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ROI of Sustainability is More Complex Than You Think

The value of energy efficiency and sustainability can prove to be greater, more lucrative or more complex than it appears on the surface.

With around 40 percent of U.S. energy consumption accounted for by buildings, most commercial real estate owners, investors and developers recognize the importance of improving the energy efficiency of their properties. And they recognize that it can be financially rewarding to invest in such sustainability upgrades. For investors, energy optimization measures have been shown to generally have a payback period of less than three years. Gone are the days that the investment community was concerned about the ability of sustainable buildings to deliver stable returns. In fact, a survey that Partner conducted in 2015 showed that commercial real estate professionals see energy optimization as the most promising area of investment in real estate assets.

When it comes to ROI, many point out that the financial argument for investing in sustainability upgrades is gaining strength. Benchmarking a building’s energy outputs and developing a strategy to implement more sustainable practices will result in a more efficiently operated asset, which in turn yields improved ROI through higher rents, quicker absorption and lower vacancies, and lower overall operating costs. In addition, the incremental cost of implementing more energy-efficient building systems is often negligible when you consider the many available utility rebates and government incentives.

But there’s more to it: the reality is that the value of energy efficiency and sustainability can prove to be greater, more lucrative or more complex than it appears on the surface. To reconcile sustainability and profitability for optimal ROI, commercial real estate owners and investors need to explore how financial, regulatory, social and market pressures increasingly encourage and reward sustainability in commercial real estate. Here are some of the “hidden” reasons why it pays to invest in energy optimization:

Cutting operating expenses beyond your utility bill
Of course, a better-operated, greener building uses less energy. Because energy usage accounts for up to 35 percent of operating costs for a typical multifamily asset, improving its operational efficiency can make deep cuts to operating expenses. But positive returns can be delivered elsewhere too.

For example, several government sponsored programs (such as the competitive Low-Income Housing Tax Credit, or LIHTC program) encourage green affordable housing by rewarding extra points to projects that have sustainability features and document the implementation energy reduction projects. And many states and local governments offer tax incentives for green building certification to encourage lower utility usage and building carbon emissions. For example, the state of Nevada offers property tax incentives for new and existing multifamily or commercial buildings that achieve a certification from LEED or Green Globes. This incentive translates to a savings of 25-35 percent of the general fund portion of property taxes, delivering a direct and significant reduction to the operating expenses. 

Access to better financing
Improved energy efficiency (and associated green building certificates) can open the door to better financing. Identifying and implementing specific energy efficiency and water conservation measures is a prerequisite for many financing programs that offer favorable conditions (such as discounted interest rates, preferred pricing or additional loan proceeds) for loans made on “green” buildings.

From a cost of lending perspective, Fannie Mae and Freddie Mac have begun offering green lending programs to encourage greater accountability from operators of multifamily properties. These green lending programs (known as Green Rewards and Multifamily Green Advantage respectively) can translate into savings of up to 39 basis points for borrowers who commit to implementing energy efficiency or water efficiency measures. Coupled with the reduction in operating costs that green retrofits generate, these agency programs can have a payback period of just a few months.

Indeed, these market-transforming green lending programs are increasingly driving many building owners to proactively fix or replace systems at the end of their efficient life, rather than their useful life.

A compliance issue
Many older buildings were built before, or to emerging and now much outdated, energy standards and do not meet the requirements set out in modern building codes. With an aging building stock and the need for improved energy efficiency in mind, many local jurisdictions are enacting energy benchmarking and disclosure laws that require building owners to quantify and report their buildings’ energy performance.

Several states and local government are even taking it a step further and mandating green building certifications for new construction, or requiring benchmarking for all existing commercial buildings that exceed a certain square footage. For example, New York City's Local Law (LL) 87 and LL84 require energy audits, retro commissioning and benchmarking for all buildings in the city. San Francisco, Chicago and the state of California, among many others, have followed suit with similar requirements.

The value of corporate responsibility
The above-mentioned energy disclosure and rating programs encourage transparency and availability of building data. This has allowed building energy performance to become one metric that is considered as part of real estate investment, leasing and financing decisions. 

Across the institutional commercial real estate industry, there is a growing expectation to display a commitment to sustainable practices, which is encouraging owner/operators to pursue green upgrades. In other words, institutional investors recognize the financial benefits and are asking for sustainability, and fund managers have to have a plan to address it.

Now, this pressure from investors and cost of capital can weigh heavy in the decision to adopt sustainable measures and benchmark large portfolios of properties. More and more I’m seeing that life insurance, pension and sovereign funds are asking their fund managers to include strategies relating to sustainability, in addition to traditional data. Organizations that assess buildings’ environmental, social and governance (ESG) performance (such as Global Real Estate Sustainability Benchmarking, or GRESB) have been striving to fill the gaps for fund managers attempting to look at energy efficiency, sustainability and benchmarking from a portfolio perspective. Having a consistent, portfolio-wide sustainability assessment is becoming an increasingly important metric to lure investors and justify the cost of sustainability investments.

Getting the most out of energy efficiency investments

Changing regulatory, social and market pressures continue to drive the ROI of energy upgrades. For example, tenants demand greener buildings (and are willing to pay a premium for it); institutional investors are being asked by their capital stack to demonstrate sustainability; and improved energy efficiency opens the door to tax credits, incentives and more favorable financing conditions. To extract the greatest return, building owners/operators need to stay informed about all financing mechanisms and incentives, and determine the best time and appropriate level of upgrades to be made (a good, product-agnostic energy consultant should be able to advise whether to undertake a “cosmetic” upgrade or overhaul all building systems). But in today’s market, it certainly pays to go green—either by seeking out energy-efficent assets or by investing in upgrades to improve the building’s sustainability.

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