Making Green History By Doing It
A spirited welcome from Sallan Foundation Executive Director Nancy Anderson opened the second panel in a two-part Market Makers series. Held on November 15, 2011, at the New York Institute of Technology, it examined management, financial, and legal innovations that can establish energy efficiency as a market-making strategy for big-city real estate.
Anderson characterized the panelists as people who are "making green history by doing it" — in effect, "writing the how-to books." Beyond yielding environmental benefits, she contended, high-performance buildings create a green multiplier effect, enhancing real estate values, commanding greater market share, and creating jobs. The ensuing discussion bore her contention out, illuminating the emergence of a historic market shift. It illuminated remaining challenges, too. The similarities among the views expressed were significant, as the panelists occupy very different vantage points in the marketplace:
- Will Goodman is Acquisitions Project Manager for Jonathan Rose Companies, a leading green real estate policy, planning, development, civic development, and investment firm operating in New York and other US cities.
- Eric Friedman is Director of Facilities Development for WilmerHale, a prominent international law firm that was the first company to adopt NYC's new energy-aligned lease.
- Greg Hale is Senior Financial Policy Specialist with NRDC's Center for Market Innovation, a board member of the NYC Energy Efficiency Corporation (NYCEEC), and a member of the PACENOW (Property Assessed Clean Energy) coalition steering committee. He works with a broad band of stakeholders to develop a large-scale market for energy-efficient retrofits in the commercial and multifamily sectors.
Moderator Jonathan Bowles, Executive Director of Center for an Urban Future, agreed that the green multiplier effect has "incredible potential." And in the current bad economy, energy efficiency can serve as "an important catalyst and make a real difference." New York City seems to have made a lot of progress, and a forthcoming study documents the benefits of energy efficiency retrofits, he observed.
He then posed the first of a series of probing questions to the panelists.
- Where are we now? Where are we heading?
- What are the biggest challenges? How can they be met?
- What anecdotes offer examples of successes? How can more projects be gotten into the pipeline to supply examples for case studies?
- In the residential market, what are the innovations and barriers?
- What's NYCEEC's potential? Can it become self-sustaining?
- What about federal PACE financing legislation?
- What should the Mayor and Governor do?
- Are we going in any wrong directions?
Where are we now? Where are we heading?
New York City is setting the pace.
"NYC is really setting the pace," Hale stated flatly, "by pulling together a lot of different pieces of the framework." The Greener, Greater Buildings Plan is important, as a kind of "mandate lite." In NYC, buildings are the biggest consumers of energy, and about 70-80% of greenhouse gas emissions come from the built environment. But while buildings offer "a massive opportunity" for energy savings, "it's whacked up into tiny little pieces." Mandatory benchmarking, which other cities are adopting too, forces attention to energy use and how to save money.
Hale termed the energy-aligned lease — devised by the City and real estate industry leaders to shorten the payback period for energy-related capital improvements, in furtherance of PlaNYC 2030 — "a great step forward" in removing the split-incentive barrier between property owners and tenants. But implementing it will take some time. A "really exciting" development is the NYC Energy Efficiency Corporation (NYCEEC). A new public-private partnership with $37.5 million in federal stimulus funding, it aims to develop scalable, energy-efficiency-retrofit financing products and services.
To "make a high performance build-out the status quo," NRDC is developing a series of business case studies for high performance tenant build-outs, which it plans to publish alongside a "streamlined build-out process roadmap."
Making the business case is essential to making high- performance buildings the status quo.
Friedman agreed that the City has made progress but cautioned that, while many new buildings are being built to high-performance standards, they're a small percentage of all buildings. The energy-aligned lease is "a great first step" and was important to his firm's decision to relocate in 2012 to 7 World Trade Center.
Goodman said owners and investors have come to view green as integral to how they expend capital. The "intersection of economic, environmental, and social values... [is] more and more the norm... Tenants want this, so we're delivering it... in New York and other cities."
Many pieces are in place, but we're still at Square One; 95% of the space out there hasn't been addressed yet.
What are the biggest challenges? How can they be met?
