CERTIFICATE PROGRAM

Developed by:

With generous support from:

COURSE 2

ENERGY PROJECT FINANCE

COURSE INSTRUCTOR:

Jack S. Nyman

Executive Director, The Steven L. Newman Real Estate Institute

Zicklin School of Business, Baruch College, The City University of New York

COURSE 2: REQUIRED RESOURCES

Required Textbooks
The Energy Management Handbook
Wayne C. Turner & Steve Doty. The Fairmont Press, 2013.

Other Required Readings: Available in the Course Module (as PDFs)

Various Websites: Links provided as appropriate

COURSE 2:
THEMES OF ENERGY PROJECT FINANCE
Core Concepts
Financing Strategies/Capital Deployment in Real Estate
Project Cash Flow and Evaluation
Project Finance Instruments
Overcoming Split Incentives to Implement Energy Projects
Writing and Negotiating Green Leases

WEEK 1

HOW ENERGY PROJECT FINANCE

FITS INTO REAL ESTATE STRATEGY

WEEK 1: LEARNING OBJECTIVES

1.

Identify strategies for increasing real estate returns.

2.

Classify financing strategies/capital deployment in real estate.

3.

Differentiate the various types of short term and long term cost
savings and cost reductions.

4.

Illustrate the impacts of incentives, tax credits and depreciation

on project cost.

5.

Identify various lease types and lease provisions.

WEEK 1: REQUIRED READINGS

Readings:
The Economic Case for High Performance Buildings, Scott Johnson.
Capitalization of Energy Efficiency on Corporate Real Estate Portfolio
Value, Ingrid Nappi-Choulet & Aurlien Dcamps.
United States Building Energy Efficiency Retrofits, Mark Fulton &
Heather Grady, eds. Deutsche Bank & The Rockefeller Foundation.

OWNER PERSPECTIVES (REVIEW)

Payback periods:
Calculate the return of a property investment over a particular time
span (investment horizon)
Consider expected resale (reversion) price of the property at the end
of investment horizon + any capital gains/losses realized
Take into account any potential fluctuations in the propertys NOI
Real Estate Asset Strategy:

Core: Long-term hold (Cash Cows)

Value-Added: Medium-term hold (Stars)
Opportunistic: Improve amenities/ systems (Question Marks)
Distressed: Identify improvements or sell (Dogs)

OWNER PERSPECTIVES (REVIEW)

FINANCING STRATEGIES AND

CAPITAL DEPLOYMENT IN REAL ESTATE
Capital Investment Characteristics:
Relatively Large (Initial/First Costs)
Benefits (Revenues/Savings) Occur in the Future
Life Cycle
Time Value of Money Concepts are Required for Evaluation
Relatively Irreversible

Terminating or significantly altering that nature of a capital investment

after the initial investment has been made, typically has substantial
negative cost consequences.
Can Have Significant Tax Implications
Depending on choice of financing methods

FINANCING STRATEGIES AND

CAPITAL DEPLOYMENT IN REAL ESTATE
Capital Investment Cost Categories

Acquisition Costs
First Costs Purchase Price, Installation Costs, Training
Preparation Costs Engineering and design, permits,
renovations
Utilization
Direct Labor and materials for routine repair &
maintenance
Indirect Energy costs, overhead (salaries, supplies, etc.)
Periodic Not expected to occur annually
Disposal
Residual Value The costs incurred (or recovered) when
the investment has reached the end of its useful life

WHAT IS AN ENERGY PROJECT?

An energy project (more precisely, an energy-efficiency project) is the process
of implementing one or more energy-saving measures, for the benefit of a
specific property or properties.
Typical energy projects include the retrofitting of any of the following
building systems to achieve a greater degree of energy efficiency:
1. Heating, cooling, and ventilation (HVAC) systems
2. Insulation, including windows and roofing
3. Lighting (including daylighting and delamping options)

4. Steam, refrigeration, and hot water systems

5. Components of industrial or production processes

The inclusion of an energy-efficient choice of building system in the

construction of a new building, or the gut renovation of an older one, can be
analyzed similarly as an energy project.

ENERGY PROJECT PERFORMANCE

1. Market Performance describes how a property is valued in relation to
comparable properties on the market. The market performance is
derived from the factors that determine a propertys attractiveness to
potential investors and tenants. These include:
A.
B.
C.
D.

