis but

yet represent real costs that need to be incurred. (Jaffe, Stavins 1994)

5.5 Optimal Energy Efficiency

In order to determine how big the energy-efficiency gap is, one must try to define the optimal

level of energy efficiency. It is beyond the scope of this thesis to define the optimal level of

energy efficiency but it is important to cover some of the issues involved with defining the

optimal level because it may help to point out why there are not more improvements being made.

Jaffe and Stavins (1994) sought to identify some of the conceptual issues surrounding process of

defining optimal energy use. They identified five notions of optimality:

1. The economists economic potential

2. The technologists economic potential

3. The hypothetical potential

4. The narrow social optimum

5. The true social optimum

The following figure by Jaffe and Stavins (1994) attempts to synthesis the relationship between

these different levels of optimality and their respective energy gaps. They suggest two distinct

concepts of economic potential and two versions of social optimum. The term, economic

potential, describes the level of energy efficiency that would be gained if different economic

barriers were removed. The first stage to economist economic potential would be achieved if

economic barriers were removed. The second stage to the technologist‟s economic potential

would be achieved if all informational barriers were removed. The hypothetical potential, which

is only slightly higher than the previous one, could only be reached if government measures

(even costly) were taken to overcome all market barriers including those related to the entire

energy market (not just energy efficient technologies).

30

The narrow social optimum can be defined in relation to the baseline energy efficiency level

after removing all the market failures through government initiatives that pass a cost benefit test

(ignoring externalities). The figure represents a pessimistic view of government‟s ability to

effectively remove these barriers as shown by the significantly lower level of the narrow social

optimum in relation to the economist‟s economic potential. This could be adjusted depending on

various viewpoints. Then we see that the true social optimum is significantly higher than the

narrow social optimum which accounts for the environmental benefits in a cost benefit analysis.

Again, this could be adjusted depending on the reader‟s beliefs on the environmental

consequences of energy usage. (Jaffe & Stavins, 1994)

Baseline or business as usual energy efficiency level

Effect of market

barriers that cannot

be eliminated at

acceptable cost

Eliminate market

failures in the

market for energy

efficient

technologies

Eliminate those market

failures whose

elimination can pass a

benefit/cost test

Eliminate high discount

rates due to uncertainty,

overcome inertia, ignore

heterogeniety

Eliminate

market failures

in the energy

markets

Additional

efficiency justified

by environmental

externalities

Economist’s

economic

potential

Technologist’s

economic potential

True social

Optimum

Hypothetical potential

Narrow social

optimum

Figure. 7: Energy-efficiency gaps.

(Jaffe, Stavins,1994)

Increasing

energy

efficiency

31

5.6 Facility Management

In order for buildings to be energy efficient, property management must ensure that everything is

working as it is supposed to, all the systems are well maintained, and no energy is being wasted.

Facility managers should apply a commissioning process, whereby the owner‟s goals and

requirements for a facility are documented and monitored for progress. (Roper & Beard, 2006)

Multifamily facility managers are directly responsible for the maintenance and efficient use of

common areas and can likely exercise greater direct control within this space. This may include

cooling, lighting, refuse disposal and recycling. However, it is more likely that a much greater

percent of the energy use will come from individual tenants. Consequently, it is important to

create an environment where the tenants‟ interests are aligned in the spirit of energy efficiency.

By taking a leadership role in championing the principles of sustainability within the building,

the property manager may instill a culture that may cause tenants to behave in a similar manner.

A sense of community may develop that places an increased emphasis on environmental

awareness and energy efficiency.

5.7 Concluding Discussion

Property managers and owners may benefit from increased knowledge pertaining to energy

efficiency investments. When the sources of reliable information become more readily available

and disseminated, we may see increased confidence and knowhow among managers to make the

types of energy efficient investments that have the highest returns Managers may also be able to

more easily communicate about potential investments to owners if the general awareness is

raised. Government may be able to play a productive role as educator in this respect as it already

has the institutions in place that act as resources to this information. As energy efficiency

becomes an increasingly important method of increasing profitability, we may see property

owners and managers to try to solve some of the principal agent dilemmas with tenants by

drafting “green leases” or other creative arrangements that promote energy efficiency.

