Green premium? Not so, as it continues to pay to go green with commercial buildings

There's a lot of greenwash in the commercial real estate industry, fostered by pundits and proponents alike. Separating fact from fiction and reality from distortion is a challenge. Except, of course, when it comes to the facts.

Take a recent report from CoStar and the U.S. Green Building Council (USGBC): Green Premium Continues to Justify Implementation Costs for Building Owners. This one's good, and it's real.

A few snippets:

• The economic payback for building owners from 'going green' has been tested in the crucible of the worst economy since the Great Depression, and while the premiums in rental rates, faster lease-up times and lower vacancy associated with green buildings varies market to market, the corresponding increases in rental income, together with the resulting energy savings in operating the property, continue to justify the modest additional costs associated with going green in most markets.
• For tenants, a growing body of research continues to show that buildings with better air quality, natural lighting and variable temperature control yield greater productivity by employees. Also, separate metering and individual utility billing of tenants for their energy use encourages conservation and additional cost savings.
• One big change, however, has been the market shift in LEED certifications from new development. Today, much of the USGBC's certification activity has shifted to LEED for Existing Buildings (LEED-EB), which has seen certifications jump sharply from less than 15% of all certifications in early 2008 to more than 35% in second-quarter 2010.
• Class A LEED office buildings that completed construction before the recession hold a significant advantage over the national average for all Class A office buildings, with the LEED buildings averaging $28.50 per square foot in rent with an average vacancy rate of 6.5%, compared with $25.89 per square foot in average rent and an average vacancy of 10.7% for all Class A office stock.

Green is, well, green. At Octus Energy, we're acutely focused on the economic virtues of improving the operating efficiency of commercial buildings -- slash utility bills first which then drives building certifications (e.g., LEED and Energy Star).

"We do find that it does continue to pay to go green," CoStar Vice President of Analytics Norm Miller said. "In the long run buildings that do not include sustainable features run the very real risk of becoming obsolete. And it will likely be very risky to own buildings that do not have sustainable features in the future."

"We also know that tenants in green buildings enjoy higher levels of productivity and see a real benefit and value to having their employees in green buildings. Because there are still so few green buildings out there many tenants haven't experienced that impact yet. But we believe this will change in time as those markets become more educated and tenants begin to pursue the productivity benefits of green buildings," Miller said. "We expect rental premiums or energy savings to more than justify the added costs for energy saving green features like separate meters, motion detection light devices, or water savings devices."

Energy Efficiency Tax Deductions: Hidden Gem for Commercial Properties?

Retrofitting commercial properties with energy-efficient equipment -- lighting, HVAC and energy management controls -- is a fairly straight-forward process. Equipment is upgraded, buoyed by utility company incentives and rebates. The reduced energy costs more than cover the cost of building improvements. And, as the building operates more efficiently, net operating incomes and asset values are bolstered. In short, reducing energy use is both the least expensive form of energy and one of the most lucrative investments a property owner can make.

Can it get better? Project financing -- oftentimes with no out-of-pocket costs for property owners; click here for information about Octus's program and other emerging solutions -- is catalytic, perhaps a game-changer. And, energy tax deductions are frosting on an already tasty cake. If your company builds, owns or leases commercial buildings, and you have installed or retrofitted the property to be more energy efficient, you may be eligible to deduct all or part of the costs associated with the installation or retrofit. Here's a summary from SourceCorp:

The EPAct §179D Tax Deduction provides a tax deduction of up to $1.80 per square foot for the installation of systems that reduce the total energy and power costs by 50 percent. Eligible building systems include interior lighting systems, heating, cooling, ventilation, hot water systems and building envelope systems.

To qualify for a full or partial deduction, the energy-efficient building property must meet the following criteria. The building:

• must have been placed in service after December 31, 2005.
• must be located in the United States.
• installation made is part of interior lighting systems, HVAC and hot water systems or the building envelope (insulation, exterior doors, exterior windows, roofing material).
• has been certified that installation will reduce total annual energy and power costs by 50 percent or more as compared to a reference building.
• energy and power consumption calculations are based on IRS-approved software programs that compare the subject facility to an ASHRAE Reference Building.
• must be certified by an IRS-qualified professional engineer or contractor licensed in the same jurisdiction as the proposed building.

"The most often overlooked tax benefit relative to the Energy Policy Act extension is the tax benefits construed for commercial building owners," said Julio Gonzalez, chief executive officer of Engineered Tax Services. "Real estate investors can now reduce the payback period in investing in energy-efficient components with the added benefit of deducting up to the entire expense of these assets immediately, versus depreciating these assets over 39 years. The Energy Policy Act of 2005 includes a tax deduction for investments in energy-efficient commercial building property designed to significantly reduce the heating, cooling, water heating, and interior lighting energy costs."

According to Gonzalez, Congress extended the energy tax benefits through 2013, and it may increase them from $1.80 per square foot to $3 per square foot later this year. A partial deduction of $0.60 per square foot is available for investments that reduce energy costs by 16 2/3% in one of three systems—lighting, heating and cooling, or building envelope.

Importantly, this is a tax deduction, and not a tax credit -- a tax credit is a dollar-for-dollar credit against your tax obligation, whereas a deduction reduces your gross income, and, therefore, will save you taxes as a percentage of the tax obligation.

