the economics of sustainability in the comemrcial real estate sector

The Economics of Sustainability in Commercial Real Estate

Kristian PetersonLEED Green Associate Director of Consulting Sustainability Roundtable, Inc.

Ross Gammill Director of Commercial Due Diligence Allonhill


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2010 IFMA Foundation

TABLE OF CONTENTS

About the Authors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Acknowledgements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Part 1 Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Part 2 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52.1 Commercial Real Estate Management Value Chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52.2 EnergyEfficiencyRetrofitsandPropertyPerformance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Part 3 Methodolgy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73.1 RetrofittingProcessforanExistingCommercialBuilding . . . . . . . . . . . . . . . . . . . . . . . . . . . 73.1.1 Building Commissioning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73.1.2 EfficiencyImprovementProjects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

3.2 ThePerspectiveonSustainabilityWithintheRealEstateIndustry . . . . . . . . . . . . . . . . . . . . 83.2.1 PropertyManagementCompanies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83.2.2 AssetManagementCompanies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93.2.3 Commercial Real Estate Owners . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

3.3 InterviewQuestions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

3.4 BuildinganEconomicModeltoAnalyzeCapitalImprovements . . . . . . . . . . . . . . . . . . . . . . 93.4.1 Return Metrics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103.4.2 KeyAssumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

3.5 ComparisonofCapitalInvestment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Part 4 Qualitative and Quantitative Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144.1 QualitativeAnalysis:IndustryPerspectiveonRealEstateSustainability . . . . . . . . . . . . . . 144.1.1 DriversofEnergyEfficiencyImprovements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144.1.2 MotivatorsBehindEnergyEfficiency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 164.1.3 CorporatePolicyRegardingSustainability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174.1.4 GovernmentPolicyRegardingSustainabilityImprovements . . . . . . . . . . . . . . . . . . . . . . 174.1.5 ValuingEnergyEfficiencyImprovements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184.1.6 CapitalAllocationDecision-MakingProcess . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.1.7 Industry Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 4.2 QuantitativeAnalysis:FindingsFromtheEconomicModel . . . . . . . . . . . . . . . . . . . . . . . . . 204.2.1 SimplePaybackPeriodAnalysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214.2.2 Project-LevelInternalRateofReturnAnalysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224.2.3 Project-LevelNetPresentValueAnalysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234.2.4 AnnualNetOperatingIncomeAnalysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 244.2.5 ReversionValueAnalysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254.2.6 TheEffectofTenantRolloveronInvestmentReturns . . . . . . . . . . . . . . . . . . . . . . . . . . . 264.2.7 EnergyEfficiencyRebates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 284.2.8 Combined Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 4.2.9 Summary of Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30

4.3 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304.3.1 IncreaseTransparency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .304.3.2 EducationandProofofConceptIsRequired . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 4.3.3 ProperValuationofEnergyEfficiencyImprovementsIsNeeded . . . . . . . . . . . . . . . . . . 31

Part 5 Case Study: Empire State Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

Part 6 Appendices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35AppendixA References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35AppendixB Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36


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ThisPublicationisSponsoredby: Manhattan Software

425FortuneBoulevard,Suite200 Milford, MA 01757 USA

www .manhattansoftware .com

KristianPeterson

KristianPetersonisanexpertinstrategicdecisionmakingregardingenergyefficiencyimprovementsincommercialofficebuildings.HerecentlyreceivedhisMasterofScienceinRealEstateDevelopmentfromtheMITCenterforRealEstate.Beforepursuinghismaster’s,Kristianspentthreeyearsadvisingexecutivemanagementataprivaterealestateinvestmentcompanywhereheperformedsiteandmarketevaluationstoestablishassetmarketvalueandcreatebuildingproforma.Intotal,headvisedontheacquisition of $1.5 billion (US dollars) in commercial real estateacrossadiversesetofinvestments,includingoffice,retailandindustrialproperties.Kristianhasalsoworkedasacommercialrealestatebrokerandmanagedtheactivitiesofamarketresearchdepartment.

Ross Gammill

Ross is director of commercial due diligence atAllonhill,aDenver-basedproviderofbothresidential and commercial mortgage due diligence.PriortoAllonhill,Rosswasanunderwriter for Bridger Commercial Funding, acommercialmortgage-backedsecuritiesconduitlender.AtBridger,Rosswasinvolvedintransactionstotalingover$400million(USdollars).Hehasunderwrittenloansfornumerouspropertytypes,includingmultifamily,office,hospitality,industrialandretail.Beforeventuringintotherealestateindustry,RossworkedforTriageConsultingasafinancialconsultanttothehealth care industry. At Triage, Ross led a team ofconsultantsinhelpinghospitalsstreamlinetheirrevenuecycles.Rosshasamaster’sdegreeinRealEstateDevelopmentfromtheMassachusettsInstituteofTechnologyandbachelor’sdegreesinEconomicsandGeographyfromtheUniversityofCalifornia, Los Angeles.

ABOUTTHEAUTHORS

www.manhattansoftware.com


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Commercialrealestateretrofitprojectsthatincludeenergyefficiencyareincreasingatarapidrate. An indicator of this is the growth of the LEED forExistingBuildings:Operations&Maintenance(LEED EBOM) Green Building Rating System. In2009,forthefirsttimesincetheUSGreenBuilding Council began rating buildings, the amountofspacecertifiedbytheLEEDEBOMratingsystemoutpacedtheamountofspacecertifiedbytheLEEDforNewConstruction (LEED NC) rating system.

Realestatefirmsarepursuingenergyefficiencyretrofitstodirectlylowertheiroperatingexpensesandmitigatetheriskassociatedwithrisingenergycosts. In an uncertain economic setting, real estate managers are increasingly focused on managingtherisksassociatedwiththeirportfoliosandturningtowardoperationalefficienciestodrivedowncostsandincreasenetoperatingincome.

Conversationswithlargeindustryparticipantsindicatethatrealestatemanagers,despitethedownturn in the US economy, are continuing topursueretrofitprojects.Forexample,membersofSustainabilityRoundtable,Inc.’sSustainableCorporateRealEstateRoundtablehavesuccessfullydeployedsolutionsthathaveoptimizedelectricityconsumptionacrossalargeportfoliotodecreasetheirelectricitycostsby 5percent.

Asindustrysurveysarereportingonaregularbasis,firmsaremovingtheirrealestateportfoliostowardgreatersustainabilitywithaprimaryfocusonenergyefficiencyupgrades.Manydecisionmakersarepursuingenergyefficiencyprojectsintheirexistingportfoliosforadditionalreasonsrelatedtoenergyefficiency,includingkeepingassetscompetitiveandattractingthehighestqualitytenantswhoareseekingmoreefficient,greenerspace.

Firmsthathavemadethecommitmenttomoresustainable real estate understand that this benefitscorporaterealestatefundamentallyinthesamemanneritbenefitsbusinessingeneral.Thatistosay:Moresustainablerealestateoperationsalignarealestateorganization’ssocialandcommercialresponsibilitytodriveinnovationandshort-termandlong-termvaluecreation.

Steven M . Byler, LEED AP Vice President, Research & Operations Sustainability Roundtable, Inc.

THEECONOMICSOFSUSTAINABILITy IN COMMERCIAL REAL ESTATE

Foreword


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ACKNOWLEDGEMENTS

‘

‘Expandknowledgeofthebuiltenvironment,inachangingworld, throughscholarships,educationandresearch’

The Vision Statement of the IFMA Foundation

Reviewers

Sarah Slaughter Senior Lecturer MIT Sloan School of Management

Brian Ciochetti Chairman and Director, Interdepartmental Degree Program in Real Estate Development MIT Center for Real Estate

TheauthorswouldliketosincerelythankMassachusetts Institute of Technology (MIT) SloanSchoolofManagementProfessorSarahSlaughter for her guidance and dedication in supervisingthisresearch.Herperspectiveandenthusiasm on issues of sustainability in the built environmentiscontagious.Itwasapleasuretoconductthisworkasaninterdisciplinarylinkbetween the Center for Real Estate and the MIT Sloan School of Management.

Theauthorswouldalsoliketothankeachofthepropertymanagers,investmentmanagersandrealestateownersthatparticipatedintheinterviewsforthiswhitepaper.Aclearindustryperspectiveonsustainabilityinrealestateiscriticaltopromotingenergyefficiencyandimprovingthequalityofthebuiltenvironment.


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1 executive Summary

Numerousstudieshaveshownthatretrofittinganofficebuildingwithenergyefficiencyimprovementscansignificantlyreduceoperatingcosts,yetmanyexistingofficebuildingshavenotbeenretrofitted.Theobjectiveofthiswhitepaperistoexplaintheincentivesandmotivationsofvariouspartiesthroughout the real estate management chain so that real estate managers can better understand whyinvestmentsinenergyefficiencyarenotmoreprevalent.Thewhitepaperfocusesspecificallyonexistingofficebuildings.

Withinthewhitepapertheauthorsexplorethequestionofwhymanyexistingbuildingshavenotbeenretrofitted,despiteoperationalsavings,frombothaqualitativeandquantitativeperspective.Thequalitativestudyconsistedofinterviewswithkeyplayersintherealestatemanagementchain,includingpropertymanagers,assetmanagers,portfoliomanagersandinstitutionalowners.Thequantitativestudyconsistedofthedevelopmentofafinancialmodeltocomparecompetingalternativecapitalinvestments.Thecompetinginvestmentsconsistedofacosmeticimprovement,which was modeled to either increase rent or decreaseleasingcosts,andanenergyefficiencyimprovement,whichwasmodeledtodecreaseutilitycosts.Severalpermutationsweretestedtogaugethesensitivityofreturnsforeachcase.Boththequalitativeandquantitativestudieswere designed to understand how industry participantsallocatedcapitaltoenergyefficiencyimprovements.

Thewhitepaperconcludesthatfinancialconsiderationsaretheprimarydriversbehindrealestateinvestmentdecisions.Secondaryfactorsthatdriveinvestmentsinenergyefficiencyimprovementsinclude:fosteringapositivepublicimage, winning new business and focusing on environmentalresponsibility.Recommendationstoincreaseinvestmentinenergyefficiencyarealsoprovidedwithinthewhitepaper.Increasedinvestmentinenergyefficiencywillresultifmanagersrecognizethatenergyefficiencyprojectscandecreasethevolatilityofreturns,andthatthesereturnsaremaximizedbymakingtheinvestmentinenergyefficiencypriortosignificantleaserollover.

Thegoalofthiswhitepaperistohelprealestatemanagersbetterunderstandthemotivationsbehindmanagementdecisionsandproviderecommendationstomakethecaseforenergyefficiencyimprovements.Questionsansweredwithinthepaperinclude:• Howdoesanenergyefficiencyimprovementgetimplemented?

• Whoisthedriverbehindthatdecision?• Whatfinancialmetricsareusedtodetermineifaninvestmentmakeseconomicsense?

• Howdoesarealestatemanagerchooseoneinvestmenttypeoveranother?


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2 iNtroductioN

Energyefficiencyinbuildingsisclearlyapressingissue.Globally,buildingsareresponsibleforaboutone-thirdoftheworld’senergyuse.Notonlydobuildings use more energy than any other industry, buttheirshareofenergyuseisexpectedtogrowever-moreintense.Numerousstudieshaveproventhatsimpleactssuchascommissioningabuildingorinstallingmoreefficientlightbulbsnotonlysaveresourcesbutalsopayforthemselvesinarelativelyshorttimeperiod.However,manyofficebuildingsintheUnitedStateshavenotevenimplementedsimpleretrofits,letalonemorecomplexandexpensiveretrofits.

Theobjectiveofthiswhitepaperistoexploretheincentivesandmotivationsofvariouspartiesthroughouttherealestatemanagementvaluechaintounderstandwhyinvestmentsinenergyefficiencyarenotmoreprevalent.Thefocusisspecificallyonexistingofficebuildingsownedbyrealestateinvestors,ratherthanowner-usersorgovernmententities.Thus,thepaperhasbeenwrittenprimarilyforthecommercialrealestateindustry,suchaspropertymanagers,assetmanagers,investmentmanagersandrealestateowners.Thegoalofthiswhitepaperistoovercomethebarrierstoimplementationofefficiencyretrofitsinexistingcommercialbuildingsby increasing collaboration between all building stakeholders,includingpropertymanagers,investmentmanagers,portfoliomanagersandowners.Torealizeasignificantreductionofenergyuse,energyefficiencyretrofitsneedtopermeatealllevelsoftherealestatevaluechainandnotberestrictedtogovernment,corporateusersandtenants.Toadvancethiscooperation, acomparativemethodologyisdevelopedtoassessandpromoteperformanceimprovementupgradestoexistingbuildingsasaprofitableinvestmenttoimprovecashflowandincreaseassetvalue.