Location;
Amenities;
Terms of the lease;
Prestige (or lack thereof)

2. Financial performance describes the condition of a propertys balance

sheet, namely, the costs and revenues that determine profitability:
A.
B.
C.
D.
E.

Mortgage payments
Rent receipts
Tax liabilities and insurance premiums
Utility costs
Repairs

ENERGY PROJECT PERFORMANCE

1. Energy project performance is mainly a subset of a propertys financial
performance because it directly impacts operating expenses. An energy
project can lead to:
A.
B.
C.
D.

Energy cost savings

Tax benefits or other incentives
Increased debt payments AND/OR
Diminished cash reserves

2. However, Energy Project Performance can also influence market

performance:
A. Lower costs for tenants or potential buyers
Leases may be structured to share benefits of savings
B. LEED certification may confer prestige
C. Potential tenants may be obligated to seek green space
D. Tenancies or investment in green properties may support a certain
institutional or corporate image

WHAT SHOULD YOU CONSIDER WHEN

EVALUATING PROJECT PERFORMANCE?
Short-term (More Tangible) savings:
1. Operations & maintenance (O&M) savings
Allocation of benefits among parties depends on lease
structure
High performance buildings can use up to 70% less energy
than traditional buildings1

Columbus Circle. Source: Wikimedia Commons

Sources:1JOHNSON

WHAT SHOULD YOU CONSIDER WHEN

EVALUATING PROJECT PERFORMANCE?
Short-Term and More Tangible Revenue/Value Creation:
Asset value enhancement
Future cash flows
Longer-Term and More Tangible Revenue/Value Creation:
Mitigating future regulatory censure and litigation
Revenue Creation:
Energy efficient buildings can achieve higher sales price per/s.f.
Average of +34.7% prices per/s.f. (Dermisi & McDonald)

Sources: Effect of Green (LEED and Energy Star) Designation on Prices/sf and Transaction Frequency: The Chicago
Office Market Sofia Dermisi and John McDonald (Journal of RE Portfolio Management) Jan-April 2011 17,1

WHAT IS LIFE-CYCLE COST ANALYSIS?

Life-cycle costing is a method of economic analysis for all costs related to
building, operating, and maintaining a project over a defined period of time.
- Harvard University Office for Sustainability

AEP Life-Cycle: Design Disposal

1.
2.
3.
4.

Historical rate increases are used to estimate utility costs over time
Future costs are expressed in present-day dollars via a discount rate
All costs and savings across the period are directly compared
Decisions are made based on total costs of ownership (TCO)

LIFE-CYCLE COST ANALYSIS: COMPONENTS

The Whole Building Design Guide (NIBS) offers some LCCA components:

Initial CostsPurchase, Acquisition, Construction Costs

Fuel Costs
Operation, Maintenance, and Repair Costs
Replacement Costs
Residual ValuesResale or Salvage Values or Disposal Costs
Finance ChargesLoan Interest Payments
Non-Monetary Benefits or Costs

Source: National Institute of Building Sciences, Whole Building Design Guide: http://www.wbdg.org/resources/lcca.php
Image: Garfield Place in Brooklyn, adapted from work by Mark ONeill, via Wikimedia Commons

LIFE-CYCLE COSTING: EXAMPLE

Initial Cost Office Building - $100/S.F.

Source: http://green.harvard.edu/theresource/new-construction/life-cycle-costing/

SHOWING HOW ENERGY PROJECTS CAN

INCREASE RETURNS ON INVESTMENT
Tradition: Analysis focuses on first costs
Theory: Life-cycle costing
Imperative: Recognize that analysis of project costs & benefits must
include the total costs of ownership.
Life-cycle costing Total costs of ownership (TCO)
Other Factors:
A. Increased Productivity
B. Corporate Image/Reputation
C. Improved Economy and
Environment
D. Risk Mitigation

Sources (part): 1 JOHNSON

INCENTIVES AND PROJECT COST

There are three major types of incentives that can impact project cost:
1. Basic incentives, including:
A. Rebates
B. Direct Utility Assistance
C. Low Interest Loans
2. Tax credits and tax deductions

These reduce yearly tax bills

3. Depreciation of taxable value

Reduces tax liability over time

Source: Guide To Energy Management 6th Edition Capehart, Turner, & Kennedy Page 159