32

6. Energy Ratings Systems

6.1 Introduction

One of the impediments facing investments in energy efficiency and renewable energy is that

their benefits are not as readily visible as many other improvements. If the owners of a property

are not expecting to hold on to it for the full life cycle of the investment then they will be

concerned with how an outside investor will perceive the value of the investment. Many

individuals lack the experience to qualify investments in sustainability, which make it difficult to

market sustainable properties without some sort of effective universal green or energy efficiency

ratings system with which properties can be compared.

6.2 Leadership for Energy and Environmental Design (LEED™)

LEED™ is a certification developed by the non-profit organization United States Green Building

Council (USGBC). It was established in order to “provide third-party verification that a building

or community was designed and built using strategies aimed at improving performance across all

the metrics that matter most: energy savings, water efficiency, CO2 emissions reduction,

improved indoor environmental quality, and stewardship of resources and sensitivity to their

impacts.”(USGBC, 2009)

It provides a systematic approach for building owners to achieve energy efficiency and

sustainability and can be applied to both commercial and residential projects. However, unlike

Energy Star™, LEED™ certification cannot be applied products but only to buildings. LEED™

is a certification process that is encompasses the entire lifecycle of the building from design,

construction, operations and maintenance, tenant fit out, and retrofit. (USGBC, 2009)

LEED™ is a comprehensive system that takes into consideration most aspects of sustainability.

It uses scoring method in which a building can earn points through the evaluation how a building

satisfies specific green criteria which classified among five categories:

33

There are different evaluation procedures for new construction and existing buildings and the

property must have full occupancy for at least 12 continuous months. Based on the level of the

score, a building can earn different levels of LEED™ certification:

One of the drawbacks of having such a complex and thorough certification process is that it may

be intimidating, time consuming, costly and too confusing for owners to be willing to pursue,

regardless of how close a property might be the standards required of LEED™. It has

encouraged many real estate professionals to obtain education in this field to become LEED™

accredited consultants.

6.3 Energy Star™

Significant energy savings will be realized on a national basis.

Product energy consumption and performance and can be measured and verified with testing.

Product performance will be maintained or enhanced.

Purchasers of the product will recover any cost difference within a reasonable time period.

Specifications do not unjustly favor any one technology.

The EPA has developed a National Energy Performance Rating System. One of the current

requirements of the Energy Star label is that a building must score in the top 25% of the EPA‟s

SS

13%

WE

11%

EA

33%

MR

15%

EQ

21%

IO

7%

Point Distribution Comparison

Sustainable Sites (SS) (12 points)

Water Efficiency (WE) (10 Points)

Energy and Atmosphere (EA) (30 Points)

Materials and Resources (MR) (19 Points)

Indoor Environmental Quality (IO) (7 Points)

Certified 40–49 points

Silver 50–59 points

Gold 60–79 points

Platinum 80 points and above

The Department of Energy and the Environmental Protection Agency

have worked together to create the Energy Star™ rating system. The

Energy Star™ certification can be awarded to household products as

well as buildings. In order to determine what specifications are required

for Energy Star certification, which are also subject to revision, the EPA

and DOE consider the following criteria:

34

rating system. In other words, the EPA compares a given building‟s energy efficiency to similar

types of buildings on a scale of 1-100 and if the building receives a score of 75 or higher it may

be eligible for the Energy Star™ certification. The EPA attempts to correctly account differences

in operating environments, regional weather information, and other factors. (EPA 2009)

Currently only 40% of the American public recognizes the energy star rating but this amount

rises to about 60% or more in regions that have active energy efficiency programs (EPA, 2003).

6.4 Other Systems

Many other ratings systems have been developed in different countries and regions such as the

European Union, Canada, United Kingdom, Netherlands, Denmark, Australia, Singapore, Brazil

to name just a few. Most of these ratings systems have a market penetration of less than 1% (Lee

& Rajagoplan, 2008, p. 3982). There may be significant economies of scale should there be a

more universally accepted rating system. The Green Building Challenge (GBC) has been an

attempt to cooperate and unify the perspectives with regard to sustainable building by hosting

conferences among many industrialized nations to develop a framework and testing method for

sustainability. It resulted in the GBTool14

, which is a software application that attempts to

benchmark the sustainability of different property types using a customizable yet objective

approach that incorporates some lifecycle assessment methodologies. The increased recognition

and ease of learning just one standard could add significant value to the certification and increase

adoption rates at the same time. This is a challenging task considering the level of variation

among real estate markets and building codes not to mention the self interest organizations that

are already developing their own standards. However, as many countries begin to adopt their

own standards and labels and the concepts and practices of sustainability become more

widespread, we may be setting the groundwork for a more universally accepted international

rating scheme.

