Take 10: Funding an Energy-Efficiency Project

April 14, 2010

Q 1. How would an appraiser value energy-efficiency enhancements in a commercial building?

There are three principal approaches to appraisal:  the cost approach, the market comparison approach and the income approach.  In the income approach to appraisal, the appraiser focuses on net operating income (NOI), since an income property is valued based on the stream of NOI that an investor could enjoy as a result of owning the property.  There are many ways that enhanced energy efficiency can support higher NOI.  For example, a tenant's occupancy cost includes not only his base rent but also his share of operating expenses;  therefore, the lower those operating expenses are, the higher the base rent per square foot can be without changing that tenant's occupancy cost.  Higher base rents support higher NOI.  In situations where the landlord is responsible for all or part of the energy costs, lowering those costs can also increase NOI.  In situations where enhanced energy efficiency supports better tenant retention/attraction, the building's occupancy rate would be higher, which should also support a higher NOI.  In conclusion, if a campaign to improve the energy efficiency of a building drives NOI higher as a result of any or all of these above-referenced effects (or others), it is likely that the asset value of the property would benefit as well.

Q 2. Where might we find funding for water conservation projects?

In many areas of the country, the need to conserve water rivals (or even exceeds) the need to save energy.  Some areas have such dire needs that water conservation is mandated, so rebates/incentives are not used.  Fortunately, there are several online resources that will help you identify potential rebates/incentives:

Here you'll find great maps…

CEE on water efficiency in commercial kitchens

In California….

In the Seattle area…

In Nevada…

In the San Francisco Bay Area…

In Arizona…

In Austin, TX…

Q 3. Why do so many ESCOs prefer to focus on the "MUSH" market rather than commercial real estate?

This preference has a lot to do with the mindsets of these two market segments.  By the way, "MUSH" is shorthand for municipal (state and local gov't), universities, K-12 schools  and hospitals.  On the MUSH side, you often see the intersection of a lot of deferred maintenance, not a lot of capital to address it, and a lack of in-house expertise or bandwidth to assess all of the opportunities for improvement.  For these reasons and others, the MUSH market has been a fertile opportunity for ESCOs who bring a wide variety of skills and in some cases capital to the table.  The commercial real estate industry, on the other hand, tends to favor taking a more direct approach to improving its energy-efficiency profile.  They would sooner hire an energy-savvy engineering firm to assess the opportunities and then have a competitive bidding process to select individual contractors to implement the work rather than engage an ESCO as the prime contractor to perform the assessment and then subcontract the actual work to local lighting, HVAC, and other specialists.   Also notice that MUSH players tend to have long time horizons, while the overwhelming majority of commercial real estate players shy away from long-term commitments (such as decade-long shared savings contracts) that might complicate a future sale or refinancing.  If you're interested in learning more about the prospects of the ESCO model in both the MUSH and CRE markets, you might enjoy reading "The MUSH Market: Problems and Opportunities", which can be found online at  http://greeneconomypost.com/mush-market-9172.htm .

Q 4. Are there incentives available for behavior-based energy-efficiency initiatives?

Behavior is powerfully linked to efficiency.  The good news is that motivating better behaviors doesn't have to be expensive.  For example, utilities who invest in Building Operator Certification (BOC) programs find that they can very cost-effectively reach and influence building engineers whose day-to-day actions determine whether the buildings they control waste or save energy.   There are other ways utilities (and other agencies) seek to finance initiatives that empower better behaviors.  Two examples are utility-sponsored benchmarking training; and, incentives that help pay for submetering in multi-tenant buildings, where we've seen evidence that moving meter visibility and responsibility from the landlord to the tenant results in better efficiency.   ALL OF THAT SAID, please realize that because utilities (and other agencies) have the goal of offsetting the need for future generation, transmission and/or distribution, they need to feel confident that whatever measure they pay for has the same predictability and "persistence" as supply that was added to the grid.  Unfortunately, there are many types of behavioral changes that could create savings today but not necessarily tomorrow.  As a result, many utilities specifically exclude behavior-only measures from their definition of what might be eligible for custom incentives.

Q 5. How can you calculate other "intangible" benefits, such as worker productivity and reduced absenteeism?

There are several approaches to including intangible benefits in your cost/benefit analysis.   One is to test the technology or approach, tracking the impact on metrics that can be both quantified and monetized.  By "quantified" I mean that the impact can be described numerically — for example, the new lighting system resulted in an "x" percent lower frequency of errors in production because workers could now see their work better.  By "monetizing" I mean that you can assign a financial benefit to that quantified benefit — for example, every production error you avoid on this assembly line saves you "y" dollars.  Similar phenomena can be observed, quantified and monetized in service businesses.   For example, if your average employee earns $50,000 per year and occupies 200 square feet, your labor is costing you an average of $250 per square foot per year.  If you find that a lighting retrofit reduces glare and eyestrain enough to encourage your people to work 15 minutes longer each day, you could calculate what that benefit is worth to you.  Given that labor is so much more expensive than energy on an annual-cost-per-square-foot basis, it would not be surprising to see productivity-related savings exceeding energy savings on a per-square-foot basis.  There have been several studies on this topic.  While intangible benefits are sometimes difficult to measure, surveys and the like have underscored the importance of going beyond simply energy savings when crafting a compelling value proposition for your proposed project.

Q 6. Are there any other tips you could offer regarding how to select and negotiate with an ESCO?