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Post-script (29 Sept. 10): Thorough, blow-by-blow recap of 179D tax deductions in an article authored by Engineered Tax Services: Are Millions of Dollars Hiding in Your Buildings? Read on. It's real, viable and lucrative for CRE owners, managers, tenants and service providers to pursue and provision energy-efficiency upgrades.

Energy Efficiency Project Financing: Solutions Proliferate

A few weeks ago, we debuted a unique project financing platform (click here to read the news release). In concert with Five Star Bank, Octus can finance energy-savings retrofit projects ranging from $25,000 to $500,000, with little to no out-of-pocket investment by property owners; the utility company rebate/incentive serves as the down payment/equity for the financing. And, energy savings generated from our work more than cover the cost of facility improvements. We're bullish about the financing vehicle and its prospects, and our program's debut coincides with several emerging energy-efficiency financing programs.

Portland-based Equilibrium Capital published a study earlier this year, Energy Efficiency: Turning Negawatts into Marketable Securities. The study commences with a quick history of the energy efficiency market opportunity:

In his 1990 article, “The Negawatt Revolution,” Amory Lovins envisioned “negawatt markets” which would treat saved electricity like any other energy source or commodity. He estimated that energy efficiency ultimately represented a trillion-dollar-a-year global market. Last year, the World Business Council for Sustainable Development estimated in their report, “Transforming the Market,” that the worldwide market for energy efficiency in buildings could be worth between $900 billion and $1.3 trillion by 2050.

Last year McKinsey & Company conducted a comprehensive study of the U.S. energy efficiency market. The study analyzed the potential of retrofitting buildings by market sector, providing metrics based on the current pace of efficiency investment. McKinsey estimated that the total 2009-2020 present value of energy savings across all U.S. sectors is $1.2 trillion, representing a 130% return on $523 billion of upfront investment. This translates to $130 billion in total annual end-use energy savings in 2020.

Big numbers, terrific macro economics. As the report states, "These numbers are impressive, but we estimate that the U.S. market will be significantly bigger. The market drivers will be increasing access to capital and utility markets, as well as making it easy for property owners to understand and attain the benefits of energy efficiency retrofits. Our forecast shows that the U.S. market for end-use energy savings due to energy efficiency will reach $170 billion in 2020 and generate attractive returns for building owners, energy providers, and investors."

But, the challenge remains: Financing commercial building energy-savings measures to capitalize such opportunities. That's where Octus's financing program comes in (on a micro, project-by-project level). And, it's where several emerging financing vehicles are focused. EqCap continues:

In the energy efficiency ecosystem, we see four major segments: utility and energy firms; energy efficiency executors; energy efficiency equipment vendors; and funding sources. While some of the major players have broad solutions covering multiple segments, including companies like Johnson Controls, Schneider Electric, Siemens Building Solutions, and Constellation Energy, we expect to see a next generation of companies that will emerge into big players in energy efficiency. The winners in this space in the long term will not only offer excellent products and services in their core area of expertise, but they will need strong alliances throughout the ecosystem, and also have a thorough understanding of government and regulatory policies in their regions.

The biggest investment opportunity in this market is innovative financial instruments that can fund energy efficiency building retrofit projects on a large scale, turning negawatts, or saved energy, into marketable securities. To-date, most of the revenue in this market has been generated in the public sector. But emerging new business models and approaches for financing retrofits will dramatically increase progress in the commercial, industrial, and residential market segments. Our portfolio company, Equilibrium Resource Management (EqRM), is one of four players addressing this major opportunity in the United States, along with Metrus Energy, Transcend Equity, and E&I Advisors.

To paraphrase Jackson Browne, at Octus, we may not have the answer, but we believe we've got a plan. Our approach focuses solely on the result commercial building owners desire -- generating energy savings through facility improvements -- which, we believe, is best accomplished through a turnkey solution: Analysis, design, utility rebates, project financing, project implementation, and measurement and verification.

Smart Hotels: Tips to Generate Energy Savings

Over the past decade, Octus Energy and our energy efficiency development arm, Quantum Energy, have developed energy-savings projects for more than 100 hotel properties. Why are hotels prime candidates for energy conservation? Energy Efficiency Guide for Colorado Businesses paints the picture:

Guests affect heating and cooling loads in their rooms, consume hot water, and increase energy use in dining facilities. Hotels and motels tend to have quite high hot water heating loads - about 33% of the total - because of showers, laundries, and food service. HVAC loads constitute another 30%, lighting 20%, and plug loads 17%.

Here's a recap of a recently-completed Quantum project, this one for a 361-room national chain hotel for whom we secured generous utility company rebates and designed and implemented two energy-savings solutions:

• An energy-efficient laundry system that reduced water heating costs by 70% and water costs by 30%, generating annual savings of $28,000 with a nine-month payback.
• Retrofit of inefficient incandescent lighting with LED lighting systems that reduced energy use by 85% and extended individual lamp life by 40,000 hours, generating annual savings of $49,000, a one-year payback, and significant reduction in lighting maintenance.

Total payback: Less than one year, with savings cash-flowing thereafter.

Of course, there are myriad moving parts in a hotel, and thus multiple opportunities to generate savings. Colorado's energy efficiency guide amplifies more than two-dozen ways hotels can cut energy use. Read on and reap the savings.