6.5 Concluding Discussion

Obtaining a rating on an energy efficiency building may help the owner market the property to

prospective tenants. Property owners can choose to seek a comprehensive sustainability rating

such as LEED or go with a more focused energy efficiency rating such as Energy Star. However,

it may be significant cost to do so. Such a cost may not be as material for larger properties but it

may be difficult for smaller buildings to absorb and may be a significant factor for why more

buildings are not rated or do not pursue energy efficiency as part of their marketing strategy.

14 See (Cole, 2001) for a thorough overview of the development of GBTool.

35

Ratings systems strive to be comprehensive, which is a respectable goal considering all the

factors that can affect sustainability, but one of the drawbacks is that it increases their complexity

which may make some owners or property managers less certain about how they can achieve the

desired rating. Add to this the non-refundable cost of applying for the rating and it leads to a

situation where owners may feel that it is too risky to undertake the process required of a rating

program, especially for smaller properties. Perhaps the cost needs to be reduced or subsidized

more by the government in order to achieve high levels of market penetration. There may also be

effective ways that ratings systems can assist certain government incentive plans designed to

promote energy efficiency (van Hal, 2007). These potential integrated measures will be explored

in the following chapter, Government Initiatives.

36

7. Government Initiatives

7.1 Introduction

There are many different ways in which the government can get involved in promoting energy

efficiency. Some are more direct in the form of fiscal incentives or investments and others can be

more indirect in the form of providing the research and information in order to help create

awareness. In order to organize the various methods, we could imagine three main roles which

the government could assume with respect to promoting energy efficiency:

Information Provider

o Government Agencies (EPA, DOE, etc.)

o Ratings Systems (Energy Star)

Regulator

o Designing, coordinating, and enforcing local building codes

o Setting mandated targets at the State, Federal, or even International level

Capital Allocator

o Offering direct subsidies and incentive plans that promote various investments

o Directing energy efficient investments in government buildings

7.2 Information Provider

Government Agencies

The Department of Energy (DOE) and the Environmental Protection Agency (EPA) collect vast

amounts of data with regards to energy consumption in the United States. Energy is seen by

many as a national security issue; therefore, it is argued that the government should complement

the data collected in the private sector by supporting these agencies.

Assisting Development of Energy Ratings Systems

The Energy Star program was created and is managed by government agencies. It may be that

the government is very well positioned to handle such systems because of its ability to collect

information.

Having such a government energy ratings system may allow for more integration with

government incentive plans designed to promote energy efficient investments. (van Hal, 2007)

For example, Mansfield (2007) argues that the government could promote energy efficiency by

37

offering differentiated levels of business rate taxes in order to reward companies operating from

energy efficient facilities (PriceWaterhouseCoopers, 2008)15

. Such incentive programs would

need to have ways to measure energy efficiency with clear and unambiguous methods

(PriceWaterhouseCoopers, 2008)16

. Therefore, effective energy ratings systems may help to

improve the effectiveness of different types of government policy instruments.

The government can further improve transparency by creating a mandatory ratings system

whereby all properties are rated. Such a measure might get significant resistance from building

owners that would prefer a lack of transparency because their properties are inefficient and,

therefore, they might benefit from asymmetric information, whereby tenants have less

information than the landlords.

Some researchers argue that simply providing information and creating awareness is not enough

in order to meet the energy savings goals. Lind, Högberg, & Grange (2009) conducted a series of

interviews which divided housing companies into four categories depending on their willingness

to undertake energy efficiency investments. One of their conclusions was that at least two of the

four types of companies would only be marginally affected by indirect policy measures and

energy efficiency objectives would, therefore, not be achieved. (Högberg, Lind, & Grange, 2009)

7.3 Capital Allocator

Federal and State Subsidized Incentive Programs

The government will often attempt to stimulate certain sectors of the economy such as the energy

sector through direct funding in order to help shape the industry. For example, one recent

stimulus plan, The American Recovery and Reinvestment Act (2009) allocated significant funds

to promote cleaner energy and will be discussed in more detail in Section 7.5.