2 .1 Commercial Real Estate Management Value Chain

The commercial real estate industry is a highly fragmentedindustry.Incentivesandmotivationsinthedecision-makingprocessarenotalwaysaligned.Therealestatevaluechainincludesadiversesetofentities,suchasdesigners,engineers,contractors,owners,financiersandpropertymanagers,amongothers.Thereareanumberofuniquevaluechainsthroughoutabuilding’slifecycleincludingthedesignphase,operationphaseanddispositionphase.Throughanyphase,thevaluechainmaybehorizontalorverticallyintegratedwithinasinglecompanyoracrossmultiplecompanies.

Intheoperationphasethevaluechainmightbeanalyzedbasedonownershipstructure:owner-userbuildingsandowner-investorbuildings.Theowner-userbuildingistypicallyowned,occupiedandmanagedbyasingleentity.Intheowner-investorvaluechain,theownerleasesthebuildingtoatenantandthevaluechainmayincludetenant,propertymanager,assetorportfoliomanager,andowner.Inthisvaluechaintheownershipmaybesingularormaybeagroupofinvestors.Inaverticallyintegratedreal estate organization, these business lines maybestructuredasseparatebusinesseswithinaholdingcompanyorstructuredasindependentdepartmentswithdifferentvicepresidents.Differentmanagersmaycompeteforlimitedinvestmentcapital;forexample,aleasingmanager, asset manager and facility manager may needtodemonstratethereturnoninvestmentforbuildingimprovementscomparedtoacompetitivereturnwithothercapitalinvestmentopportunities.


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2.2 Energy Efficiency Retrofits and Property Performance

Theenergyefficiencyofabuildingislimitedby how the building is designed, engineered, constructed,operatedandmaintained.Achievinggreaterenergyefficiencyinanexistingbuildingdependsonseveralfactors,includingthebuildingenvelope,systemtypesandefficiency,energyenduse,suchasplugloads,andbuildingoperationandmaintenancepractices.Theefficiencyofthebuildingenvelopeimpactstheenergyloadforthebuilding,includingtherequiredenergyusedtoheat,coolandventilate.Simplestrategiesto reduce heating and cooling loads include appropriateinsulation,optimizingwindowglazingarea,minimizingtheinfiltrationofoutsideair,andusinganopaqueroofingmaterial.Additionally,theenvelopeimpactsthelightingloadforthebuilding,dependinguponhowmuchnaturaldaylightpenetratesthroughwindowsintotheinteriorspaces.Commondesignfeaturesinclude the enhancement of natural daylight intoabuildingthroughtheuseofskylights,lightshelves,tubulardaylightingandothermeansofdaylightharvesting.Mechanicalsystemsimpactbuildingenergyefficiencybasedontheageoftheequipment,repairandmaintenanceprogram,andwhethersystemsareoperatedasdesignedandhavebeencommissioned.Inefficientmechanical

systemsexpendmoreenergythannecessarytoheatorcoolthebuilding.Plugloadsalsoimpactbuildingefficiency.Plugloadsincludecomputers,copiersandappliances.Energyinefficientequipmentand“vampirepower,”orenergydrawnbyapieceofequipmentwhilesittingidle,bothcanhaveasignificantimpactonoverallbuildingenergyefficiency.

Theefficientuseofenergyimpactstheoperatingcostofabuilding.Theaveragecostofenergyforatypicalcommercialbuildingmaydependonseveralfactors,includingthegeography,climate,buildingtypeandlocation.Energycostsarealsooneofthemostcontrollableexpensesunlikeothermajorlineitems,suchastaxesandinsurance.Theenergyexpenditureforallbuildingsis$1.09persq.ft.($11.73persquaremeter)(USdollars)and$1.40persq.ft.($15.07persquaremeter)(USdollars)forofficebuildings(CEBECS2003).Figure1showstheaverageenduseofenergyforboth commercial and residential buildings. Energy priceshavesignificantlyincreasedoverthepastseveralyears,underscoringtheimportanceofenergyefficientoperations.Since2000,averagecommercialenergypriceshaveincreasedapproximately25percent(Ciochetti&McGowan2009).

Figure 1: Total energy consumption by real estate sector

(US DOE 2008)


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3 metHodoLoGy

Retrofitting Process for an Existing 3 .1 Commercial Building

Energyefficiencyprojectsmayyieldsubstantialoperationalsavingstoabuildingowner.Understandingend-useenergyconsumptionisacriticalstepinrealizingvaluefromanefficiencyretrofitproject.Examplesofend-usemeasurementtoolsandmethodsincludesub-meters,dataloggers,monthlyutilitytrackingsheetsandannualenergyaudits.Manyefficiencyretrofitopportunitiesareoverlookedbecauseofinadequateend-userinformation.A2007worldwidestudyfoundthatonlytwo-thirdsofcompaniestrackedenergydataandapproximately60percenttrackedthecostofenergy,althoughthenumbersvariedbythenationaloriginofthecompany(WBCSD2007).

3 .1 .1 Building CommissioningAnothercriticalfactorinanenergyefficiencyupgradeiscommissioningorrecommissioningofanexistingbuilding.Commissioningorrecommissioningabuildingisgenerallyperformedbyanindependentthirdpartytoverifythatbuildingsystemsoperateastheyweredesigned.

Recommendations from a commissioning agent maybesimple,likeadjustingthebelttensiononthefanofanair-handlingunit,tocomplexandcostly,likereplacinganunderperformingchiller.TheLawrenceBerkeleyLaboratory(LBL)estimates the median cost of commissioning existingbuildingstobe$0.27persq.ft.($2.90persquaremeter)(USdollars)offloorspaceandtheaverageannualenergysavingstobeabout15percentwitha0.7-yearsimplepaybackperiod(LeonardoAcademy2008).Despitethecostsavingpotential,anecdotalevidencesuggestsfrequentbuildingcommissioningisnotwidelyperformedthroughoutthecommercialrealestateindustry.

3.1.2 Efficiency Improvement ProjectsThereisawiderangeofsolutionsavailabletoincreasetheefficiencyofacommercialbuilding.Onewaytolookatthesesolutionsistocategorizeprojectsbyexpectedinitialcost.Categoriesmightincludeno-costimprovements,low-costimprovementsandsignificantcostimprovements(Dirksen&McGowan2008)(Table1).

Table 1: Sample energy efficiency improvement projects

No-cost improvements Seal window and door frames

Changefiltersregularly

Replacewashersandcartridgesinleakingfaucets

Replacelightbulbs

Reviewcurrentbuildingoperatingprocedures

Low-cost improvements Equipmenttune-ups

Reviewsequenceofoperations

Calibrate controls

Performminorequipmentupgrades

Installoccupancysensors

Significant cost improvements Windowreplacement

Faucetandtoiletreplacement

Photovoltaicinstallation

Equipmentreplacement


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Manyoftheno-costandlow-costimprovementsmayprovidesignificantreductionstobuildingenergyconsumption.Accordingtoarecentreportbasedonseveralcasestudies,energyconsumptionforheating,ventilatingandairconditioning(HVAC)canbereducedby20percentby detecting mechanical faults and ensuring systemsoperatecorrectly(NSTC2008).ManycostsavingsrelatedtoHVACcanbemadebychangingoperationprocedures,whichdonotrequireretrofits.

Lightingisalow-costimprovementwithsignificantenergyreductionpotential.Alightingretrofitmayincludereplacinglamps,ballastsortheentireluminaire(boththelampandballast).Forexample,simplyreplacing40WT12lampsandmagneticballastswith32WT8lampswithstandardelectronicballastscouldsave87Wand$39(USdollars)perfixtureperyear(Conley2010).Asecondexamplewouldbereplacingawall-mountedlightswitchwithanoccupancysensor,whereappropriate,canreduceenergyconsumptionupto25percent(Roberts2009).It should be noted that any solution should beevaluatednotonlyoncostbutholistically.Forexample,providingatenantcontroloverventilationmayreducecoolingloadsandalsoimproveoccupantcomfort.

The Perspective on Sustainability Within 3 .2 the Real Estate Industry

Realestatemanagerssharedecision-makingresponsibilitywithanumberofparticipants,includingpropertymanagers,assetmanagers,portfoliomanagersandinstitutionalowners.Insomecases,thesedecisionmakersmaybeverticallyintegratedinasinglefirmortheymaybeathird-partyserviceprovider.Arecentstudyconducted by the MIT Center for Real Estate providesinsightintohowmanymanagersaremakingthebusinesscaseforsustainabilitytodecisionmakers.

Companieswereselectedprimarilybasedontheamountofmarketshareintheirrespectivebusiness.Firmswithasignificantshareoftheirassetsinofficepropertiesweretargetedandatotalof19firmslocatedin13differentcities

Figure 2: Professional roles of interview participants

participated.Overall,27individualsparticipated,includingnineassetmanagers,12propertymanagers,threeinvestors,onedeveloperandtwogovernmentofficials.

Thelevelofdecision-makingresponsibilityamonginterviewparticipantsvariedwidely.Participantsrangedfromapropertymanagertoachiefoperatingofficerresponsibleforthemanagementof multibillion dollars of real estate. The perspectiveofeachparticipantwasnotalwaysinalignment.However,eachindividualofferedvaluableinsightintothedecision-makingprocess.

3 .2 .1 Property Management Companies AccordingtoareportbytheNationalRealEstateInvestor,thetop25largestpropertymanagementcompaniescollectivelymanageapproximately8.3billionsquarefeet(7.7x108 squaremeters)offloorspace1 (National Real EstateInvestor2008).Ofthetop25companies,sixparticipatedintheinterview(Table2).Thesesixcompaniescollectivelymanageapproximately4.8billionsquarefeet(4.4x108squaremeters)ofcommercialproperty.Interviewparticipantjobresponsibilitiesrangedfromindividualpropertymanagers to senior managing director.

1 Total property under management includes all commercial product types as well as multifamily residential.


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Rank Property management company Square feet under management Square meters under management

1 CBRichardEllisGroup 1,900,000,000 176,510,000

2 Jones Lang LaSalle 1,200,000,000 111,480,000

3 Colliers International 868,000,000 80,637,200

5 CushmanWakefield 500,000,000 46,450,000

7 Grubb&Ellis 265,600,000 24,674,240

20 Transwestern 124,000,000 11,519,600

3 .2 .2 Asset Management CompaniesInterviewswereconductedatsixofthetop25investmentmanagementcompanies(Pensions&Investments2006).Assetmanagerswhohavemanagementresponsibilityfortheperformanceofrealpropertywereselectedfortheinterviews.Thelevelofjobresponsibilityofinterviewparticipantsrangedfromassetmanagertothechiefoperatingofficer(COO)ofNorthAmerica.Table3summarizesthecompaniesinterviewed.

3 .2 .3 Commercial Real Estate OwnersTheownershiproleincommercialrealestateincludesbothpassiveinvestmentmanagementandactiveinvestmentmanagement.Accordingly,a number of the largest real estate owners often are included on the list of the largest investmentmanagementcompaniesandpropertymanagementcompanies.Sixlargeownerswithsomelevelofverticalintegrationineitherassetmanagement,propertymanagementorbothparticipatedintheinterviews.

3 .4 Building an Economic Model to Analyze Capital Improvements

Anyrealestatemanagertaskedwithoperatingabuildingisfocusedonmaximizingthenetoperatingincome(NOI)ofthatbuilding.Realestate managers focus on both sides of the equationbyincreasingnetoperatingincome throughincreasestogrossrentalrevenues or decreasestooperatingexpenses.Thereisatrend within the real estate industry for managers tofocusongrossrentalrevenueasameanstoincreaseNOI.However,decreasestothe

Table 2: Participant property management companies by size

(NationalRealEstateInvestor2008)

Rank Real estate investment managers Total assets under management (US dollars)

5 PrincipalRealEstate $32,511,000,000

6 UBS Global Real Estate $29,396,000,000

7 JPMorganAssetManagement $29,068,000,000

11 INVESCO Real Estate $17,347,000,000

25 AEWCapital $4,855,000,000

26 ColonyRealtyPartners $4,406,000,000

(Pensions&Investments2006)

Table 3: Participant asset management companies by size

3 .3 Interview QuestionsInterviewquestionsweredevelopedtoexplorethedecision-makingprocessforcapitalallocationforenergyefficiencyretrofitsandtodeterminetheincentivesandmotivationsbehindadecisiontoinvestinenergyefficiencyimprovementsandhowtheseincentivesmayshapetheoutcome.Therelationshipamongdecisionmakerswasalsoanalyzed.Thequestionsweredesignedtodiscoveranyperceivedorrealbarriersinmakingthedecisiontoinvestinenergyefficiencyimprovements.