IMPACTS OF INCENTIVES
Example:
Bonus depreciation (federal): 50% in first year, for certain projects.
1. To qualify, a project must satisfy these criteria:
A. Recovery period of 20 years or less
B. Original use must begin with taxpayer claiming the deduction
C. Property generally must have been acquired between 2008-2013
D. Property must have been placed in service between 2008-2013
2. A reduction of up to $1.80 per SF is available to owners who install:
A. Interior Lighting
B. Building Envelope, or
C. Heating, Cooling, Ventilation, or Hot Water Systems
3. Installations must reduce total energy cost by 50%, compared to
minimum requirements of ASHRAE Standard 90.1-2001.

Federal Bonus Depreciation: http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US06F&re=1&ee=1

Deductions: http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US40F&re=1&ee=1

IMPACTS OF INCENTIVES
Benefits increase net cash flows:
0
Acquisition Cost

10

($2,000,000)

Utilization Cost

($100,000) ($100,000) ($100,000) ($100,000) ($100,000) ($100,000) ($100,000) ($100,000) ($100,000) ($100,000)

Energy Savings

$500,000

$500,000

$500,000

$500,000

$500,000

$500,000

$500,000

$500,000

$500,000

$500,000

Annual Savings

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

Residual Value
Cash Flows

$500
($2,000,000) $400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,000

$400,500

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

Incentives, Rebates & Tax Credits

Tax Rate

35%

Depreciation Benefit

50%

$350,000

Tax Credit

10%

$200,000

Incentives

20%

$400,000

Subtotal
Net Cash Flows

$950,000
($2,000,000) $1,350,000

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$38,889

$438,889

$438,889

$438,889

$438,889

$438,889

$438,889

$438,889

$438,889

$439,389

Federal Bonus Depreciation: http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US06F&re=1&ee=1

Deductions: http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US40F&re=1&ee=1

INTRODUCTION TO LEASES
Legal Definition of a Lease
A conveyance of lands or tenements to a person for life, for a term of
years, or at will, in consideration of a return of rent or some other
recompense. The person who so conveys such lands or tenements is
termed the lessor, and the person to whom they are conveyed, the
lessee; and when the lessor so conveys lands or tenements to a lessee,
he is said to lease, demise, or let them.

- Blacks Law Dictionary

NET LEASE VERSUS GROSS LEASE

1. Net Lease
A. Tenant pays, in addition to rent, some or all of the property
expenses which normally would be paid by the property owner
B. Landlord passes operating costs through to tenants

2. Gross Lease
A. Landlord pays for the buildings property taxes and insurance
B. Landlord pays some or all of the propertys operating costs

Source (partly): NYSERDA Lease Based Analysis PDF (Page 25)

LEASE PROVISIONS: CALCULATING

OPERATING COST CHARGES FOR TENANT
The tenants share of operating costs is determined by two major
approaches:

1.

2.

Source: NYSERDA Lease Based Analysis PDF (Page 6)

LEASE PROVISIONS: ESCALATION CLAUSES

Escalation clauses also known as stop clauses, or pass-through clauses
are provisions that limit an owners responsibility for certain expenses.
Items subject to an escalation clause are known as escalatables.
A base-year cost is assumed by the landlord, and costs that exceed the
base amounts are passed through to the tenant. Thus, lowering base-year
operating expenses can increase an owners net income.

Source: NYSERDA Lease Based Analysis PDF (Page 8)

LEASE PROVISIONS:
COMPONENTS OF BASE OPERATING COST
Base operating costs are strongly influenced by how escalatables are
treated in the lease

Source: NYSERDA Lease Based Analysis PDF (Page 9)

LEASE PROVISIONS:
PASS-THROUGH OF CAPITAL COSTS
Lease provisions sometimes allow the pass-through, or escalation, of
capital costs.

Source: NYSERDA Lease Based Analysis PDF (Page 10)

LEASE PROVISIONS: ESCALATABLES &

CAPITAL COST AMORTIZATION
If permitted as escalatables, capital costs may be amortized in various ways:

Over life of lease

With payments no greater than projected savings

Terms set by owner

Source: NYSERDA, Lease-Based Analysis (Page 11)

LEASE PROVISIONS:
ELECTRICAL DELIVERY METHODS
1.

Direct meter service

2.

Sub-meter service

3.