Adjusting the tax code

Changes in the tax code in the form of various tax credits, legal deductions, or reduced rates can

be used to stimulate investments in particular areas. If properties could be effectively measured

in terms of their energy performance, maybe certain incentives, such as reduced property taxes,

could be effective in rewarding the owners of energy efficient properties.

15 Cited from (Mansfield, 2009) 16 Cited from (Mansfield, 2009)

38

Government Buildings

The U.S. government is the single largest tenant in the United States. Therefore, it would be

quite hypocritical if the government were to mandate energy efficient measures without pursuing

them itself. According to Roper & Beard (2007), the federal and state governments have used the

authority required to provide a very substantive change to lower consumption and use of

resources, less waste and healthier facility environments.

7.4 Regulator

Mandating Minimum Standards

The local and federal government can undertake programs that outlaw use or forbid the

continuing sale of inefficient energy consuming equipment. We can recall the previously used

example of the regulation of magnetic ballasts for fluorescent lighting in the United States.

Prohibiting the sale of standard ballasts was the only effective in getting consumers to switch to

the more energy efficient and cost effective fluorescent lighting. (Koomey et al.)17

Code Restrictions and Enforcement

Koebel (2008) found that one of the areas of contention facing large developers, causing them to

be reluctant to adopt new technologies that may lead to more efficient buildings is that building

codes are developed on a regional level, which can lead to quite different codes. The large

developer would prefer to have a building standard that fits as many of these codes as possible in

order to achieve economies of scale in operations. If regional municipalities could somehow

cooperate better to achieve a more uniform building code, which at the same time allows for the

use of new energy efficient technologies, multiregional builders may be more willing to

incorporate new efficient energy technology to their models. (Koebel, 2008) This would also

require that all municipalities were readily adaptable to new technologies.

Carbon Emissions Cap and Trading Schemes

One environmental policy, commonly referred to as “cap and trade,” attempts to promote

innovation and efficiency through a mandatory cap on emissions and, at the same time, offers

some flexibility by allowing high polluters to buy credits from low carbon emitters.18

In the

United States, certain states would be impacted more than others by a carbon cap. A state with a

large portion of energy coming from heavy emitting coal energy plants may have a more difficult

17 Cited from (Brown, 2001) 18 See (EPA, Cap and Trade, 2009) for more information on different cap and trade systems

39

time with a carbon emissions cap and trading system than a state that has a large share of lower

emitting natural gas plants, all other things being held equal.

There are several potential problems with a carbon emissions cap and trade system. One is that

such a system may have the undesired consequence of raising food prices beyond the standard

rate of inflation. This is because it increases the demand of bio fuels which causes farmers to

change land use patterns so that land that would be used to grow crops for ordinary consumption

would be used for bio fuels. The lower supply agriculture production for food could cause and

increase in prices. (Wise, et al., 2009) Despite these potential adverse effects, Roland-Holst and

Kahrl (2009) undertook a quantitative analysis of the probable effect of a federal carbon cap on

the Florida economy. They concluded that even using conservative assumptions as to the

benefits, Florida‟s economy could readily adapt to a carbon cap. (Roland-Holst & Kahrl, 2009)

7.5 Recent State and Federal Policy Measures

While the list of government programs is too vast and intricate to give a detailed account for this

report, it is important to go over some of the main programs in order to see what solutions the

government has been leaning towards. We can use the State of Florida as an example of state

legislation being that it is a large U.S. state and in the middle ground for energy efficiency

legislation.

States Incentives

There are so many different state incentives that it becomes so difficult to keep track. Taking

Florida alone, for example, there are over thirty four different programs among the different

counties.19

Some of the more notable incentives in Florida include:

A sales tax exemption for solar and renewable energy equipment.

Solar water heat, PV system, Solar Pool Heating rebates from $100-$5000

Commercial building envelope improvements utility rebate program maximum incentive 15,000

Commercial equipment rebate programs up to $75,000

The number and quality of incentives can vary widely from state to state. For example,

California has about ninety three different incentive programs through the State, Local

Governments, and Utilities while West Virginia only has one. (North Carolina Solar Center,

2010)

19 See (North Carolina Solar Center, 2010) for an exhaustive online database of state energy efficiency incentives

40

Florida Energy and Economic Development Legislation (June 2008)

In 2008, Florida passed the Energy and Economic Development Legislation (HB7135), in an

attempt to promote and achieve sustainability, energy efficiency, and economic development.