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operatingexpensesofabuildingmayalsocreatesignificantvalue.Buildingafinancialmodel(aproforma)wherebyrealestatemanagerscanevaluatecompetinginvestmentalternativeswillassistthemanagerinmakingmoreinformeddecisions.Theobjectiveofusingafinancialmodelistoapplyreturnmetricsthatvariousrealestatemanagersusetoanalyzeaninvestment,andtothencomparetheorderofmagnitudeofthevariousreturns.

Oneofthebiggestfactorsaffectinginvestmentinenergyefficiencyupgradesistheinitialcapitalrequiredtoimplementanupgrade.Aspreviouslydiscussed,realestatemanagersmayhaveconflictinggoalsforinvestmentcapital.Forexample,aportfoliomanagermaybemotivatedtokeepthevolatilityofhisportfoliotoaminimum,whichresultsinkeepingmajorcapitaloutlaystoaminimum.Meanwhile,apropertymanagerismotivatedtoincreaseoperationalefficiency,whichmayinvolvesignificantcapitalimprovements.

Belowisastepwiseprocessonhowtobuildafinancialmodelofcompetinginvestmentreturns. The following illustration is based on afictitioussuburbanofficebuildingandusesindustryaveragesasinputs.Ahypotheticalcapitalinvestmentof$200,000(USdollars)forthebuildingisused.Thisinvestmentcaneitherbeintheformofacosmeticupgrade(e.g.,remodelingalobby)oranenergyefficientupgrade(e.g.,retrofittingallofthelightfixtures).Comparingtheamountoftheinitialinvestmentwiththechangeincashflowandcapitalappreciationwillrevealtheorderofmagnitudeofreturnsprovidedbyeachinvestment.

3 .4 .1 Return MetricsSimplepaybackperiod,changetonetoperatingincome,internalrateofreturnandnetpresentvaluearecommonlyusedreturnmetrics.AdescriptionofthesetermsisfoundintheGlossaryattheendofthepaper.Thefinancialmodelwillincorporatemanyofthesemetricstoreachthebroadestaudienceofrealestateprofessionals,includingpropertymanagers,assetmanagersandpropertyowners.

3 .4 .2 Key AssumptionsThefollowingkeyassumptionswereusedtobuildthefinancialmodel:

Fictitious building:• ThefactsandfiguresusedinthemodelareroughestimatesforanaveragesuburbanofficebuildinglocatedintheUnitedStatesandarebasedonindustryaveragessuchas those found in the Institute of Real Estate Management(IREM)Income/ExpenseAnalysis:OfficeBuildings(IREM2008).

No financing:• Itisassumedthattheup-frontcostforthecapitalinvestmentwillbepaidbythepropertyowneroutofacashreserve.

Employee productivity:• Inpredictingtheeffectsofvariousinvestments,itisassumedthatnoneoftheinvestmentalternativeswillaffectemployeeproductivityeitherpositivelyornegatively.Measuringproductivityorchangestoproductivityisbeyondthescopeofthisstudy.

•Lease type:Theleasesinthefinancialmodelareassumedtobeamodifiedgrossleasewithabaseyearstop.Thismeansthatthetenantagreestopayalloperatingexpensesaboveaspecifiedannuallevelknownasthe“stop.”Forexample,ifatenant’sleasespecifiesgrossrentof$20.00persq.ft.($215persquaremeter)(USdollars)witha$5.00persq.ft.($54persquaremeter)(USdollars)baseyearstop,thelandlordisagreeingtopayforthefirst$5.00persq.ft.($54persquaremeter)(USdollars)worthofoperatingexpenses,whichmayincludewater,electricity,solidwaste,propertyinsurance,realestatetaxes,propertymanagementfeesandothergeneralpropertyoperatingexpenses.Iftheexpensesweretoriseto$5.50persq.ft.($59persquaremeter)(USdollars)inthesecondyear,thelandlordwouldpaythefirst$5.00persq.ft.(USdollars)andthetenantwouldpaytheextra$0.50persq.ft.($5.40persquaremeter)(USdollars).

Expense reductions:• Iftheoperatingexpensesin any one year decrease below the base year stop,dependingontheleasestructurethelandlordmaykeepallorsomeofthesavings.Usingtheexampleabove,iftheexpensesdecreaseto$4.50persq.ft.($48persquaremeter)(USdollars),thelandlordonlypays$4.50persq.ft.($48persquaremeter)(USdollars)


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and the tenant does not share in the $0.50 persq.ft.($5.40persquaremeter)(USdollars)savings.Thetenantisstillresponsibleforpayingtheentire$20.00persq.ft.($215 persquaremeter)(USdollars)grossrent.

•Base year reset: It is assumed that when a tenantrenewstheirlease,theirbaseyearstopresetstothecurrentyear’sactualoperatingexpenses.Additionally,whenanewtenantsignsanewlease,theirbaseyearstopisalsosetatthecurrentyear’sactualexpenses.Thesetwoactionssimplifythemodelsothatwheneveraleaseisexpired,thebaseyearstopforthatspacewillalwaysresettothecurrentyear’sexpenses.

Lease expiration:• Forsimplification,themodelassumesfivetenantsofequalsize.Leaseexpirationsareasfollows:twotenants’leasesexpireinyear2oftheanalysis,threemoretenants’leasesexpireinyear3,andone

tenant’sleaseexpiresinyear5.Thetenantwiththeleaseexpirationinyear5isassumedtohavesigneda3-yearleaseinyear2.Thetenantexpirationisstaggeredtoshowtheeffectofinvestmentinthepropertywithvaryingrolloverpercentages.

Lease term:• Four leases are assumed to be 5-yearleasesandoneleaseisassumedtobe a3-yearleaseforthereasonstatedabove.

Revenue and expenses:• ThefinancialmodelassumesasuburbanofficebuildingusingnationalaveragesforrevenuesandexpensespublishedbytheInstituteofRealEstateManagement (IREM). Table 4 shows a summary oftheaveragesforallUSsuburbanofficebuildings in 2006.

Suburban office building (2006)Total $/sq ft

(US dollars)

Percentage change

2005-2006

Percentage of total

operating costs

Gross rents $19.43 2.50%

Utilities $1.96 5.40% 23.60%

Janitorial/maintenance $2.11 2.90% 25.40%

Admin/benefits $1.08 -3.60% 13.00%

Insuranceservices $1.04 -1.90% 12.50%

Netoperatingcosts $6.02 2.90%

R.E./othertaxes $1.90 4.40% 22.90%

Totaloperatingcosts $8.30 3.50%

Occupancylevels 95.00% 0.00%

Operatingratio 0.43

US median management fee 3.24%

(IREM 2008)

Table 4: Average US suburban office building revenue and expenses


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Thefinancialmodelevaluatesabuildingof100,000sq.ft.(9,000squaremeters)withtenantsofequalsizeof20,000sq.ft.(1,900squaremeters),forsimplicity.AprogramsuchasArgus,orotherfinancialmodelingsoftware,ishelpfulwhenbuildingafinancialmodelwithtenantsofvaryingsizeandleaseexpirations.AssumptionsaboutrentandexpensesarebasedonindustryaveragesprovidedintheIREMMedianIncomeandExpensereportbetween2004and2006.Theassumptionsaboutescalationpercentagestooperatingexpensesandrentgrowth,tenantretentionandabsorptionarearbitraryandusecommon commercial real estate underwriting practices.Finally,thesalescaprateisassumedtobe9percent.Table5summarizestheseassumptions.

• Cap rate: Acaprateof9percentwasarbitrarilychosen.Giventhecurrentmarketconditionsatthetimeofthispaper,thereisalmostnoinvestmentsalesactivitytoestablishamarketcaprateassumption.Thecaprateremainsfixedforallscenarioanalysis.

Tenant renewal probability:• The tenant renewalprobabilityreferstothelikelihoodanexistingtenantwouldrenewaleaseinthebuildingatleaseexpiration.Theselectionofa75percentprobabilityiscommontocommercialrealestatefinancialunderwriting.

Absorption:• Theabsorptionperiodisthenumberofmonthsanofficesuitemaysitvacantfromthetimeanexistingtenantleaseexpiresandanewtenantleasestarts.Itrepresentsthelostrevenuetothelandlordandisoftenreferred

toas“downtime”throughoutthecommercialrealestate industry. Assuming a normal real estate marketcycle,sixmonthsabsorptioniscommontocommercialrealestatefinancialunderwriting.

Table6usestheaboveassumptionstoyieldtheyear1cashflow.

Table 6: Proforma Year 1 cash flow (US dollars)

3 .5 Comparison of Capital InvestmentTheproformaisusedtoanalyzetheimpactofacapitalinvestmenttothenetoperatingincomeandcapitalappreciationofthebuilding.Twotypesofcapitalinvestmentsareanalyzed:acosmeticimprovementandanenergyefficiencyimprovement.Forcomparison,eitherimprovementprojectisassumedtocost$200,000(USdollars).Anyimpacttothefinancialmodelisrealizedintheyearfollowingtheimprovementproject.

Cosmetic improvement: The cosmetic improvementisassumedtoraisetheaestheticqualityofthebuildingandcouldincludeprojectslikealobbyupgrade,bathroomrenovation,landscaping,oramixtureoftheseandvariousotherprojects.Thepurposeoftheimprovementis to increase the gross income generated by the building.Inpracticemanyoftheseimprovementsaremadetoeitherraisethebuildingtoamarketstandardorpreventthebuildingfrommarketobsolescence. The decision may also be made torepositionabuildingwithinamarket.Grossincome could increase as a result of the following threescenarios:

Increased average rent:1 . The cosmetic improvementraisesthequalityofthebuildingandincreasestheachievablerentsforthebuilding.

Input assumptions

Grossrentableofficearea 100,000sqft(9,290m2)Averagetenantsize 20,000sqft(1,858m2)

Averagesuburbanofficerent $19.43 (US dollars)Averagesubopexpense $8.30 (US dollars)Opexpensegrowth 3.50%Rent growth 2.50%Reversioncaprate 9.00%

Tenantrenewalprobability 75.00%Absorption 6 months

Table 5: Financial model input assumptions

Year 1

Grossrentalrevenues $1,943,000

Lessvacancy&absorption $0

Plusexpensereimbursements $29,050

Effectivegrossincome $1,972,050

Totaloperatingexpenses -$859,050

Netoperatingincome $1,113,000


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Increased renewal probability:2 . The improvementincreasestheprobabilitythatanexistingtenantwillrenewaleaseuponexpiration.

Decreased absorption period:3 . The improvementisexpectedtoenhancetheaestheticqualityofthebuildingtherebymakingitmoreattractivetoaprospectivenewtenant.Theeffectisadecreaseinabsorptiontime.

Asensitivityanalysiswasrunwiththreescenariostomodelchangesinaveragerent,tenantrenewalprobabilityandabsorption.Themodelassumesthatbothrenewalprobabilityandabsorptionbehaveintandem:Ifleaserenewalprobabilityofanexistingtenantincreases,thesameattributesofthebuildingmayalsodecreasetheabsorptiontime for a new tenant to sign a lease.

Energy efficiency improvement: There are many possibleenergyefficiencyprojectsincluding,butnot limited to, building commissioning, lighting retrofitsandHVACretrofits.Thefinancialmodelassumesthelandlordspends$200,000(USdollars)inenergyefficiencyretrofitstodecreasetheenergyconsumptionofthebuilding.Forsimplicity,thebuildingisassumedtoconsumeonlyelectricityastheprimarysourceofenergy(e.g., no natural gas, district steam, etc.).

Electricityconsumptionforthebuildingusedinthefinancialmodelillustrationisassumedtobe15.70kWh,basedontheaverageconsumptionforasuburbanofficebuildingpublishedbytheUS Energy Information Administration in the 2003CommercialBuildingEnergyConsumptionSurvey.Further,themodelassumestheaveragecommercialpriceofelectricitytobe$0.106/kWh (USdollars)accordingtostatisticsprovidedbytheDepartmentofEnergy(2008).Table7summarizestheelectricitycostandconsumptionassumptions.

Table 7: Electricity assumptions

Usinganassumptionofanelectricityusedecreaseof38percent,theadjustedannualenergy consumptionforthebuildingafterthe retrofitis9.73kWh.Atthestatedelectricitycostof$0.106/kWh(US dollars), the electricity bill for thebuildingbeforetheretrofitisapproximately$166,000($1.66persq.ft.or$18persquaremeter)(USdollars)andaftertheretrofitis$103,000($1.03persq.ft.or$11persquaremeter)(USdollars).Thesavingsoftheenergyretrofitisapproximately$0.63persq.ft.($6.80persquaremeter)peryear(USdollars).Assuminga3-yearpaybackperiod,thetotalcostoftheprojectforthesubjectbuildingwouldbeapproximately$1.90persq.ft.($20persquaremeter)(USdollars).

