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How Utilities Can Overcome Barriers to Energy Efficiency in the Commercial Real Estate Market

In the United States, commercial buildings account for 20 percent of all energy use. With the right programs in place, you might imagine plenty of potential for energy savings in commercial real estate (CRE). And you’d be right. But utilities have struggled to serve this hard-to-reach market for a few reasons. It’s a complex, multifaceted network that contains many different building types, decision makers with conflicting incentives, rigid investment cycles, and divergent priorities. This presents a challenge to implement energy efficiency through the traditional utility channels.

Historically, there have been a number of barriers keeping utility efficiency programs from making inroads in this market.

The ‘split-incentive’ problem

For CRE customers, the opportunity for both owners and tenants to capitalize on efficiency incentives has never been so great. However, when the stakeholder who pays the upfront costs of an energy efficiency improvement is different from the one who benefits from energy savings, we get a ‘split-incentive’ disconnect. In an investor-owned, multi-tenant office building, for example, the costs and benefits of efficiency improvements may be misaligned among the owners and tenants. So, the chances are one or more parties won’t agree to even the most financially attractive efficiency projects.

Solutions

In each situation, determine basic value propositions for all parties involved early in the process, and make sure programs are flexible enough to align incentives for everyone.

It’s key, of course, to understand the leasing structures in place. For example, in full-service gross leases, the owner receives full energy savings. In triple-net leases, it’s the tenant who benefits from full savings. In modified gross leases, the savings are split.

You also need to know who fronts the cost of any tenant improvements, and whether the space is master-metered (so the owner captures the buildings’ energy savings) or sub-metered (allowing tenants to benefit from savings they generate).

Understanding and navigating the dynamic environments within multi-tenant spaces is critical so you can provide the right stakeholders with the right information at the right time.

The information gap

stakeholder-frustrated

Many existing utility programs offer great benefits for the CRE market, but stakeholders just don’t see what’s in it for them. From a CRE perspective, the top priority is to keep their tenants happy and improve the net operating income (NOI) for ownership. So, energy efficiency planning becomes a low priority for them.

Solutions

Focus on developing strong relationships and communication channels with property managers, owners and tenants. Collaborate with key decision makers, providing timely support in creating effective business cases for efficiency investments.

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Target your messaging, using language and media that resonate with your intended audience. For example, a property owner might respond well to a personal call reminding her that energy efficient tenant spaces save money and increase asset value by contributing to certifications like ENERGY STAR—while the same information in a weekly newsletter repeatedly left her cold.

The value (mis)perception

Actual or perceived costs associated with energy efficiency programs, together with misunderstandings of the benefits, commonly prevent stakeholders from investing.

But utilities frequently communicate the benefits of energy efficiency in terms of kWh usage and peak kW demand reductions, rather than in terms of clear financial ‘value added,’ which the CRE market needs to hear.

Solutions

Make sure CRE stakeholders really understand the business case for energy efficiency. Even where there’s a split incentive, building owners can benefit from market differentiation—and often command higher rents and longer tenures. Recent research shows energy efficient buildings attract rent an average of 2–6 percent higher than standard and can sell for a premium of 16 percent. They also attract higher quality tenants and have lower default rates for commercial mortgages.

When you present your energy efficiency business case, use metrics that commercial owners and customers easily understand and appreciate—such as spend per square foot, payback period, value added to net operating income (NOI) and return on investment (ROI).

The timing mismatch

Property life cycles and budget schedules are structured and immovable. If you recommend an efficiency project after a CRE customer’s capital planning cycle has ended, when a tenant improvement program has just finished, or toward the sell period of a property when the owner is less likely to invest, you’ve probably missed the boat, at least for this fiscal year.

Solutions

Align your recommendations with customers’ annual capital budgeting cycles—most are planned in August or September for the following year. And as tenant spaces roll over, provide check-your-calendardesign guidance to help make sure planned renovations include cost-effective efficiency measures.

"Understanding the capital budgeting cycle is crucial in obtaining timely commitments from building management for energy efficiency projects," according to a report by Waypoint Energy.

Because the property investment lifecycle can be as short as 2–5 years, an owner is often more willing to consider large capital upgrades, including efficiency improvements, early in the cycle when investments will still pay off before the disposition phase. Aim to identify and capitalize on these critical times in the investment lifecycle, so you can offer appropriate incentive programs at key moments.

Taken together, these solutions could make a big difference to utilities, helping overcome current stumbling blocks in the CRE market and boosting uptake of existing incentive programs in traditionally hard-to-reach sectors. Franklin Energy partners with Waypoint Energy to bring comprehensive CRE solutions to our mutual clients. Schedule a meeting with a Franklin Energy expert today to learn more.

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References

ACEEE (2016) ‘Connecting the Commercial Real Estate Market and Utilities: Achieving Energy Savings in Commercial Buildings’: https://aceee.org/files/proceedings/2016/data/papers/4_680.pdf
U.S Department of Energy (2016) ‘Energy Efficiency in Separate Tenant Spaces – A Feasibility Study’: https://www.energy.gov/eere/buildings/downloads/energy-efficiency-separate-tenant-spaces-feasibility-study
Ed McGlynn
Written by Ed McGlynn

VP of Large C&I Strategy
When describing Ed McGlynn’s duties, the list is not a short one. He develops new products and services for the commercial and industrial segment, offers consulting advice to electric and gas utilities and provides support to Franklin Energy’s regional operation teams, which implement demand side management programs across the country. His 30 years of experience with utilities and demand side management have allowed him to develop and apply vision, leadership and innovation. Ed serves on the board of directors for the New Buildings Institute (NBI) and is a former board member of the Association of Energy Service Professionals (AESP) and the Compressed Air Challenge (CAC). An electrical engineer, Ed also holds an MBA from Providence College and is a certified energy manager (CEM) and certified building commissioning professional.

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