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Jul 28, 2015

Teaching the Arithmetic of Deep Retrofit Value

RMI and the Institute of Real Estate Management partner with new online courses


Does it make business sense to do a deep energy retrofit on a commercial building? Many investors currently overlook the retrofit’s value beyond its energy cost savings, but now their asset managers will be able to do a more complete calculation and paint a fuller picture of a retrofit’s value. Rocky Mountain Institute (RMI) and the Institute of Real Estate Management (IREM) have partnered to create a series of online courses that debuted this month. Known as the Analyzing and Presenting Deep Retrofit Value series, they teach the analytical skills needed to calculate and report on the value beyond energy savings of potential deep retrofits of buildings. The courses are based on RMI’s report How To Calculate and Present Deep Retrofit Value: A Guide for Investors and are offered to IREM’s membership of more than 18,000 property managers, as well as the public.

Deep energy retrofits employ an integrated array of energy efficiency measures to reduce energy consumption by 30 percent or more compared to pre-retrofit energy use. They deliver other non-energy benefits, too, yet “lots of organizations still don’t prioritize these metrics in their decision-making process,” says Douglas Miller, a senior associate at RMI and coauthor of the Guide for Investors report. Energy and sustainability retrofits are almost exclusively evaluated by the simple payback provided solely by the energy costs savings, and must meet a very high return rate of 30 percent or more to be considered an attractive investment. “Deep retrofits rarely can meet this financial hurdle rate based on energy cost savings alone,” says Michael Bendewald, a manager on RMI’s buildings team and coauthor of the Guide for Investors report.

Value Beyond Energy—And Beyond Sustainability

However, there is serious economic value in deep retrofits that extends well beyond the simple payback of energy efficiency measures. “Yes, a more-energy-efficient building uses less energy and is less costly to run,” says Bendewald, “and the low-cost attributes of the building can translate to increased income and sales price.” What is less well known is this latter—usually much bigger—form of value, which can be derived from low building-energy costs as well as improved tenant satisfaction and other factors. “Sustainable buildings—primarily energy-efficient ones—deliver more value to those who occupy, own, or invest in the buildings than just lower energy bills,” Miller says, “and that’s the bigger story.”

The report explores four additional values that deep retrofits can realize for investors: 1) increase the sale price of a property, 2) increase rents, 3) reduce non-energy operating costs, and 4) even reduce development costs when combined with other, needed renovations. A fifth valuable dimension of a retrofit process is a risk analysis that maximizes the value of the other elements. “When we say ‘additional value,’ this is not a reference to traditional externalities such as carbon reductions or public health,” says Miller. “It’s about how you can charge higher rent, or how you can sell the property for more, or how you’re likely to have more occupied space in the building.” In other words, values that are intrinsic to a company’s finances and have simply been left out of the math—but they shouldn’t be.

But how to turn these underemphasized value opportunities into common knowledge? The Guide for Investors report “provides the research demonstrating that this additional value is there and highlights examples of those value elements being considered out in the market,” says Miller.

But the report alone cannot move the vast U.S. real estate market. That’s where IREM’s course series comes in. IREM members manage 13 billion square feet of property worth about $800 billion. And when it comes to forging a low-carbon future in the U.S., says Bendewald, “improving the energy efficiency of existing buildings is critical.” IREM is used to educating its members. “They provide a lot of good, quality education,” says Bendewald. “They’re able to take our content, our thought leadership, and convert it into a curriculum.”

Finding Value Step by Step

“The courses take the extensive research on the multiple value streams that result from deep retrofits and put this body of work into a practical guide to enable investors to make smarter decisions,” says Iain Campbell, managing director of the buildings practice at RMI. Fundamentally, the online courses show how to quantify and demonstrate the potential value of deep retrofit projects. “We want real estate investment professionals to have those analytical abilities to evaluate these projects and how they might contribute to a property’s value,” says IREM’s sustainability program manager, Todd Feist. RMI’s Guide for Investors report and IREM’s membership “seemed like the perfect match,” Feist says. “It seemed like they were already putting that content together for our audience.” The courses take professionals through the process of valuing projects step by step.

Much of the added value of deep retrofits stems from increasing regulations for energy-performance improvements and from the fact that, in many markets, “people are willing to spend more for a better property,” says Miller. These factors vary from place to place. “Sustainability is very market-specific, especially the degree to which you can capture the financial benefits,” says Feist. “But it’s becoming increasingly common for investors and tenants to value and demand sustainability and energy efficiency.” Furthermore, Feist says, “markets change quickly, regulations pass quickly.” He advises property managers that “all of a sudden you may get an email from a tenant that says ‘Hey, what are you doing on sustainability in this building?’”

Because local buyers and renters of space value sustainability so differently, the first step is market research. “The deep retrofit methodology outlined by RMI and taught in the courses provides a reliable and repeatable framework for assessing that demand from investors and tenants,” says Feist. “Once you do that qualitative analysis, the preliminary analysis of the context for the deep retrofit project and sustainability in your market,” he says, “you can move into analyzing each of the five value elements that potentially contribute to adding to the value of a property.”

Finding these value elements is key for anyone thinking about investing in an efficient building. According to Miller, the courses will allow property managers to say, “‘this will help reduce risk associated with the building’ or ‘we can charge a higher rent with this’ or ‘we can have office space be vacant for a shorter amount of time.’” The final step, says Feist, “would be a deep retrofit value report, which is the presentation to your decision-makers and stakeholders on the potential deep retrofit projects.”

A Toolbox for Investors

There will be three courses that progress in detail on the deep-retrofit-value methodology. One is already live and the others will be released in the coming weeks, into early fall. Bendewald explains: “The first course introduces the main topics of how to think about the full value proposition from deep retrofits or super-efficiency in buildings in general. The second course goes into a little bit more detail on how you make the calculations and more advice on how to build a business case.”

Finally, says Bendewald, “the third course is actually geared toward asset managers, the people who are operating at the portfolio level, so that third course includes a tool to start to incorporate these different values into your capital allocation process.” Feist adds: “It walks the learner through a discounted cash flow analysis using a spreadsheet tool that analyzes how a deep retrofit project will contribute to the net present value of a real estate asset.”

These courses meet a core need of IREM’s members. “If you work for a real estate services firm and you work with clients, your duty is to make sure that you’re doing everything possible to increase the value of their assets,” says Feist, “and sustainability and these deep retrofits are another tool, a powerful tool, in your toolbox to fulfill your client’s goals.” Bendewald explains: “If you reduce costs and you maintain your revenues—that equates directly to improving the fundamental economics of that building.”

For RMI, says Miller, the key is that the courses “help people reveal the additional value of investments in sustainable buildings.” That value “is largely excluded from decision making and, as a result, is leading to less investment in sustainable buildings than would happen were people to value it properly.” When investors decide to pursue deep retrofits, says Miller, “the resulting energy use reductions lead directly to carbon emissions savings.”

For IREM’s members, the courses are important because it gives them the edge over the competition, no matter where they operate. “The deep retrofit methodology will allow you to understand sustainability and building improvements more thoroughly and give you analytical skills that have value in any market,” Feist says. Campbell emphasizes this point by saying “professionals working in this space really need to know about this.” Miller is delighted that the course series is under way. “I think the courses are powerful because they show how to enhance the case for deep retrofits in terms that resonate with investors.”

Image courtesy of Shutterstock.

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