The following scenarios demonstrate the ways in whichaninvestmentinenergyefficiencyprojectscouldreduceabuilding’soperatingexpenses:

Electricity consumption decrease:1 . The energyefficiencyimprovementisexpectedtodecreaseelectricityconsumptionbelowthe15.70kWhintheproforma.Theenergyreductionisrealizedinthecashflowintheyearfollowingtheimprovement(e.g.,iftheimprovementismadeinyear0thedecreaseisinyear1).

Rebates:2 . Utilitycompanies,inadditiontomanylocal,stateandfederalgovernmentagencies,offerrebatestoreduceelectricityconsumption.Theserebatestypicallycoveraportionoftheup-frontretrofitcost.Inthismodel,rebatesof$0.60persq.ft.($6.45persquaremeter),$1.20persq.ft.($12.92persquaremeter)and$1.80persq.ft.($19.40persquaremeter) (US dollars) are analyzed according to recommendationsfromindustryparticipants.

Asensitivityanalysiswasrunontheenergyefficiencyimprovementusingthreedifferentpermutationsbecausetheperformanceoftheenergyefficiencyimprovementdoesnotalwaysalignwiththeoriginaldesignspecification.Thesensitivityanalysistestsanenergyefficiencyimprovementatvariousperformancelevels.Thebaseline energy reduction used in the analysis is 30percent,aslightadjustmentdownwardfromtheassumed38percentinitiallynoted.

Electricityconsumption 15.70kWh

Electricityprice $0.106/kWh(USdollars)

Electricitypriceannualgrowth 2.55%


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4

Thequestionofenergyefficiencyretrofitswithinthispaperisapproachedfromtwodifferentangles.First,aqualitativestudywasconductedwherebynumerousplayersintherealestatevaluechainwereinterviewedinordertoexaminecurrentperceptionsofpotentialenergyefficiencyprojects.Second,aquantitativeapproachwasdevelopedthatwasdesignedtoprovideaframeworkfordiscussingchangestovariousreturnmetricsastheresultofcapitalinvestments.Thissectionofthepaperexaminestheresultsofboththequalitativestudyandthequantitativemodel. Theincreasedperspectiveonrealestateowners’motivationsandaquantitativeenergyefficiencyimprovementsframeworkequiprealestatemanagerstomakeabusinesscaseforinvestmentinenergyefficiencyimprovements.

4 .1 Qualitative Analysis: Industry Perspective on Real Estate Sustainability

4.1.1 Drivers of Energy Efficiency ImprovementsTherearemanytrendsregardingenergyefficiencyretrofitsthroughoutthecommercialrealestateindustry.Understandingtheprincipledriversandmotivationsofindustrypeerswillhelprealestatemanagersmakethebusinesscasetostakeholdersbothinternalandexternaltothecompany.Analyzingrecentinterviews,salienttrendsinmanagerialthinkingbecameapparent.Table8summarizescurrentthoughtleadershiponmakingthecaseforefficiencyimprovements.Fromtheinterviews,itwasconcludedthatsustainabilityimprovementsaredrivenbythemostvisibleplayersintherealestateindustry,primarilycorporatetenantsandinstitutionalrealestateinvestors.Tenants,landlordsandgeographyalsoimpactedenergyefficiencydecisions.

QuaLitative aNd QuaNtitative aNyLySiS


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Interview Results Summary

Category Key points

Drivers of energy efficiency

projects

Visibility Largetenantsandlargeownerswithhighpublicvisibilityaremostinter-

ested in sustainability.

Largercompaniesaremorelikelytohavetheavailablecapitaltoinvestin

energyefficiencyprojects.

Geography Attitudesvarydependingonlocation.Coastalcitiesreportmuchmore

focusonenergyefficiencythancentralcities.

Motivations behind energy

efficiency projects

Economics Projectsmustshowapositivefinancialreturnortheywillnotbeimple-

mented.

Market advantage Propertymanagerscanusetheirexpertiseinenergyefficiencytowinnew

clientsinbothpropertymanagementandsustainabilityconsulting.

Shifting class standard ClassAbuildingsarealmostexpectedtohaveefficientlightingandauto-

maticfaucets.Theseimprovementsarepartiallymotivatedbyeconomics

andpartiallybycosmetics.

Efficiencyimprovementsindicatetopotentialpurchasersandtenantsthat

a building is well managed.

Corporate policies Benchmarking Overhalfofcompanieshaveasustainabilitypolicy.Mostarebenchmark-

ingusingENERGySTAR.

Compensation Mostcompaniesdonottiecompensationtoenergyefficiency.Property

managersareexpectedtofocusonefficienciesaspartoftheirjob.

Government policies Lack of awareness Fewcompaniesarepreparingtheirbuildingstobeincompliancewith

governmentenergyefficiencyregulations.

Value of energy efficiency Payback period Afterimplementingno-coststrategies,managersevaluateexpenditures

basedonapaybackperiodof2-3years.

Government,owner-occupiersandownerswithlongerholdperiodswill

acceptslightlylongerpaybackperiods.

Effect of lease structure Ownerismuchmorelikelytomakeinvestmentsiftheleasesaregross

ormodifiedgrossandthelandlordcancapturemuchofthesavingsfrom

energyefficiency.

Manyleasesallowthelandlordtoamortizethecostofimprovementsback

totenants.Thishelpsincreasethelandlord’sreturnoninvestment.

Rebates Manystatesandmunicipalitiesproviderebatestohelppayforenergy

efficiencyimprovements.

Capital allocation decision Priorities Toppriorityisalwayssafetyandrequiredcodeissues.

Secondistenantretention,whichusuallyconsistsoffront-of-the-house

cosmeticimprovementsratherthanback-of-the-houseenergyefficiency.

Real estate cycle Decreased investment Whenthemarketisindecline,thereislesscapitalingeneraltospendon

energyefficiencyprojects.Companiesarepreservingwhatcapitalthey

haveavailable.

Industry structure Fund structure Opportunisticfundsarefocusedonminimizingcapitalinvestmentandsell-

ingquickly.Theyhaveshorterholdperiodsandahighercostofcapital.

Corefundsaremorewillingtoinvestcapitalduetotheirlongerhold

periodandlowercostofcapital.

Reporting period Fundmanagersreportreturnsonmonthlyorquarterlybasis.Theyare

motivatedtokeeplargeinvestmentsandreturnvolatilitylow.

Lack of education/belief Managerseitherhavenotseenstudiesshowingthatenergyefficiency

makeseconomicsenseorarenotconvincedbythesestudies.Timewill

tellifthetechnologiespayoff.

Table 8: Summary of key drivers and motivations


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Tenants: High-profiletenants,suchaslargecorporationsorFortune500companies,aremorelikelytorequestsustainabilityfeaturesinabuilding that they are considering to lease. One reasonforthisisthatannualreportspublishedbypubliccorporationsareoftenscouredbyindustryanalystsandshareholders.Thereportsoftenincludeasectiononcorporateresponsibility,including a commitment to sustainable business practices.Somecompaniesheraldtheselectionofsustainablerealestateasavisiblecommitmentto their constituents. These tenants are more likelytopartnerwitharealestatemanageronachievinggreatersustainabilityinaproperty.

Landlords: For the real estate manager of primarilyleasedspaceanunderstandingoflandlordcommitmentisimportant.Largeinstitutionalrealestateownersarelikewiseveryvisiblecompaniestotheinvestmentcommunity.Manyinvestmentmanagersreportedagrowingnumberofinvestors–albeitsmallinnumber– areenquiringaboutcorporatesustainabilitypolicy,includinginvestmentandmanagementofsustainablebuildings.Tofacilitateraisingcapitalfromtheseinvestors,fundmanagersmayhaveanincentivetopromotesustainability.

Asidefrombeingamarketingtoolforlarge,high-profilecompanies,thesesamecompaniesaremorelikelytohavecapitalavailabletoinvestinenergyefficiency.Itismorelikelythatsmallerinvestorsdonothaveexcesscapitalavailabletoinvest,whilesomelarger,well-capitalizedfirmsareabletocontinuemakinginvestmentsaslongastheycreatevaluetotheinvestor.

Geography: Geographyplaysasignificantrole in the awareness of sustainable realestatemanagementpracticesandamanager’swillingnesstoinvestinsustainabilityimprovements.Interviewparticipantsincitiesknowntobeenvironmentallyprogressivewerenearunanimousinstatingthatimprovingenergyefficiencyinexistingbuildingswasamajordriverintheirrealestatemarkets.Theseparticipantsstatedthattenants,investorsandpotentialpurchasersalikeareaskingabouttheenergyperformanceofabuilding.Sometenantsinmainlycoastalmarketsareinsertingclausesintorequestforproposals(RFPs)thataddresstheproperty’ssustainabilityprogram.Incontrast,participantsmanagingassetsinless

environmentallyconsciousmarketsstatedthatinformationontheenvironmentalimpactforabuildingwasnotafrequentrequestbyexistingornew tenants.

4.1.2 Motivators Behind Energy EfficiencyFinancialconsideration,marketingadvantage,marketdifferentiator,indicatorofmanagementandparadigmshiftarethekeymotivatorsidentifiedbehindenergyefficiency.

Financial consideration: Financial consideration wastheprimaryfactoraffectingcapitalallocationtosustainabilityimprovements.Asexpectedwithanyinvestment,interviewresponsesindicatedthatifitmakessensefromaneconomicperspectiveandcapitalisavailable,thenmanagerswillallocatemoneytotheinvestment.Likewise,somerealestatemanagersreportedthattenantsarewillingtospendmoneyontheirownspaceiftheimprovementspayforthemselvesduringthetermoftheirlease.Similarly,propertyownersarewillingtoinvestinenergyefficiencyiftheyareabletorecovertheseinitialcostsandmakeasuitablereturnoninvestment.Otherfactorsinfluencingthefinancialdecisionincludeaverageholdperiod,costofcapitalandexpectedreturnoninvestment.

Marketing advantage: Thereareseveralnonfinancialmotivationstowardsustainabilityretrofits.Morethanonepropertymanagerstatedthatincreasingtheirknowledgeofenergyefficiencywasastrategicmovetowinbusiness.Onecompellingexampleconsistedofapropertymanagerbuyingahalf-pageadvertisementinthelocalnewspapertoutingtheenergyexpensereductionshehadcreatedforpropertyowners.Further,somemanagementfirmsnotonlyusetheirknowledgetowinpropertymanagementcontracts, but also to win consulting contracts. Mostinstitutionalownersdonothavethespecializedstaffinplacetoimplementcomplicatedprojects,includingthecertificationprocessforLEEDforExistingBuildings:Operations&Maintenance(EBOM).Otherpropertymanagementfirmsconsideredtheefficientmanagementofabuildingmerelyasaservicetotheirclients–somethingagoodmanagershouldbe doing anyway.


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Market differentiator: Energyefficiencyimprovementsarenotonlyconsideredasawaytodecreaseoperatingexpenses,butalsoasawaytodifferentiateonebuildingfromothers.MultiplemanagersstatedthatenergyefficientfeaturesarepartofanewshiftingclassstandardforClassAbuildings.Forexample,arestroomthatdoesnothaveautomatictoilets,faucetsandpapertoweldispensersmayappearoutdatedcomparedtoasimilarbuildingwiththesefeatures.Likewise,energy-conscioustenantsonapropertytourlookforanupdatedceilinggridwithefficientlightingcomparedtoolder,outdatedlighting.Understoodinthiscontext,energyefficientfeaturesbecometangible,visiblequalitiesofabuilding.

Indicator of management: Anefficientbuildingmayalsobeamarketsignaltotenantsandprospectivebuyersofcompetentassetmanagement. This was a recurring theme asmanagersinvolvedinacquiringpropertiesexpressedthattheymaybemorecautiouspurchasingapropertylackingenergyefficientretrofits.Notonlywasthisasignalthattheremaybesignificantcapitalcoststoupgradethebuildingaftertheacquisition,butmayindicatethepreviousownerlikelyeitherdidnothaveenoughcapitaltoproperlymaintainthepropertyorwassimplyinexperienced.

Paradigm shift: Severalmanagerssharedstoriesoftangentialbenefitstomakingenergyefficiencyimprovements.InoneexampleapropertymanagerchangedoutinefficientfansintheHVACdistributionformoreefficientfans.Thenewerfanswerequieterandtenantswerepleasedwiththedecreaseinnoiselevel.Anotherpropertymanagerswitchedthejanitorialservicetoadaytimecleaningschedule.Notonlydidthissaveenergy because it was no longer necessary to light the building at night, but tenants were able to requestspecificcleaningassignmentsandmonitorquality.Oneastutemanagercommentedthatenergyefficiencyretrofitsofmechanicalequipmentbeforetheendoftheexpectedusefullifemayverywellavertacrisisbeforeasystemfails.Thisiscontrarytomuchofthecurrentownershipmentality:“ifitain’tbroke,don’tfixit.”