The key features20

of the bill were:

Consolidate energy policy through the creation of the Florida Energy and Climate Commission

Expand incentive programs to encourage development of alternative and renewable energy

Create a consortium of state universities to share information in the development of new energy

technologies

Requiring major carbon emitters to report emissions through The Climate Registry and developing a

cap-and-trade system to control greenhouse emissions

Energy efficiency codes for construction have been made more stringent so that new buildings must

be at least 50% more efficient by 2019 and increasing energy efficiency of certain appliances.

American Recovery and Reinvestment Act (February 2009)

As part of the economic stimulus package, American Recovery and Reinvestment Act, which

was enacted in February 2009, the federal government allocated over $60 billion towards clean

energy and energy efficiency projects. Of that $60 billion the DOE and the State Energy Program

(SEP) will distribute $3.1billion was to individual states for their own programs. The State of

Florida received $126,089,000 (third highest).21

Name of Proposed Sub Total Cost

E85/B20 Public Fueling $5,000,000

Compressed Natural Gas Fleet Fueling $4,000,000

FSEC – SunSmart Schools and E-Shelter $20,000,000

Solar Thermal Revolving Loan $10,000,000

Sunshine State Buildings Initiative $1,000,000

Energy Opportunity Fund $22,000,000

Renewable Energy Sector Gran Program $24,089,000

Shovel Ready Energy Project Grants $20,000,000

Florida Residential Retrofit $15,000,000

Solar Energy Systems Incentive Program $5,000,000

TOTAL $126,089,000

(Florida Department of Management Services, 2009(b))

20See (Florida Department of Management Services, 2009) for a more complete information 21 See (Pelosi, 2009) for more complete information on the federal bill as well as the funds distribution to various

states

Table 1. Florida‟s Allocation of Recovery and Reinvestment Act (2009) State Grant

41

About one-sixth of the money will go to a vague energy opportunity fund, which is supposed to

provide venture capital to companies and funds with respect to but not limited to energy

efficiency. Without strict guidelines on how funds should be spent, there may be a greater

potential for corruption and loss and too little accountability.

Integrating Energy Efficiency with other Housing Programs

Many programs such as Low Income Housing Tax Credits (LIHTC) which are very popular in

promoting construction of low income multifamily buildings have developed a green twist.

Developers have to apply for these programs and their projects are scored a certain number of

points depending on various features such as the number of low income residents, the rents

charged, and quality. States are only given a certain allocation tax credits available for LIHTC so

only the projects with the highest scores are awarded the credits which are used to help fund the

project. Now the program has added green characteristics to the possible ways that developers

can raise their scores, which should give added incentives to include energy efficiency features

in new construction and refurbishment projects of multifamily properties.

7.6 Concluding Discussion

As we can see there a wide range of options available to the government. However, because of

the complexities involved in the matter and the amount of expertise required to matter to make

the appropriate decisions, policy makers need to be cautious not to overstep their boundaries and

19%

8%

4%

1%

12%

16%

16%

17%

4%3%

Florida Grant Allocations

Renewable Energy Sector Gran

Program

Solar Thermal Revolving Loan

Solar Energy Systems Incentive

Program

Sunshine State Buildings

Initiative

Florida Residential Retrofit

FSEC – SunSmart Schools and

E-Shelter

Shovel Ready Energy Project

Grants

Energy Opportunity Fund

42

promote certain investments over others when they may not have adequate knowledge or the

time to fully evaluate the situation.

For example, the $126 million that was handed to out to Florida for the American Recovery and

Reinvestment act was allocated to various programs (some new) very quickly and may have

created an unnecessary amount of bureaucracy and paper pushing, especially considering the

funds were not that substantial. The funds may have been more effective under one simple to

administer program with one clear purpose. It should give taxpayers pause to whether or not

handouts such as these are the best route to take given the potential risks involved. Maybe a

better approach for direct incentive plans is to cut taxes instead of creating more bureaucracy.

However, this still leaves the dilemma of where taxes should be cut. This is why energy ratings

systems can be so useful.

An effective energy ratings system could be an integral component to incentive plans by giving

policy makers a more objective, transparent, and efficient method of determining which

properties should be rewarded. Not only could a rating system benefit the efficient allocation of

government funds, but it could help private investors and tenants as well. The government

already has a great foundation in place with the Energy Star rating system and it seems a logical

step to expand and improve upon this system, which could create a better signal for the efficient

allocation of both private and public capital.