Rent inclusion

LEASE PROVISIONS: DIRECT METER SERVICE

1.

Each unit is hooked up to a separate meter

2.

Meter measures only that units electrical consumption

3.

Unit meter is read by local utility company servicing that area

(e.g., Con Edison, PSE&G)

4.

Utility company reads the meter and issues monthly utility bill
to end user

5.

Billing based upon kilowatt hour consumption.

6.

Occupant billed at retail rates per kilowatt-hour of

consumption.

7.

This rate varies with the cost of energy

8.

Provides a strong incentive for the tenant to conserve energy

Source: Sam Irlander, CDEI. Used with permission.

LEASE PROVISIONS: SUB-METER SERVICE

1.

Owner purchases electric from the utility company in bulk.

2.

Owner pays one master bulk bill at wholesale rates. Billing covers:

3.

1.

All common areas; and

2.

Tenant spaces/their consumption

3.

Tenant spaces have own meters, read by owner

Owner is responsible for:

1.

Meter reading

2.

Billing and

3.

Collections from tenants

4.

Billing to tenants is at retail rates; ownership realizes spread from

actual cost.

5.

Currently, a 3% -15% markup for tenants (over wholesale prices) is

typical.

6.

More likely to incentivize energy-savings by the tenants

Source: Sam Irlander, CDEI. Used with permission.

LEASE PROVISIONS: RENT INCLUSION

1.

Typical of 60s and 70s construction

2.

One master meter to measure the entire buildings consumption

3.

Each tenant pays a base minimum per square foot amount

4.

Per square foot base established by dividing the annual electric bill by
the total rentable area of the building (currently averaging in NYC
about $3.50/square foot)

5.

Tenant use may be measured by electrical consumption survey

6.

Also subject to increase in the cost of energy

Survey is conducted by electrical survey company hired by Ownership

7.

Ownerships right to perform the survey at any point during the term
of the lease provided for in the lease

8.

Rent inclusion provides a weak incentive for landlords to reduce

energy usage; but surveys shift incentives strongly to tenants

Source: Sam Irlander, CDEI. Used with permission.

LEASE PROVISIONS: SPLIT INCENTIVES

A split incentive occurs when the benefits of a proposed investment will
not accrue primarily to the party that would be required to pay for that
investment.
In an energy context, split incentives often occur where a building owner
would need to pay for retrofits, but the savings from reduced energy
usage would mainly accrue to the tenants.

Source: PlaNYC - http://www.nyc.gov/html/planyc2030/downloads/pdf/111213_eal_presentation.pdf (Page 3)

LEASE PROVISIONS:
ENERGY EFFICIENCY UPGRADES
Lease provisions also shape the financing of retrofits for energy efficiency.

Source: NYSERDA Lease Based Analysis PDF (Page 25)

LEASE PROVISIONS: IN PRACTICE

The actual mix of lease provisions largely depends on the relative
negotiating power of the parties.
Larger Tenant

Smaller Tenant

Fixed %
Operating
Cost
Electric rent
inclusion

Source: NYSERDA Lease Based Analysis PDF (Page 16)

Operating
cost
escalation
Direct or
Submeter

WEEK 1: IN-CLASS EXERCISES

1.

In 1-2 paragraphs, provide examples of the types of costs that are

typically escalated in net leases. Explain how escalation clauses could be
used to incentivize energy-efficiency retrofits. Is it more important to
treat certain expenses as escalatables than others? If so, which ones?

2.

In the Excel spreadsheet, manipulate Incentives, Tax Credits, and

Depreciation data, and observe the effects of your variations. In 1-2
paragraphs, analyze the impacts of different assumptions on overall
Project Cost. How significant are variations to the viability of a project?

3.

Submit your write-up in a Word document through the Course Module.

WEEK 1: HOMEWORK
1.

How strong is the economic case for energy-efficiency projects in

real estate? Has the case for investing in such projects changed
much since Scott Johnson published his article, "The Economic
Case for High-Performance Buildings," in 2000?

2.

Differentiate between a property's market performance and

financial performance, and explain how are the two concepts are
intertwined. How do short-term and long-term considerations
play into these concepts?

3.

What is one of the most common scenarios in which split

incentives might arise? How do you think real estate owners and
managers could find ways to share the incentives for energy
savings with their tenants? Why might doing so be crucial to
success?