4 .1 .3 Corporate Policy Regarding SustainabilityRecentcorporatemarketingcampaignstoutsustainabilityinitiatives.Suchcampaignsinclude

oilcompanieshighlightingtheirinvestmentsinrenewable energy or automobile manufacturers callingthemselvesthegreencarcompany.Aspartoftheinterviewprocess,theauthorsaimedtodiscoverhowmuchofthissustainabilitymindsetpermeatedintocommercialrealestate.Questionsincludedspecificsofacompany’scorporatepolicyandhowthecompanyensuredthepolicywasfollowed.

Morethanhalfofthecompaniesinterviewedclaimedtohaveanofficialcorporatesustainabilitypolicythatrangedfromenergyconsumptionreductionsinbuildingstorecyclingprogramsorprintingonbothsidesofasheetofpaper.ThemostcommonstatedpolicyistobenchmarkmanagedbuildingswithENERGySTARPortfolioManager.UponobtaininganENERGySTARscore,manycompanieswillperformaLEEDgapanalysistodeterminethefeasibilityofupgradesthatcouldleadtotheLEEDEBOMcertification.However,severalmanagerscautionedthatchasingLEEDEBOMcertificationmaybeadetractortotherealestateindustryfrommakingsignificantenergy-specificimprovements.ThereasoningwasthatfirmswerespendingmoneyonLEEDconsultantsthatotherwisecouldhavebeenspentonefficiencyupgrades.

Despitethelaudableeffortsofasustainabilityprogram,executionandimplementationare not without challenge. One real estate managerstatedthatoftenacorporateinitiativedistributed by senior management went straight tothebottomoftheproverbialinbox.Othermanagersconsideredenergyefficiencyandsustainabilityhisorherpersonalresponsibilityto educate both owners and tenants. Only one companyinterviewedtiesasmallportionofanemployee’sannualbonustosustainability.Whenotherscompanieswereaskedwhythereisnocompensationtieddirectlytoapropertymanager’senergyefficiencyperformance,themajorityofrespondentssimplystatedthatitisapropertymanager’sjobtokeepoperatingexpenseslow.

4 .1 .4 Government Policy Regarding

Sustainability ImprovementsInterviewparticipantswerealsoaskedabouttheincreasing number of federal, state and local governmentregulationsonenergyefficiencyrequirementsinbuildings.Lessthanhalfofall


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respondentsstatedtheyarecurrentontheseregulations. Of those that are aware, they are payingcloseattentiontogovernmentpoliciesregardingenergyefficiency.Theyarewellawarethatthegovernmenthasspecificrequirementsregarding energy use reduction, but they are alsorealisticaboutjusthowmucheffecttheseregulationscanhave.Forthisreason,theresponsesindicatedthatgovernmentregulationsare a tertiary consideration behind economics and corporatepolicy.

4.1.5 Valuing Energy Efficiency ImprovementsNearlyeveryassetandportfoliomanagerstatedthatifacapitalimprovementwasaccretivetoassetvalue,theywouldmaketheinvestment.Mostintervieweesdescribedanumberofoperationalchangesthatrequirenocostandthusdidnotrequireaninvestmentreturnmetric.Aspreviouslydiscussed,shiftingthejanitorialstafftoclean during the day rather than late at night can saveenergy.Alternatively,iftenantsdonotlikedaytimecleaning,anothersolutionistohavethejanitorialstaffworkasateamandmovethroughoneflooratatime,preventingthewholebuildingbeing lit during night cleaning hours. Another no-costefficiencyimprovementistodecreasethehourswhentheheatingorcoolingoperatesonweekends.Onemanagernotedadrasticdecrease in energy costs after reducing the number of hours the building was heated or cooled tojustSaturdaymorningratherthanafulldayonSaturday–proudlynotingthat“notonetenant”issuedacomplaintaboutthechange.

Thefinancialmetricusedtoanalyzepotentialenergyefficiencyimprovementsthatintervieweeswereunanimousincitingwaspaybackperiod.Thevastmajorityofparticipantscitedapaybackperiodhurdleof2-3yearsmaximum.Ifanenergyefficiencyprojecttakesmorethan2-3yearstopayback,itwilllikelynotbeimplemented.

TheexceptionisaRealEstateInvestmentTrust(REIT),whichinvestssolelyincoreassetsandhasaholdperiodof7-10years.OneREITstatedthattheycouldconsiderpaybackperiodsofupto4-5years.

Besidesmakingareturnoncapitalinvested,therewerevariousotherreasonsforamanagertoinvestinenergyefficiency.Infact,throughan

upgradetobuildingmanagementsystemsoneintervieweesetupacentralcontrolroomthatallowedonepersontomonitoranentirebuildingportfolio.Thoughoverheadreductionsarenottypicallyincludedwhenanalyzingenergyefficiencyinvestments,theymakeforaninterestingancillarybenefittothepropertyowner.

Lease structure: The structure of the lease between tenants and landlords also has a large effectonwhetherornotaninvestmentinenergyefficiencywasmade.Notonlydoleasesdictatewhobenefitsfromareductioninenergycosts,buttheyalsodictatewhopaystheinitialcost.Theleasesinplacewereconsideredamajorfactorinwhetherornotalandlordiswillingtomakeinvestmentsinenergyefficiency.Inthecaseofagrosslease,thelandlordismorelikelytomaketheinvestmentbecausethelandlordmaycaptureenergysavings.Inatriplenet(NNN)lease,thelandlordisveryunlikelytomakeanenergyefficientimprovementbecausehe/shewouldbepayingfortheimprovementwhilethetenantrealizedanysavings.

Mostintervieweesstatedthattheleasesintheirofficebuildingsaremodifiedgrossleaseswithanexpensestop.Asaresult,managersanalyzetenantrolloverinthepropertytoevaluatewhentomakeinvestmentsinenergyefficiency.Ifthereissignificantupcomingrollover,thelandlordmaytaketheopportunitytoreduceenergyexpensestherebyreducingtheexpensestopforanynewleasesorleaserenewals.Alowerexpenseforthebuildingflowsthroughtoahighernetoperatingincomeandgreatercapitalizationoftheincomeatpropertydisposition.Thisconceptwillbeexploredin greater detail in the discussion about the proformabelow.

Many leases also allow the landlord to amortize thecostofcapitalimprovementstothetenant,providedthatthecapitalimprovementshaveadirectpositiveimpacttothetenantthroughthereductionofoperatingexpenses.Thisleaseclausemayapplytoenergyefficiencyimprovementsifthetenant’senergycostsdecreaseasaresultoftheimprovement.Whiletheintervieweesweresplitonwhethertoamortizethecostoftheimprovementoverthelifeoftheleaseorthepaybackperiodoftheimprovement,theyallconfirmedthatgettingthetenanttoshareinthecostofanyimprovementshelpedmakethedecisiontoinvestinenergyefficiencyeasier.The


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followingissamplelanguagethatexplainshowalandlordcanamortizethecostofimprovementstoatenant:

Amortization of the cost of capital investment items which are installed primarily to reduce operating expenses for the benefit of all of the project’s tenants or which may be required by any governmental authority. All such costs, including interest costs, shall be amortized over the reasonable life of the capital investment items, with the reasonable life and amortization schedule being determined by the landlord according to generally accepted accounting principles, but in no event to extend beyond the reasonable useful life of the building.

Managersareencouragedtocheckwiththeirlegalstaffontheinterpretationofthisclause.

Rebates: Inrecentyears,localutilitycompaniesandmunicipalitieshavebeenofferingrebatestobuildingownerstomakeenergyefficiencyimprovementstotheirproperties.Thepresenceofrebateswasfrequentlycitedasamajorfinancialconsiderationwhendecidingwhetherornottomakeinvestmentsinenergyefficiency.One national manager stated that he would makeinvestmentsinrenewableenergy(mostlyphotovoltaic),butthattheseinvestmentswerebeingmadeonlyinstatesthatprovidedrebates.Alongsimilarlines,adirectoratapropertymanagementfirmillustratedthispointwithalightingretrofitprojectthatcost$1.80persq.ft.($19.38persquaremeter)(USdollars)butwasmorethanpaidforby$2.00persq.ft.($21.52persquaremeter)(USdollars)inrebates.

4 .1 .6 Capital Allocation Decision-Making ProcessAsignificantfocusoftheinterviewswastoanalyzehowpropertymanagers,assetmanagersandownersselectamongcompetingcapitalimprovementprojects.Theunanimoustopprioritywasanylifesafetyissueorcodecompliance.Cosmeticimprovementsthatwerethoughttoincreasebuildingoccupancywerethenextpriority,followedbyinvestmentsinenergyefficiency.Similarly,respondentsprioritizedcapitalexpenditure,inpart,onthetimingofthedisposition.Ifanownerfeltthathe/shewould

eitherrecoupthecostorbeforcedtoreducethesalespriceatdisposition,he/shewasmorewillingtospendmoneyonenergyefficiency,suchasanew,efficientboiler.

Thestructureoftheinvestmentvehicle,whetheritwasasingleassetaccount,pooledfundorREIT,wasalsoafactorinenergyefficiencydecisions.Themanagersofopportunityfundsstatedthatsincetheircostofcapitalwassohigh,thetimevalueofmoneyhasanimpactonthedecision.Asimplepresentvaluecalculationshowsthatspendingadollartomorrowispreferabletospendingadollartoday.Asaresult,short-termfundmanagersindicatedtheymighttrytopushanymajorcapitalinvestmentsintothefuture.Onemanagerofavalue-addedfundexplainedthisconceptquitesuccinctly:“Ifmyhurdlerateis20percent[peryear],I’mnotgoingtospend$500,000[USdollars]toupgradethebuildingunlesssomebodywillpayme$600,000[USdollars]forthatupgradewhenIsellthebuildingnextyear.”

Otherfactorsinfluencingcapitalallocationwereassetqualityandmarketposition.Ifanassetwasseentobeofalesserimageinthemarket,capitalwasallocatedtoimprovingtheaestheticappealofthebuilding,orfront-of-the-houseimprovements.Sustainabilityimprovements,withtheexceptionofafewregionalmarkets,arebyandlargeback-of-the-houseexpenditures,whichoftentakeasecondpositionincapitalplanning.Further,severalpropertymanagersstatedthatmanybuildingslackthestructuralormechanicalattributestorealizesignificantvaluefromefficiencyimprovements.Manyownerssimplydonothavethecapitaltomakethenecessaryimprovementstothesebuildings.Foronepropertymanager,80percentofhisbuildingshadenergyefficiencyimprovementsofsomekind,whiletheremaining20percentofownershadnoavailablecapital.

4 .1 .7 Industry StructureThefinancialstructureofarealestateinvestmenthasapronouncedeffectoncapitalexpenditureinenergyefficiencyimprovements.Manyoftheintervieweesownormanagerealestateinarealestateinvestmentfund.Oneindustryveteranwhosecompanymanagesmultiplebillionsofdollarsworthofassetsstatedthatoverhalfof


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hisrealestatefundsarevalue-addedfunds.Itisthisproliferationofvalue-addedfundsthatmaybeactingasabarriertoinvestmentinenergyefficiencyretrofits.

Withaholdperiodofjust3-5years,thereisoftenlittleincentiveforvalue-addedfundstomakeimprovementstoabuilding’senergyefficiency.Onereasonistheinvestorsmaynotrealizeareturnoninvestmentpriortodispositionoftheasset.Anotherreasonistheinvestmentisfocusedonhigh-risk,high-returncapitalappreciation,asopposedtolower,stablecashflowyields.Additionally,duetothehighcostofcapitalforsuchfunds,anycapitalallocatedtoaprojectneedstoimmediatelyshowastrongreturnoninvestmentasindicatedbyseveralassetmanagers.Withsuchhighreturnhurdlesto cross, many fund managers are not willing tomakeinvestmentsintechnologieswherethereturnisconsideredtobeunproven.Further,realestatefunds,whethercoreoropportunistic,generallyreportearningstoinvestorseitheronamonthlyorquarterlybasis.Asenior-levelmanageratapropertymanagementfirmsummeditaccordingly:“Thecommitmenttosustainability[fortheinvestmentcommunity]needstobestrongerthanthecommitmenttoquarterlyearnings.”Afundmanagerisevaluatedontheperformanceofacollectivesetofassets.Forthisreason,amanagerisveryriskaverse,preferringtokeepthevolatilityofreturnstoaminimum.Assuch,amanagerhasanaturaltendencytoavoidcapitalexpendituresthatshowupasalargenegativenumberonafund’sprofitandlossstatement.

