Given a new U.S. administration, many people have asked me if I am optimistic about energy efficiency projects. My answer is YES. But it has nothing to do with a new administration. No matter how you analyze it, energy efficiency is a great investment.
Energy efficiency projects have high returns and extremely low risk. What they typically don’t have is a compelling event forcing them to get done. Unlike a roof leak that demands repair, energy waste does not cause the same kind of immediate concern. Most energy projects are discretionary and optional. Nevertheless, the value created by energy conservation should attract the attention of building owners.
This month’s article focuses on one undersold aspect of energy savings upgrades – the positive impact on a building’s asset value. Even when owners are not planning to sell their building, this benefit is attractive. For example, a business with larger assets looks better to banks and lenders.
Would you believe that a conservation project that saves $200,000 per year in energy can increase a building’s value by $1 million? It’s true. I work with many real estate companies that are using this particular selling point to get massive projects approved and implemented.
I will show you a logical, mathematical approach that you can use to make your own calculation.
An Easy Calculation
There are only two steps to calculate the improved building value:
1) Understand the hurdle rate, or simple payback, required by the building owner
2) Multiply the simple payback by the annual energy savings from a project.
STEP 1 – Let’s begin with the hurdle rate. What minimum return on investment (ROI) is necessary for approval by your organization? Some of my industrial customers (who have a short-term view) want a 50% ROI, which means a payback of approximately two years. Some of my government clients (who have a longer view) are comfortable with a 10-year payback (~10% ROI). Many commercial properties require a 3- to 5-year payback, which would represent 33% to 20% ROI, respectively.
To make a quick analysis, remember that the rate of return is roughly the inverse of the simple payback. For example, assume your prospective project must meet a five-year payback or less. That is roughly a 20% return (which by the way is still probably better than many other available investments).
If you feel that your organization’s high hurdle rate for energy projects is unfair (given the lower risk), you might challenge it. For example, compare a two-year payback (50% ROI) to your company’s profit margin, which is not likely to be as high. Then you make the point that the energy project would improve the company’s profit margin because its return is higher than the company’s operational return. For more information on such approaches, see my articles, videos and webinars.
STEP 2 – Here is an example to calculate increased building asset value. Imagine that you have two identical buildings, A and B, that spend $1 million annually on energy and maintenance. Suppose you implement an energy project on building B and that it reduces the operating cost by $200,000 per year. As a result, building B costs only $800,000 per year to operate.
Recall from Step 1 that the company requires a 20% ROI for project approval. Thus the building owner approves projects only if the money is returned within five years. Now imagine a prospective buyer of the building. If the buyer’s minimum payback period is also five years, then he/she would be willing to pay $200,000 per year over five years, or $1 million in increased building sale value, because the buyer would recover that additional investment in five years.
So I ask you this: If you were presenting this energy project to a CFO, which sales pitch would sound more appealing: Do this project and save $200,000/year, or do this project and increase your building’s value by $1 million?
In fact, you can present both benefits because both are true and they are not mutually exclusive. From personal experience, I know that some building owners consider the increased building value to offset the cost of a project. For example, if a project costs $40,000 and adds to the building value by $40,000, then some buyers mentally consider the project as neutral, even though they wouldn’t recoup the additional sale value unless they sold the building.
Note: If your company requires a five-year payback, you can use the formula above to compute the increased building value. However, what really matters is the financial criteria of a prospective buyer. Many buyers are likely to have a relatively long view, 7 to even 10 years, so a multiplier of five years is comfortably conservative.
I hope you can leverage this selling point to get your energy projects approved in 2017. When you do, please let me hear about your success by emailing me at [email protected].
If you want more information on these concepts and other selling points for energy conservation, watch these free videos: http://www.profitablegreensolutions.com/sep-course-samples
Good luck in 2017. Let me know your successes and ideas!