"We have a lot of the pieces in place," Hale declared. But "we're still at Square One... 95% of the space out there hasn't been addressed." Along with financing products, NYCEEC will provide information, education, and outreach to help generate deals. Working with trade organizations can help, too. "It's hard to speak to owners in energy efficiency; it's a language they're not schooled in. But when you start talking with them about occupancy, they get that... We have to make the business case": they can lower operating costs and increase property values.
If energy programs are done properly, long-term savings can be realized.
Goodman pointed to "a huge knowledge gap": owners need help understanding cost-effective energy strategies. Friedman added, "It's all about educating tenants and owners... removing the fear factor... incorporating trust," and helping the parties understand that, if energy programs "are done properly, long-term savings can be realized." The risk to capital is very low; the opportunity to lower long-term costs is very high. Progress requires successes that can be pointed to.
Hale noted that most NYC lease cycles run for 10-15 years and parties are reluctant to open up existing leases. In addition to the energy-aligned lease, a side agreement is needed for use mid-lease, or outside a lease, to allocate costs and savings for energy upgrades. The end goal is collaboration; to get anywhere close to net-zero buildings, it's essential.
Friedman cautioned that if retrofits aren't done voluntarily, regulations will require them, "probably the wrong way to go."
Absent a library of case studies, what anecdotes offer examples of successes? How can more projects be gotten into the pipeline to supply examples?
Data has its place in making the business case, but you don't need "perfect data". Investors routinely factor risk into the business equation.
"There's a concept that we have to have perfect data" to make the case for green buildings, Goodman observed. But many investors and venture capitalists routinely invest on the basis of imperfect information; they "go where opportunities are," and the level of risk is "reflected in the risk-return parameters of the investment. Data has its place but it's not the whole game." His company is seeing tenant demand for green buildings and greater tenant retention in them.
Hale added that, for tenants, vibrant, efficient, attractive green space delivers "soft benefits" - ber employee recruitment, retention, and productivity - which drives to the bottom line.
Friedman cited the benefit of healthier employees, and he stressed the importance of benchmarking. His firm is working with NRDC to document energy savings and soft benefits. Hale said he's encouraged by "the movement toward open source": putting case studies online. The Empire State Building retrofit was part of a much larger renovation, a model "it's really important to follow." Goodman reflected that real-time feedback about energy use can change owners' and tenants' behavior.
In the residential market, what are the innovations and barriers?
In many major markets, without LEED certification of Class B+ and Class A buildings, it's hard to compete, Goodman reported. In multifamily buildings, particularly affordable housing, submetering is a big hurdle because tenants fear added cost. But a NYSERDA study showed that it saved 15-25% on electric bills.
Friedman remarked that, although environmental awareness is being promoted, where commercial tenants pay a flat rate for electricity, some people don't care how much is consumed. But more commercial tenants are demanding submetering, so they can pay for exactly what they consume.
What's NYCEEC's potential? What are the challenges of making it self-sustaining?
Hale said the City views NYCEEC as the financing component of the Greater Greener Buildings Plan, which targets buildings larger than 50,000 square feet. So NYCEEC will focus first on commercial office and large multi-family properties.
In attempting to become self-financing, NYCEEC has no model to follow.
NYCEEC is a nonprofit intended to become self-sufficient, through interest on its loans and other revenue mechanisms. To catalyze the retrofit market, NYCEEC wants to price loans cheaply and make some riskier loans. But to be self-sufficient, it must generate revenue, which means charging more and taking fewer risks. "To make it work, we're going to have to expand the balance sheet." More funding won't come from the federal government but might come through the utility system benefit charge, or the NYS energy efficiency portfolio standard. To attract private investment, NYCEEC will try to develop new financing models and will share the results online.
PACE has enormous potential to scale efficiency in the residential sector.
What about federal PACE financing legislation?
Hale termed PACE (Property Assessed Clean Energy) — which permits property owners to repay low-cost loans for energy efficiency and renewable energy projects through property taxes assessments, using savings realized by the projects - "a controversial subject." Proposed federal legislation would require federal mortgage giants Fannie Mae and Freddie Mac to accept PACE assessments; those agencies and the FHFA are holding it up for the residential sector. "PACE has enormous potential to scale efficiency, particularly in the residential sector . . . because it has all of the attributes needed to bring private capital from the securitization market to play." It's a way of realizing "this massive opportunity in little tiny chunks . . . aggregating, getting municipalities behind a program." In the commercial sector, PACE programs are starting in several places outside New York; it remains to be seen to what extent existing mortgage lenders will permit commercial PACE deals to move forward.