Another way in which the real estate industry structuremayinhibitenergyefficiencyimprovementsisthedifferinggoalsamongmanagementplayers.Accountabletoownersandinvestors,portfoliomanagersaregenerallymakingdecisionsthatwillbothincreasereturnsandsmoothvolatility.Theconsensusamongrealestatemanagersisthatastand-alonecapitalimprovementprojectcannotdecreasetheoverallfundperformance.Assetmanagers,ontheotherhand,statedthattheirobjectiveistomaximizethevalueofvariousrealassetsataspecificpointintimesothateachwillfetchthehighestpriceatdisposition.Inastrongrealestateinvestmentmarket,significantvalueiscreatedthroughcapitalappreciationatsale,whichinevitablyleadstoa

high churn rate of buildings being sold. As one assetmanagerstated,“Therealestateindustrylacksproperlong-termplanning.”Meanwhile,propertymanagersarefocusedonmaximizingrevenueanddecreasingcostsinjustoneasset.Eachoneoftheseobjectivesleadstoslightlydiffering goals in the real estate management business.

Arecurrentthemeamongintervieweeswastherealestateindustrylackspropereducationontheissueofenergyefficiency,whichfurtherinhibitsawide-scaleadoptionofenergyefficiencyretrofits.Mostrespondentsstatedthatitwouldbeverydifficulttomakeacapitalinvestment,suchasanenergyefficientchiller,andrealizethefullvalueofthatinvestmentatdisposition.Purchasersandappraisersalikeunderwritethehistoricalutilitybillsofthepropertyandthusimproperlydiscountthefutureperformanceofaretrofit.Anenergyefficiencyinvestmentthereforeneedstoshowadecreaseinenergyconsumptionofasignificantmagnitude. At the same time, that decrease in energy use needs to be sustained for a number of yearsbeforethevaluewillbecapitalizedintothevalueofthebuilding.Knowinghowtheindustryunderwritesacquisitions,manyownersarehesitanttoinvestinefficienttechnologiesiftheycannotrecoupthatinvestmentinareasonabletimeframe.Severalmanagerscommittedtosustainabilitydescribedtheeducationprocessasincremental:investinginincreasingcapital-intensiveefficiencyprojectsasperformanceoflower-costimprovementsintheirbuildingsisproven.

4 .2 Quantitative Analysis: Findings From the

Economic ModelTheprimarypurposeofcreatingafinancialmodelwastoshowhowvariouscapitalinvestmentsaffectthefinancialreturnsataproperty.Whilethe measurements in the model are not intended toprovideprecisereturns,themodelisusefulfordetermininganappropriateorderofmagnitudeofreturns.Withineachinvestmentscenario,multiplepermutationswererun.Thefollowingtablessummarizethevariouspermutationsthatweretestedandthesensitivitieswithineachscenario.


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Base case scenario: Noinvestmentismadeineitheracosmeticupgradeorenergyefficiencyupgrade(Table9).

Investment scenario 1 (“rent increase”): An investmentof$200,000(USdollars)ismadeincosmeticupgradestothebuilding,suchasthelobby,restrooms,etc.Thebuildingimprovementisexpectedtopositionorrepositionthebuildingtoreceiveahigherrentthanthebasecaserentof$19.43persq.ft.($209persquaremeter)(USdollars).Allothervariablesstayfixed.Table10summarizesthespecificrentincreasepermutationsthatweretestedwithinscenario1.

Table 10: Permutations for rent increase scenario

Investment scenario 2 (“lease-up improved”): Similartoinvestmentscenario1,aninvestmentof $200,000 (US dollars) is made in cosmetic upgradestothelobby.However,inscenario2,theimprovementisexpectedtobothincreasetenantretentionanddecreasetheabsorptiontimeforanyvacantspace.Noothervariablesarechanged.Renewalprobabilitywillincreasefromthebasecaseof75percentandatthesametimeabsorptionperiodwilldecreasefromthebasecase of 6 months. Table 11 summarizes the three permutationswithinscenario2.

Table 11: Permutations for lease-up improved scenario

Investment scenario 3 (“energy decrease”): Ininvestmentscenario3,ratherthaninvestingincosmeticupgradestothelobby,aninvestmentof$200,000(USdollars)ismadeinenergyefficiencyupgradestothebuilding,suchasalightingretrofit,upgradeofanHVACsystem,etc.Noothervariablesarechanged.Energyconsumptionwilldecreasefromthebasecaseof15.70kWhwhichwill result in energy cost reduction from the base caseof$1.66persq.ft.($17persquaremeter)(US dollars). Table 12 summarizes the three permutationswithinscenario3.

Table 12: Permutations for energy decrease scenario

4 .2 .1 Simple Payback Period AnalysisThemajorityoftheinterviewrespondentsstatedpaybackperiodisthemostimportantmetricwhenanalyzinganinvestmentinabuilding.Figure3 showsthesimplepaybackperiodsforeachpermutationwithineachinvestmentscenario.

Base building assumptions Base electricity assumptions

Averagesuburbanofficerent

(2006)

$19.43 (US dollars)

Electricityconsumption 15.70kWh

Averagesubopexpense(2006) $8.30 (US dollars)

Electricityprice(perkWh) $0.106/kWh(USdollars)

Opexpensegrowth(‘05-’06) 3.50% Electricitypriceannualgrowth 2.55%Rentgrowth(‘05-’06) 2.50% Electricityexpenseperbuildingsquarefoot $1.66 (US dollars)Tenantrenewalprobability 75.00% Electricity%operatingexpenses 20.05%Absorption 6 months

Scenario 1

Percentage rent increase

$/sq ft increase (US dollars)

Permutation1 0.83% $0.25



Scenario 2

Renewal probability

Absorption period (months)

Permutation1 80.00% 5Permutation2 85.00% 4Permutation3 90.00% 3

Scenario 3

Electricity expense decrease

First year decrease op

expense per sq ft(US dollars)

Permutation1 25.00% $0.44 Permutation2 30.00% $0.53 Permutation3 35.00% $0.61

Table 9: Base case scenario


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Figure3illustrateshowinvestmentinacosmeticupgradecanbelesspredictablethaninvestmentinanenergyefficiencyupgrade.Therentincreasescenario(scenario1)isverysensitivetowhetherrentincreases$0.25,$0.50or$0.75persq.ft.(USdollars)withpaybackperiodsrangingfrom4.11yearsto9.07years.Similarly,thelease-upimprovedscenario(scenario2)isalsoverysensitivetoeachpermutationwiththepotentialforthequickestpaybackat1.94years,butalsothelongestpaybackat9.8years.Contrastingwiththeother two scenarios, the energy decrease scenario (scenario3)resultsareclusteredveryclosetogetherwithlittledifferencebetweenthevariouspermutations.Thisanalysissuggeststhatthoughinvestinginenergyefficiencyimprovementsmaynotprovidethequickestpossiblepayback,itmaybeabetterinvestmentformanagersinterestedinkeepingvolatilityofreturnstoaminimum.

4.2.2 Project-Level Internal Rate of Return

AnalysisEachinvestmentscenarioandpermutationwasalsoevaluatedonmeritofinternalrateofreturn(IRR)overa10-yeartimehorizon.Figure4showsacomparisonoftheIRRforeachinvestmentscenarioandpermutationswithinthescenario.The IRR is calculated based on the initial cost of theimprovementprojectandusestheincrementalincreasetothenetoperatingincomeasthestreamofcashflows.Thisisaproject-levelIRRanddoesnottakeintoaccountreversionvalue,whichwillbeanalyzed later in this section.

Figure 3: Project-level payback period comparison


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Figure4displayshowboththerentincreasescenarioandlease-upimprovedscenariohaveanegligiblereturninpermutation1,whiletheenergydecreasescenarioreturnsa14percentIRR.Inthe energy decrease scenario the decrease to operatingexpenseisrealizedinthecashflowoftheyearfollowingtheimprovement.Thisresultsinahighernetoperatingincomerealizedearlierinthe10-yeartimehorizon,whichincreasestheoverallIRR.Incontrast,therentincreasedoesnotimpactthecashflowuntilthereissignificantrolloverandleaseratesareresettothehigherrents.Thelease-upimprovedscenarioishighlysensitivetotherolloverinthebuildingthusimpactingthecashflow.

4.2.3 Project-Level Net Present Value AnalysisThethirdmetrictoevaluatethefinancialimpactofeachinvestmentscenarioisanetpresentvalue(NPV)analysis.TheNPVassumesadiscountrateof7.5%,whichassumesa10-yearTreasury(3.49%yield)plusariskpremium(400basispoints).Figure5showstheproject-levelNPVofeachinvestmentscenariobasedona10-yearcashflow.TheNPViscalculatedusingtheinitialcostoftheproject,thediscountrateandincrementalincreasetonetoperatingincomeasthecashflowstreamanddoesnottakeintoaccountreversion.

Figure 4: Project-level 10-year IRR comparison (no reversion)


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Figure 5 shows that the rent increase scenario netsthehighestpositiveNPVtotheprojectandthelease-upimprovedscenarionetsthelowestpositiveNPV.TheenergydecreasescenarioistheonlyscenariotoreturnapositiveNPVinpermutation1.Likewise,theenergydecreasescenario is shown to be the lowest in return volatility,measuredbythedifferencebetweenthelowest and highest outcomes.

4 .2 .4 Annual Net Operating Income AnalysisThefollowinganalysiscomparesallthreeinvestmentscenariosagainsteachother.Forsimplicity,onlythemiddlepermutations(permutation2)areused.Themiddlepermutationswereselectedastheyaremostlikelyto occur for each scenario.

Eachinvestmentscenarioisanalyzedbasedonhowmuchthenetoperatingincome(NOI)increases each year. Figure 6 shows the annual NOIincreaseforeachtypeofimprovementaslineswiththeunitsontheleftyaxis.Thegraphalsoshowsthepercentageoftenantleaserollovereach year, shown as bars with the units on the rightyaxis.

Figure 5: Project-level 10-year NPV comparison (no reversion)


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Figure6clearlyshowsthatwheneveratenantleaserollsover,theannualNOIforthelease-upimprovedscenarioincreasesdrastically.Duringyearswhenthereisnotenantrollover,however,NOI does not increase at all. In contrast, the NOI for both the rent increase and energy decrease scenariosincreasesastenantleasesrollover,thengraduallygrowsovertime.Thiscomparisonshowsthataninvestmentdecisionforacosmeticupgradetoincreasetenantretentionexhibitsvolatilereturns.Iftheintentoftheinvestmentistoraiserentsordecreaseexpenses,however,thesereturnsarelessvolatileandmorepredictable.

4 .2 .5 Reversion Value AnalysisTheNOIanalysiswasextendedtocalculatethefinancialimpactonassetvalue.ThiswasdonebyapplyingacapitalizationratetotheNOIduringeach year of the analysis. As can be seen in Figure 7, the base case, rent increase and energy decreasescenariosareallquitevolatilebecausethereversionvaluedipswheneversignificantlease-upcostsareincurred.However,thelease-upimprovedscenarioactuallydecreasesthevolatilityofreversionvaluebecauseitdecreasestheseverityoflease-upcosts.Managersshouldrecognize that while changes to NOI are more volatileunderthelease-upimprovedscenario,decreasinglease-upcostscanactuallysmooththevolatilityoftotalreturns.Figure7showstheassetvalueateachyearbyinvestmentscenario.

Figure 6: Annual NOI increase vs . rollover percentage


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4 .2 .6 The Effect of Tenant Rollover on Investment Returns

Thefinancialmodelalsotestedforsensitivitytoleaserolloverontherentincreasescenarioandenergydecreasescenario.Thelease-upimprovedscenariowasnottestedbecausereturnsinthisscenarioaredrivensolelybytenantrollover.Theimpactofleaserolloverwastestedbyvaryingthetimingoftheinvestmentagainstleaserolloverof60percent,40percentand20percent.

Energy efficiency improvements: Many interviewrespondentsstatedthattenantleaserolloverwasadecidingfactorinconsideringanenergyefficiencyimprovement.Theenergyefficiencyimprovementlowerstheoveralloperatingexpenseofabuilding,increasingtheNOI.Byreducingoperatingexpensesjustpriortoarollover,anynewleasethatissignedwillhavealowerexpensestop.Therefore,withaloweroperatingexpenseandalowerexpensestoptoreimburseexpenseescalations,thelandlordwouldbenefitfromsavingscreatedbytheenergyefficiencyimprovement.Totestthisassertion,themodelwasrunwiththeenergyefficiencyimprovementbeingcompletedinoneofthreeyears:year1,year2oryear4.Therolloverschedulewaskeptfixedinalloftheseteststoseewhenthelandlordwouldbenefitmostfrommakingthisinvestment.TheincreasetoNOIwasusedasthefinancialmetrictomeasuretheresults.Figure8 plotsthechangestoNOIineachtestagainsttherolloverschedule.

Whentheinvestmentismadeinyear1,40•percentoftenantsrolloverwithinoneyearandtheremaining60percentrolloverthenextyear.Inthiscase,theNOIincreasesveryrapidlyandremainsatthishighlevelthroughout the analysis life.