The following guidelines were suggested by the US Department of Energy for a successful ESCO project (as paraphrased in a Practice Guide produced in 2008 by the University of Louisville):

  1. Look for more than the low bid.  Select an ESCO with a good track record that can provide other necessary services, such as project design, installation and maintenance….and remember to get references!
  2. Negotiate a contract that reasonably limits ESCO profit-making and establishes a win-win arrangement.  Carefully weigh the pros and cons of shared savings versus fees for services and other contractual arrangements.
  3. Require that the ESCO takes a comprehensive approach rather than cream-skimming.
  4. Ensure the agreement does not allow the ESCO to sacrifice quality for energy savings.
  5. Ask the ESCO to incorporate extended product warranties and personnel training into the bid specification.
  6. Organize an in-house project team to work with the ESCO to choose appropriate energy measures, prepare bid specs, pre-qualify prospective bidders, and perform other tasks when the contract is signed.
  7. Work with the ESCO to test new technologies in order to determine their performance and applicability.
  8. Design the project and coordinate construction in a way that minimizes disruption of the building's functions.
  9. Document both energy and non-energy benefits of your project and publicize its successes to the community.

Q 7. With a very large portfolio of buildings, where do you start in assessing priorities?

Unfortunately, many owners/operators of large portfolios use arbitrary rules of thumb to decide where to focus their energy-saving efforts, such as buildings that have the highest energy cost per square foot.   However, a much better approach would be to use a normalized metric — such as EPA's Portfolio Manager benchmarking score that takes into account building size, space type, occupant density, PC count, operating hours and weather.  It's entirely possible that the lowest hanging fruit is not in the building that happens to spend the most per square foot on energy....What if that highest-cost-per-SF facility happens to be a data center, for example?   Another great way to prioritize energy-efficiency campaigns is to focus on areas of particularly generous rebate/incentive availability.  For example, if you find an area where the utility will rebate 30% of the cost of an energy-saving measure and finance the other 70% at zero interest using on-bill financing, it's certainly worth considering.  Still another variable to study is cost per unit of energy consumed (e.g., cost per kWh).  Energy-saving projects will have better financial returns in areas with higher energy rates.   Ideally, prioritizing the order in which facilities should be studied will be an interdisciplinary triage involving variables like cost per unit of energy, benchmarking score, rebate availability, anticipated holding period, etc.

Q 8.  Is it possible for non-taxable entities to monetize any tax deductions or credits that they might earn (but be unable to use) from doing energy-efficiency projects?

One nice thing about the tax system in this country is that it is flexible enough to accommodate the allocation of tax benefits between the various parties in a transaction.  For example, if a non-taxable entity wishes to install an energy-efficiency project that would normally qualify for tax benefits, it could procure that project through a taxable entity who would retain the tax benefits as part of its compensation.  These arrangements can be quite complex, and the specifics of structuring tax-advantaged financing vehicles is beyond the scope of this Webcast.  However, you'll find that there are plenty of financing organizations out there who could walk you through the process if you were interested.  And of course, I recommend that you seek qualified tax and accounting counsel to help you with your due diligence in this regard.

Q 9. What is the difference between a rebate and an incentive?

While some people use the terms interchangeably, the term "rebate" is generally used to describe an amount of money that is earned after something is purchased/installed or implemented, while the term "incentive" is generally used to describe an amount of money that is provided after the funding source (e.g., a utility) has pre-approved the measure that is about to be purchased/installed or implemented.  This seemingly subtle nuance is worth emphasizing because you don't want to be in a situation where you're applying for an incentive, but you have already purchased/installed or implemented the measure for which you are seeking funding.

Q 10. Can a tenant receive a rebate for equipment that it plans to install in its space at its own expense if the utility bill is in the name of the landlord?

While program rules/regulations vary by program, it has been our experience that as long as the transaction is clearly disclosed and throughly explained to the funding source, a tenant and landlord can work together to make sure that the rebate dollars are collected and that the appropriate party(ies) receive the appropriate share(s) of the proceeds.  Delineating and then documenting the precise relationship between the parties and the intentions of both parties allows the utility or other funding source to have a paper trail tracing the path of the rebate or incentive to the proper party(ies).

Q 11.  How receptive would a local utility be to receiving an unsolicited request for an incentive if a large energy-saving retrofit project were about to occur in their jurisdiction but was not covered by a pre-existing prescriptive program?

First of all, please reference my answer re: the difference between a rebate and an incentive.  If a utility's programs are structured as incentive programs, and it thinks that you would do the project in the absence of financial assistance, you might find them to be unreceptive to your proposal.  If, on the other hand, you share that the project will not happen without the utility's help, you might be on better footing.  Also, if the utility already has a performance-based or custom program where they expect folks to bring non-prescriptive energy-saving solutions to the table for potential funding assistance, they should be open to talking.  As I mentioned in my remarks immediately after our Webcast, their level of interest would also depend on their relative experience offering rebate and/or incentive programs.  Utilities in mature rebate territories (e.g., California, the Pacific Northwest or New England) would probably be more open to "special requests" than a utility that opened its first program just this year and has decided to stick with garden-variety compact fluorescent light bulb replacements and other tried-and-true, easy-to-account-for savings opportunities.  By the way, it helps if a proposed project's estimated savings are modeled using a commonly used energy modeling software tool prior to making the initial contact with the utility.  It also helps to work with an experienced rebate administrator who is likely to have a good working relationship with the utility in question and could present the opportunity to that utility in the most positive light.

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