Recapitalization and refinancing situations offer a huge opportunity.
Along with the focus on midstream retrofits, where the owner must get the lender's consent to modify an existing loan, recapitalization and refinancing situations offer a huge opportunity, Goodman suggested. Much commercial mortgage-backed security debt will be coming due soon. Tax credits for many buildings are expiring. Many buildings must be refinanced. Lenders could make retrofits an important piece of standard mortgage products in those situations. Will lenders include predicted savings from retrofits in projecting net operating income? Hale asked. So far, no; "NYCEEC is here to . . . credit-enhance that wedge."
What should the Mayor and Governor do?
Hale urged attention to how money that utilities are required to spend on energy efficiency could be applied to financing programs. "A corollary to NYCEEC would be statewide credit-enhanced financing for retrofits."
Goodman endorsed credit enhancement as a "really important" government role. He also cited Seattle's pilot performance-based building code, which gives owners flexibility in how to meet retrofit goals.
Friedman stressed that success stories about energy-aligned leases are needed to foster tenant-landlord cooperation.
Shift the rhetoric to the economic case, the national security case, and making cities climate resilient.
Are we going in any wrong directions?
This query elicited a collective pause. Hale then suggested that criticisms of the Solyndra project are "disturbing" because loan guarantees for risky technologies will inevitably experience some failures. Goodman urged less emphasis on environmental benefits and more on smart investing, risk mitigation strategies, job creation — the economic case, the national security case, and making cities climate resilient.
The Q&A session ranged widely. LEED certification, including of interiors, is a valuable marketing shorthand for green initiatives that enhance corporate identity and branding and strengthen recruitment. Training in-house staff to properly monitor and maintain equipment — "to be the heroes of the building," as Hale put it — is important. Tenants' own trained staff can avoid costly service calls to landlords, Friedman said.
A niche market for third party players such as energy service companies will probably emerge because they are structured to sustain energy savings; when NYCEEC lends to a building owner that has no ESCO, proper construction and operations and maintenance still must be ensured. But with or without a third party, certain green lease provisions can incentivize efficient operations.
Financing retrofits is one piece; smart lending for mortgages and refinancing is another.
Undertaking retrofits through an Energy Services Agreement model transforms retrofits from a capital cost to an operating cost for building owners, another way of addressing the split-incentive problem. How to get lenders to factor energy savings into their financial products and how to ensure the reliability of energy savings projections are open issues. The Save Act, pending in Congress, would require banks to consider energy costs in underwriting home mortgages. Energy-efficient homes would qualify for larger loans - a market driver. Some smart lenders now view energy costs as part of the long-term risk they're acquiring; one large national bank did an energy audit on a property for which refinancing is sought.
Utilities must be incentivized to promote efficiency. Their regulators are the inertia in the system.
Retrofitting smaller buildings remains a massive challenge. Residential tenant organizations that initiate green improvements need resources to tap. Utilities' revenue model must be redesigned so they make money by promoting efficiency. But redesign will be difficult; utility regulatory commissions are the inertia in the system.
The evening, however, generated a sense of momentum. A story recounted by Goodman seems emblematic. In a building his firm owns in West Harlem, three boilers that were manually controlled and operating at around 60% efficiency have been replaced by one computerized, programmable boiler that operates at around 85%. "Somebody used to have to go down into the boiler room and crank a lever; now it's all programmed," and that person can be doing the other things "that make a great building." Truly, useful knowledge for greener cities!
Warmest thanks go to event co-planner Micah Kotch, Director of Operations, New York City Accelerator for a Clean and Renewable Economy (NYC ACRE), and Nada Anid, Dean of the School of Engineering and Computing Sciences, New York Institute of Technology, which hosted the event.
To learn more, see the Deutsche Bank/Living Cities Data Study.