Whentheinvestmentismadeinyear2,60•percentoftenantsrolloverwithinoneyear,buttheremaining40percentdonotrolloveruntilyear7.Inthiscase,ittakesmuchlongerfortheNOItoclimbtothemaximumwhentheinvestmentismadeinyear1.

Whentheinvestmentismadeinyear4,only•20percentoftenantsrolloverwithinoneyearand the remaining tenants are not fully rolled overuntilyear8.Inthiscase,NOIisclearlylower than either of the other two scenarios for a much greater time.

Thisanalysisconfirmstheassertionsbeingmade by most real estate managers. In order tofullyrealizethevalueofanenergyefficiencyimprovement,itismostbeneficialtohavetenantsrollingoversooner,ratherthanlater,aftertheimprovementismade.

Figure 7: Reversion value comparison (Year 0 investment)


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Figure 8: Sensitivity of energy efficiency improvement to lease rollover

Cosmetic improvements: Theimpactofrolloverwas also analyzed for the rent increase scenario. Similartotherolloveranalysisonanenergyefficiencyimprovement,thetimingofthecosmeticimprovementwasvarieddependingontherollover

schedule of the building. The increase to the NOI exhibitssimilarcharacteristicstothedecreaseinenergywithrespecttorolloversensitivity:theincreasetoNOIisproportionatelyrelatedtorolloverinthebuilding(Figure9).

Figure 9: Sensitivity of rent increase to lease rollover


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Tocomparetheorderofmagnitudeforeachscenario on increase to NOI, each was analyzed witha60percenttenantrollover.Figure10showsacomparisonoftheenergydecreasescenarioandtherentincreasescenario.Thereturnvolatilityissimilar;however,theenergydecreasescenarioshows a greater increase to NOI earlier in the cash flowandpersiststhroughouteachyear.

4.2.7 Energy Efficiency RebatesUtilitycompaniesandvariousgovernmententitiesroutinelyproviderebatestopropertyownerswhoperformenergyefficiencyimprovements.Thoughrebatesmaynotalwaysbeavailableasfundingsources,manyintervieweesstatedthattheyplayaroleindecidingwhetherornottoinvestinenergyefficiency.Guidedbyrecommendationsfromvariousinterviewees,rebatesof$0.60persq.ft.($6.46persquaremeter),$1.20persq.ft.($12.92persquaremeter)and$1.80persq.ft.($19.38persquaremeter)(USdollars)wereanalyzedtodeterminetheireffectonsimplepaybackperiodwitha$2.00persq.ft.($21.53persquaremeter)(USdollars)investment.Startingfromabasecaseassumptionwheretheenergyefficiencyimprovementreducesenergyconsumptionby30percent,rebatesinyear1oftheanalysishadthefollowingeffectonsimplepaybackperiodasshown in Table 13.

Table 13: Energy efficiency rebates payback period

analysis

Rebatesclearlyhavealargeimpactonthepaybackperiodofaninvestment.Whileutilitycompaniesandgovernmententitiesmaynotcontinuetoofferrebatesinperpetuityasenergyefficientimprovementsbecomemoreprevalentin the industry, one can clearly see why they arecurrentlysuchadrivingforcebehindtheinvestmentdecision.

4 .2 .8 Combined CaseAninvestmentinabuildingdoesnothavetobecategorizedaseitheracosmeticimprovementoranenergyefficiencyimprovement.Ifalobbyisretrofitted,itwilllikelyreceiveupdated,moreefficientlightfixtures.Similarly,alightingretrofitnotonlysavesenergybutmayenhancethe

Figure 10: Comparison of NOI increase: energy decrease vs. rent increase scenario

Rebate amount (US dollars) Payback period (years)

$0 3.53

$0.60 2.53

$1.20 1.48

$1.80 0.86


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aestheticqualityofthebuilding.Toanalyzethiseffect,thetwotypesofinvestmentsmightbecombinedwiththeassumptionbeingthatanintegrateddesignapproachwillachieveresultsaboveandbeyondthoseachievableifeachinvestmentwascompletedonitsown.Acosmeticupgradeispresumedtoalreadyincorporatesomeenergyefficientfeatures.However,sinceconstructionwillalreadybetakingplace,theincrementalcosttoimproveenergyefficiencytoanevengreaterdegreeisrelativelysmallincomparisontocompletinganenergyefficiencyimprovementalone.

Inthecombinedcasescenarioforthesubjectbuilding, a $200,000 (US dollars) cosmetic improvementisassumed.Anadditionalinvestmentof$100,000(USdollars)toupgradetheimprovementstobemoreenergyefficientisaddedtothecost,anapproximatecostincreaseof50percent.Assumingthatmuchoftheenergy

efficiencyimprovementcostmayalreadybe partofthecosmeticimprovement,anadditional 50percentcostisaconservativeestimate. The combinedcaseisassumedtohavebothapositiveeffectonrentsbyanincreaseof$0.50persq.ft.($5.38persquaremeter)(USdollars)andloweroperatingcostsbyadecreaseinenergyconsumptionof30percent.

In the combined case the return would be expectedtobegreaterthanifeachprojecthadbeenundertakenseparately.Spendingtheadditional $100,000 (US dollars) on the cosmetic improvementyieldsapproximatelythesamereturnasifeachprojectwascompletedindependently.Inthisscenario,spending$300,000(USdollars)todayprovidesasimilarreturntospending$400,000(USdollars)intwoseparateprojects.Figure 11 shows the incremental effect of the combinedcaseincomparisontoeachindividualcaseinvestmentscenario.

Figure 11: Comparison of NOI combined case vs . individual scenarios


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4 .2 .9 Summary of ResultsThequantitativemodelincludedthreepotentialscenariosforinvesting$200,000(USdollars)inafictitiousbuilding:

1)Invest$200,000(USdollars)inacosmeticimprovement,whichresultsinarentincrease

2)Invest$200,000(USdollars)inacosmeticimprovement,whichresultsinincreasedtenantrenewalprobabilityanddecreasedabsorptiontime

3)Invest$200,000(USdollars)inanenergyefficiencyproject,whichreducesoperatingexpenses

Eachscenariohadthreeseparatepermutationstotestthesensitivity.Allthreescenariosshowedthatanycapitalinvestmenthasahighsensitivitytotenantrollover.Ingeneral,thevalueoftheinvestmentisnotcaptureduntilanewleaseissigned,soamanagerwouldbewisetomakeanyinvestmentspriortosigningnewleases.Thelease-upscenariowasparticularlyvolatilecomparedtotheotherscenariosasvaluecreationishighwhenaleaserollsoverandzeroatallothertimes.Keepingthepriorpointaboutrolloverinmind,ifabuildingisalreadynearfulloccupancy,thelandlordmaybewisetonotinvestuntilatenantrollovergetsclose.Finally,thereturnsofbothcosmeticscenariosvarywidelyinmagnitude and timing of the return.

Incontrast,theinvestmentinenergyefficiency,whilenothavingthehighestreturninallscenarios,isbenefitedbylowvolatilityandanarrowrangeof returns. In a time of general uncertainty in the realestatemarkets,thepredictabilityaffordedbyenergyefficiencyinvestmentsmaybewell-suitedfor many real estate managers.

Analyzingtheissueofenergyefficiencyfrombothaqualitativeandaquantitativeperspectiveallowedtheauthorstodiscovertheindustrypracticeandattitudetowardenergyefficiencyimprovementsandthenconfirmiftheseviewswerewarrantedusingafinancialmodel.Arecurringthemeamongdecisionmakerswasthatgetting tenants into the building would always beatoppriority.Thiswilllikelyalwaysremainthe case because without tenants, it does not matterhowefficientabuildingis.However,mostportfoliomanagersstatedthattheyareconcernedwithshowingasteadyreturnandkeepingreturn

volatilitytoaminimum.Accordingly,anenergyefficiencyimprovementthatisaccretivetoNOIeach year should be considered alongside more volatileinvestmentstrategies,suchastryingtoincreasetenantretention,whichisonlyaccretivetoNOIwhenaleaserollsover.

Onecounter-intuitiveresultwasregardingthetimingandvolatilityofreturnsineachscenario.Theestimatedpaybackperiodsforbothcosmeticimprovementscenarios(rentincreaseandlease-upimprovement)exhibitedgreatvariationbetweeneachpermutation.Incontrast,whiletheenergyefficiencyscenariodidnotexhibitpaybackperiodsaslowassomeoftheotherscenarios,thepaybackperiodwaslessvolatileoverall.Similarly,thespreadofNOIpossibilitiesvariedwidelybetweenpermutationsinthecosmeticinvestmentscenarios.Meanwhile,thespreadofpossibleNOIincreasesresultingfromenergyefficiencyimprovementswasmuchlessvolatile.

Interviewparticipantsalsosaidtheyweremorelikelytomakeinvestmentsinenergyefficiencyjustpriortoleasesrollingover.Thefinancialmodeldemonstrates why this is such a large factor andshowsthedrasticeffectthatrolloverhasonNOI increases resulting from both cosmetic and energyefficiencyimprovements.Insum,thedual-focusedapproachofinterviewscoupledwithafinancialmodelwasabletoconfirmmuchoftheindustry sentiment while also bringing forward severalissuesthatmayhavebeenoverlookedbytherealestateindustryoverall.

4 .3 RecommendationsThepurposeoftheresearchpresentedwithinthispaperwastodiscoverwhetherthereisamisalignmentofincentivesandmotivationsthroughouttherealestatemanagementvaluechainthatpreventinvestmentinenergyefficiencyretrofitstoexistingbuildings.Thefollowingconclusionscallattentiontoinefficiencyandofferrecommendations for correction.

4 .3 .1 Increase TransparencyOneofthemostfrequentlycitedreasonsfrominterviewparticipantsforinvestinginenergyefficiencywastobetterthecorporateimage.Manyfirmsuserealestatetoshowcasecorporatecommitment to sustainability to their shareholders, clientsandpartners.LEEDEBOMcertification


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istakingholdformultitenantofficebuildings,butcriticspointtothelackofemphasisonenergyuseandtheprescriptivenatureofthepointsystem.BothLEEDEBOMandENERGySTARPortfolioManagerarevoluntaryprograms.Currently,whentenantsandpurchasersareevaluatingabuilding,itisdifficultforthemtoknowhowmuchenergythebuildingactuallyusesandthereforeitsoverallenergyefficiency.Beginningin2010,CaliforniaandWashington,DC,willrequirepropertyownerstodiscloseabuilding’sENERGySTARratingpriortoanymajortransaction.

ThesedisclosurelawswilllikelyadvanceinvestmentsinenergyefficiencyascurrentownersstrivetogettheirENERGySTARratinghigherpriortoatransaction.Further,asshownthroughthefinancialmodel,investmentsinenergyefficiencywillnotonlymakeabuildingwithlowenergyconsumptionattractivetobuyers,butwillalsoprovideapositivefinancialreturn.Withenergy disclosure, tenants and buyers will become informedinmakingdecisionsabouttheoperationalperformanceofabuilding,whichmayresultinahighervaluationforenergyefficientbuildings.Ownersandlandlordsmayfindinvestmentsinenergyefficiencyprojectstobemoreliquidastheimprovedbuildingperformancebecomesvisibleanddesirabletothemarket.

4 .3 .2 Education and Proof of Concept Is Required

Arecurringperceptionfromtheintervieweesregardingenergyefficiencyretrofitsisthatmanyimprovementsrequiretheuseofnewtechnologiesthatarenotyetproven.Thecasecanalsobemadethatthetechnologiesareactuallywell-proven;ratheritisthecertaintyofreturnsfromthosetechnologiesthatisunproven.Regardlessofwhetherthetechnologiesareunprovenorthefinancialreturnsfromthetechnologiesareunproven,hesitationfromrealestatemanagersexists.Inaperiodwhereinvestmentcapitalisscarce,projectsthataremorevisible,suchasaestheticimprovementstoaproperty,areselectedoverenergyefficiencyprojects.

Asenergyefficiencyimprovementsarefurtherproventoreduceexpensesandcreateapositivereturnoninvestment,adoptionoftheseimprovementscanbeexpectedtobecomemoremainstream.Asthequantitativeanalysishasshown,energyefficiencyprojectshavetheadded

benefitofdecreasingthevolatilityofreturns.Knowledgeofthesebenefits,bothdecreasedvolatilityanddecreasedexpenses,needstospreadthroughouttheindustry,specificallytolendersandappraiserssothattheymakefundingavailablefortheseprojects.Aclearinghouseofdata,perhapsintheformofathird-partyresearchfirm,wouldhelpinthedisseminationofinformationbetweenparties.Withgreaterproofofenergysavingsandincreasedlenderwillingnessforenergyefficiencyprojects,theseimprovementswillbecomemorefrequent.