43

8. Summary and Conclusions By establishing a framework for analyzing the principles found in the literature that may

ultimately direct the flow of capital to energy efficient investments and end user behavior, we

can begin to understand how these principles interact and how one might bring about desired

changes. However, in order to determine which changes in behavior might be preferred, we

reviewed the literature in a critical manner to extract conclusions that may be applied to energy

efficient investments in Florida multifamily buildings. These are the main conclusions from this

research:

There are many potential energy efficiency investments which relatively high returns

with respect to energy cost savings benefits and certain investments such as improving

building insulation provided much greater returns than investing in an additional energy

source such as PV panels.

Problems relating to the high technicality of the investments, lack of proper incentive

structure, and asymmetric and imperfect information resulting, in part, from the opacity

of ECMs can lead to an underinvestment in ECMs.

Energy ratings are growing in acceptance and are likely to solve many of the problems

causing underinvestment in energy efficiency.

The government can strengthen the institutions it already has in place to help provide

more information and make the energy star award more accessible to properties that

deserve it. It could also integrate the ratings system into other government programs to

make them more effective.

At this point in time, it is likely more important to improve the efficiency of existing buildings

rather than primarily promoting energy efficient new construction for two reasons. Based the

current oversupply of housing in Florida, excessive new construction could increase the housing

oversupply and expend more resources than is needed. This may also be the case on the national

level, which also has an oversupply of housing, but Florida has an even greater imbalance.

Moreover, the total benefits would be relatively minimal from strong efficiency gains in new

housing alone in the medium term due to the low annual turnover rate of existing housing in

general (Mansfield, 2009). If we want total efficiency increase substantially within the decade,

we need to improve the existing buildings.

Estimating the correct assumptions is crucial to an accurate analysis of the profitability of energy

efficiency investments because small changes in these assumptions can have a large impact. The

future price levels of energy will have a large impact on the profitability of energy conservation

measures. Should demand in Asia continue at its current pace and/or confidence in the dollar as a

store of value continue to wane, there may be significant real and/or nominal price increases of

44

energy and commodities which would substantially alter the value of certain building

improvements, especially those which increase energy efficiency.

Based on the success of the energy star rating system in contrast to the seemingly haphazard

allocation of government energy stimulus funds, it is in our opinion that the government may be

more capable as a clearing house for information than provider and administrator of capital to

direct energy efficiency investments. We recognize that while direct incentives may be needed,

an effective ratings system may be a crucial first step. By improving the information available

and making ratings such as Energy Star more widespread and comprehensive, the private sector

can more easily direct capital to energy efficient improvements and properties. In addition, the

government will be more able to effectively reward top performing properties by further

developing and promoting its rating system which could be used to benchmark property

performance. The government should make the application process more streamlined and

subsidize the cost to have properties rated. Instead of focusing just on the top performing

properties, the ratings system should rate every property but save special awards for the top tier.

They dynamics behind multi-housing properties present some challenges for owners and

property managers that wish to make their properties more efficient but at the same time retain a

large enough portion of the benefits to make the investment profitable. One reason may be

because it is difficult for tenants to ascertain the energy efficiency of the dwelling. This possible

problem may also be solved by a more established ratings system, which could reduce the risk of

adverse selection, thus, making tenants more willing to pay a higher rent for properties that are

more efficient because they feel they know how much they can save in energy costs in

comparison to a competing rental property.

Evaluating energy efficiency in buildings and the potential rewards from energy efficiency

investments can be difficult to measure, among many other things, because of their technical and

somewhat invisible nature. Government may have a viable role in education and consumer

protection in order to improve transparency and awareness. By improving transparency, we

improve the administration of capital. By improving awareness, knowledge about energy

efficiency could spread exponentially.

Further research should be done to investigate the costs and benefits of instituting a mandatory

energy ratings system. There have been several studies reflecting commercial tenants and

buyers‟ responsiveness to a property's sustainability attributes, however, further research should

be done to multifamily tenant‟s responsiveness to energy demand savings. In addition, it may be

helpful to try to investigate the specific burdens of applying for energy certifications and their

effect on different sizes of properties in an attempt to estimate at what cost smaller buildings

might be willing to pursue various sustainability labels.

45

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