4.3.3 Proper Valuation of Energy Efficiency Improvements Is Needed

Propervaluationofenergyefficiencyimprovementsislackingintherealestateinvestmentmarket.Intervieweesweresplitroughlyequalbetweenthosewhobelieveenergyefficiencyretrofitsareacapitalexpenseandthosewhorecognizethattheseretrofitscanbe aprofitableinvestment.Assuch,anoftencitedreasonformakinginvestmentsinenergyefficiencyimprovementprojectsistodecreaseoperatingexpensestherebyincreasingtheNOItoabuilding.ArelatedreasonforenergyefficiencyinvestmentisthatbuildingswithimprovementsareviewedtohavepotentiallyincreasedNOIinthefuture;therefore,alowersalescaprateshouldbeconsideredwhencapitalizingNOItoapurchaseprice.However,buyers and sellers should not count on realizing both of these effects at the same time.

Valueiscreatedthroughenergyefficientinvestmentsinbuildingsbecauseeither:Expensesdecreaseforasufficienttimeto•increaseNOI.AmarketcapratewouldbeusedinconvertingthisincreasedNOItoapurchaseprice,orTheenergyefficiencyinvestmentshavenothad•enoughtimetoprovethattheypermanentlyincrease NOI. In this case, a slightly lower than marketcapratewouldbeappliedbasedonthepotentialthatNOIwillincreaseinthenearfuture.

TouseanincreasedNOIandalowercaprateatthesametimewhenvaluingabuildingwouldbeliketryingtocapturethevalueofanenergyefficiencyinvestmenttwice.RecognizingtherelationshipbetweencapratesandNOIwillhelpbuyers,sellers,lenders,appraisersandothersplaceanappropriatevalueonenergyefficientinvestmentswithout“doublecounting”anypotentialincreaseinvalue.


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5

Astrikingexampleofahigh-profilemultitenantofficebuildingenergyefficiencyimprovementcomesfromarguablythemostfamousofficebuildingintheworld–theEmpireStateBuilding.AnnouncedonApril6,2009,theEmpireStateBuildingisanticipatedtoreduceenergyuseandgreenhousegasemissionsbyupto38percent.Whiletheretrofitisexpectedtocostapproximately$20million(USdollars),annualenergysavingsare estimated at $4.4 million (US dollars) (Jones LangLaSalle2009).Thegoaloftheprojectmaygobeyondloweringoperatingcostsandreducingtheemissionsfromthisbuilding.Theprojectteamhasalsocapitalizedonthelandmarkstatusofthebuilding in order to become a model for building owners throughout the world. As stated in the projectcharter:

“The retrofit of the Empire State Building into a Class A pre-war trophy building will transform the global real estate industry by transparently demonstrating how to create a competitive advantage for building owners and tenants through profitably greening existing buildings.” (Jones Lang LaSalle 2009)

Theprojectteam,consistingofJonesLangLaSalle,ClintonClimateInitiative,RockyMountainInstitute,JohnsonControlsandEmpireStateBuildingOperations,isaimingtoachieveaLEEDGoldcertificationandanENERGySTARratingof90.However,theteamdidnothaveanopen-endedbudget.Asafor-profitcorporation,theEmpireStateBuildingCompanyhadtoensure

caSe Study: emPire State BuiLdiNG

Figure 12: Empire State Building: NPV vs . carbon reduction

(JLLProjectPlan,2009)


33


Direct digital controls (DDC) Directdigitalcontrolsallowremote,Web-basedcontrolofabuilding’ssystemstoensure

thattemperaturesandenergyuseremainintheoptimumrange.

Tenantdaylighting,lightingandplugloads Thismeasureinvolvesreducinglightingpowerdensityintenantspaces;usingambient,

direct/indirectandtasklighting;installingdimmableballastsandphotosensorsforperime-

terspaces;andprovidingoccupantswithaplugloadoccupancysensorfortheirpersonal

workstation.

Variableairvolumeair-handlingunits Variableairvolumeair-handlingunitswillreplacetheexistingconstantvolumeunits.

Upgradedwindowglazing Approximately6,500existingdouble-hunginsulatedglasswindowswillbereplacedwith

suspendedcoatedfilmandgas-filledwindows.

Tenant energy management Independentmeteringwillbeprovidedtomanyofthetenants.Tenantswillhaveaccess

toonlineenergyandbenchmarkinginformationaswellassustainabilitytipsandupdates.

Radiativebarrier Morethan6,000insulatedreflectivebarrierswillbeinstalledbehindradiatorunitslocated

attheperimeterofthebuilding.Inaddition,theradiatorswillbecleanedandthethermo-

statswillberepositionedtothefrontsideoftheradiator.

Tenantdemand-controlventilation Carbondioxidesensorswillbeinstalledtocontrolthevolumeofoutsideaircooled.One

returnaircarbondioxidesensorwillbeinstalledperairhandlingunit.

Retrofitofthechillerplant Thechillerplantretrofitwillincludetheretrofitoffourindustrialelectricchillersinaddition

toupgradestocontrols,variablespeeddrivesandprimaryloopbypasses.Duetothe

approachofreducingheatingandcoolingloadsfirst,theprojectteamwasabletoavoid

replacingthechillerandcouldinsteadsimplyretrofittheexistingchiller.

(esbsustainability.com 2010)

Table 14: Empire State Building retrofit projects

thattheupgradesprovidedthemaximumbenefitat the most reasonable cost. To this end, the team analyzedover60potentialprojectsandeventuallysettledoneightfeasibleprojectstoimplement.Theprojectteamperformedenergymodelingtoachieveenergysavingsofupto45percent.However,themarginalcostofincreasingsavingsfrom38percentto45percentprovedtobeprohibitivelyexpensiveundercurrentmarketconditions.Wantingtobeasustainableandprofitableexampleforotherbuildingowners,theprojectteamstrivedforabalanceofcostversuscarbonreduction.Figure12(page32)showsacurverepresentingtotalnetpresentvalueofthe

retrofitscomparedtothecarbonreduction.TheprojectteamdecidedtosettleatthepointalongthecurvelabeledNPV“Mid”whichprovedtobeanappropriatebalancebetweeninvestmentandcarbon reduction.

Toreduceenergyuseby38percent,theEmpireStateBuildingprojectteamimplementedaholisticdesignapproach.First,theprojectteamreducedthe cooling loads in the building. This allowed the chillerplanttonotbeoversized,alsocalledright-sizing. The team settled on the following eight projectsoutofthe60-plusprojectsconsideredfortheretrofit(JLL2008)(Table14).


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Theeightenergyefficiencyprojectslistedaboveindividuallyeachplayapartinreducingenergyconsumptioninthebuilding.Itisthroughtheintegrationoftheseprojectsintoabuildingsystemthatsignificantenergyreductionisachieved.Figure 13 shows the energy reduction of each projectasacomponentoftheintegrateddesign.

Asstatedabove,partoftheimpetusbehindtheEmpireStateBuildingretrofitistoprovideexampleprojectsforotherbuildingownerstofollow.Notonlyaremanagersabletodotheenvironmentallyresponsiblethingthroughtheseretrofits,butalsostrivetoprovethatbeingenvironmentallyresponsiblecanbeprofitable.Withafirmbackgroundofcommercialrealestateandhighperformancebuildingknowledge,thiswhitepaperwillhelppropertymanagersmakethecasetoownersthatenergyefficiencyretrofitscanincreaseNOI,thusincreasingtheowner’sbottomline.

Figure 13: Eight key measures to retrofit the Empire State Building

(Johnson Controls, 2009)


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6 aPPeNdicieS

6.1AppendixA:References

CEBECS(2003).2003CommercialBuildingsEnergyConsumptionSurvey,USEnergyInformationAdministration:www.eia.doe.gov/emeu/cbecs/cbecs2003/detailed_tables_2003/detailed_tables_2003.html#consumexpen03

Ciochetti,B.A.,&McGowan,M.D.(2009).EnergyEfficiencyImprovements:DoTheyPay?Cambridge,MA:MITCenterforRealEstate.

Conley,B.(2010).LightingSolutions,Sustainability“How-ToGuide”Series.IFMAFoundation:

Dirksen,T.H.,&McGowan,M.D.(2008).GreeningExistingBuildingswithLEED-EB!UnpublishedThesis, MIT Center for Real Estate.

esbsustainability.com(2010).EmpireStateBuildingSustainabiltyWebsite.

Hahn,T.C.,Geltner,D.,&Gerardo-Lietz,N.(2005).RealEstateOpportunityFunds:PastFundPerformanceasanIndicatorofSubsequentFundPerformance.Cambridge,MA:MITCenterfor Real Estate.

IREM(2008).InstituteofRealEstateManagement(IREM)Income/ExpenseAnalysis:OfficeBuildings.

JohnsonControls(2009).EnergyEfficiencyIndicator.Milwaukee,WI.

JLL(2008).JonesLangLaSalle.ALandmarkSustainabilityProgramfortheEmpireStateBuilding.Newyork.

LeonardoAcademy(2008).TheEconomicsofLEEDforExistingBuildingsforIndividualBuildings2008Edition.Madison,WI.

NationalRealEstateInvestor(July1,2008).Top25PropertyManagers.RetrievedJune23,2009,fromNationalRealEstateInvestor:

NationalScienceandTechnologyCouncil[NSTC](2008).FederalResearchandDevelopmentAgendaforNet-ZeroEnergy,High-PerformanceGreenBuildings.Washington,D.C.:USFederalGovernment.

Pensions&Investments(October16,2006).Pensions&Investments.RetrievedJune15,2009,fromLargestRealEstateInvestmentManagers:

Roberts,T.(April1,2009).Cost-EffectiveGreenRetrofits:OpportunitiesforSavingsinExistingBuildings.EnvironmentalBuildingNews.

USDepartmentofEnergy[DOE](2008).2008BuildingsEnergyDataBook.Washington,D.C.

WBCSD(2007).WorldBusinessCouncilforSustainableDevelopment.EnergyEfficiencyinBuildings.Geneva:WorldBusinessCouncilforSustainableDevelopment.

www.eia.doe.gov/emeu/cbecs/cbecs2003/detailed_tables_2003/detailed_tables_2003.html#consumexpen03

www.ifmafoundation.org/programs/sustain_wp.cfm

www.nreionline.com/research/real_estate_top_property_managers_0701/index.html

www.pionline.com/apps/pbcs.dll/article?AID=/20061016/CHART/101011593&template=printart

http://www.esbsustainability.com


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6.2AppendixB:Glossary

Core fund:Acorefundisgenerallyconsideredtobealower-risk,lower-returninvestmentthatseeksstabilizedassetsinestablishedmarketsorlocations.

Internal rate of return: The internal rate of return (IRR) is the discount rate established by an organizationasthethresholdforwhichaninvestmentisconsideredeconomicallyviable.Itiscalculatedusingthevalueoffuturecashflowsinaninvestmentwherethenetpresentvalueisgreaterthanorequaltozero.Itcanalsobethoughtofastheannualcompoundedrateofreturnonecanexpectonaninitialinvestment.

Net present value: Thenetpresentvalue(NPV)ofaninvestmentisthesumofallfuturecashflowsfromaninvestmentdiscountedbacktothetimeoftheinitialinvestment.Thediscountrateshouldbeequaltotherateofreturnthatcouldbeachievedinanalternateinvestmentwithsimilarriskcharacteristics.

Net operating income (NOI) increase:Thereasonformakingacapitalinvestmentinabuildingistoincreasethenetoperatingincomecreatedbythatbuilding.Byanalyzingtheup-frontinvestmentincomparisontotheannualincreaseinNOI,decisionmakerscandecideiftheinvestmentwillmeettheirreturncriteria.Further,dividingtheincreasedNOIbyacapitalizationratedetermineshowmuchaninvestmentaddstothetotalvalueofaproperty.

Pooled funds:Pooledfundsareaggregatedfundsfrommanyindividualinvestorsforthepurposeoftheinvestment.Thereisawiderangeofpooledfundsavailable,generallycharacterizedbytherisk-returnstructureofthefund.Twocommonpooledfundsarevalue-addedfundsandcorefunds.

Real estate value-added fund: Arealestatevalue-addedfund,alsocalledanopportunisticfund,istherealestateequivalentoftheprivateequityandalternativeinvestmentclassthatseekhighreturnsandoftenfocusondevelopmentorturnaroundproperties(Hahn,Geltner&Gerardo-Lietz2005).

Simple payback period:Thesimplepaybackperiodofaninvestmentistheamountoftimethatthereturnsfromtheinvestmenttaketopaybacktheinitialcostoftheinvestment.Abasicexamplewouldbea$100(USdollars)investmentthatpays$25(USdollars)peryear.Inthiscase,thesimplepaybackperiodis4years,andthediscountedpaybackperiodwouldbeslightlyless,sincethevalueoffuturecashflowsisdiscountedusingamarketdiscountrate.

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the economics of sustainability in the comemrcial real estate sector

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