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UNLOCKING ENERGY EFFICIENCY IN COMMERCIAL BUILDINGS
Leasing Strategies Commercial Tenants Can Take to Make Buildings Energy Efficient
OBJECTIVES
1. To clearly identify the nature of the “split incentive” in commercial leasing.
2. To show in economic terms how the split incentive inhibits building retrofits.
3. To explain how to fix the split incentive.
4. To convey the importance of measurement and verification for purposes of fairness and building efficiency.
5. To establish the benefits for tenants of adjusting traditional approaches to capital and operating costs in commercial leasing.
ENERGY EFFICIENCY AND BUILDINGS
THE SPLIT INCENTIVE
HOW TO FIX IT
WHAT’S IN IT FOR TENANT AND LANDLORD
NEXT STEPS
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In dense urban areas, buildings are the principal source of energy use.
*2005 Greenhouse Gas Emissions Inventory
CO2 Emissions by Sector, New York City 2005
77%
3%
20%
Buildings
Transit
On-Road Vehicles
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Commercial buildings emit more than other types.
CO2 Emissions from Buildings, New York City 2005
16%
24%
32%
16%
12%Residential Small
Residential Large
Commercial
Institutional
Industrial
6
0
10
20
30
40
50
60
70
80
1995 2000 2005 2030
19.3 21.7 23.434
2022.6 23.6
29.213
12.612.4
11.8
1.41.3
1.1
1.1
Solid Waste/Methane
Combustion Vehicles
Heating Fuels
Electricity
Electricity and heating fuel represent the bulk of the emissions, and their share is growing.
Trends in Source of CO2 Emissions, New York City (millions of metric tons)
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Some emissions come from systems that commercial tenants control, others from systems they do not.
TENANT SYSTEMS
Lighting
Plug-ins (e.g. computers, printers)
Sometimes Air Conditioning
CORE BUILDING SYSTEMS
Boilers and Chillers (HVAC)
Pumps, Motors, Fans
Elevators
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Most of the energy use comes from a building’s central systems.
CORE BUILDING SYSTEMS
TENANT SYSTEMS
Plug-ins (computers, appliances)
21%
Lighting 18%
Ventilation 20%
Cooling 17%
Heating 20%Conveying 4%
Efficient Building
Inefficient Building (30% + greater)
Conveying
Lighting 23%Plug-ins(computers, applian
ces, etc) 27%
Heating 15%
Cooling
17%Ventilation13%
5%
Core Building50% - 60% ± 10% dep on
tenant cooling
Tenant Lighting
13%
Plug-Ins27%
Core Building59% - 69%
± 10% dep on tenant cooling
Plug-Ins21%
TenantLighting
10%
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Improving these systems has a direct, measurable $ impact.
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LEED and other green standards are not a requirement for saving energy and $.
≠Energy Efficient
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Typical buildings are inefficient – total energy reductions of 20% - 30% could pay back in 5 years.
• Direct digital control and sequencing of major systems
• Scheduling, setpoint and setback optimization
• Demand controlled ventilationControls
• Constant to variable primary/secondary chilled water
• Controls, valves, variable frequency drives (VFDs)
• Power factor correction capacitorsMechanical
• Constant to variable air volume with VFDs
• Automation of terminal units
• High efficiency boilers and chillersHVAC
Lighting• High efficiency lighting
• Controls, scheduling CORE BUILDING SYSTEMS
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• High efficiency bulbs and ballasts
• Daylighting/occupancy sensors
• De-lamping of overlit spaceLighting
• ENERGYSTAR computers, printers, and appliances
• Controls that shut down unnecessary night-time loadsPlug-ins
• Optimize air management and free cooling
• Load management and server optimization
• On-site generation and use of DC powerData Centers
Air conditioning
• High efficiency rooftop systems
• Retro-commissioning and tuning
Tenant system improvements can increase potential savings to 30% - 40%.
TENANT SYSTEMS
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ENERGY EFFICIENCY AND BUILDINGS
THE SPLIT INCENTIVE
HOW TO FIX IT
WHAT’S IN IT FOR TENANT AND LANDLORD
NEXT STEPS
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The most important factor affecting efficiency is who pays for it.
Full service gross
Modified gross Net lease
Owner pays for all core building operating and capital expenses.
Owner pays for capital and a “pool” of operating expenses.
Tenant pays all increases in the pool after the first year of the lease.
Tenant pays base rent and all operating costs defined in the lease, and may or may not pay for capital improvements.
Owner pays
Tenant pays
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In modified gross leases, tenants pay for a pool of core building operations as they exceed Year 1 of the lease.
CORE BUILDING SYSTEMS
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Tenant responsibility for capital expense is usually very limited.
• Only operating costs included as “Additional Rent”
No capital expense sharing
• Amortized to tenant by useful life (GAAP)
Capital expense sharing only for items that save
operating
CORE BUILDING SYSTEMS
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Split incentive affects most NYC buildings.
* 2003 leasing activity, Real Deal
Small Leases
Large Leases
Leases
Small Leases
Large Leases
Square Footage
In NYC, most of the square footage is in a modified gross lease.
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Landlord Operating
Costs (Up to Base Year)
Tenant Operating
Costs (Above Base Year)
Exp
ense
sEx
pen
ses
Why? Because it gives cost predictability to landlord and lender, expense review/control to tenant.
CORE BUILDING SYSTEMS
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Landlord Operating
Costs (Up to Base Year)
Tenant Operating
Costs (Above Base Year)
Expen
ses
But savings (e.g. from an energy retrofit) go entirely to the tenant.
CORE BUILDING SYSTEMS
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A typical project.
IMPROVEMENT SAVINGS COST
Bldg Control System $270,000 $1,000,000
Lighting $190,000 $450,000
Variable Freq. Drives $90,000 $550,000
High Efficiency Chiller $450,000 $3,000,000
$1,000,000 $5,000,000
Simple Payback 5 years
CORE BUILDING SYSTEMS
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Capital sharing restrictions substantially alter the economics – and GAAP requires silo’ing of measures.
IMPROVEMENT SAVINGS COST
USEFUL
LIFE
ALLOCABLE
RECOVERY(AT 7%)
Bldg Control System $270,000 $1,000,000 10 $142,378
Lighting $190,000 $450,000 7 $83,499
Variable Freq. Drives $90,000 $550,000 12 $69,246
High Efficiency Chiller $450,000 $3,000,000 25 $257,432
$1,000,000 $5,000,000 $552,554
Adjusted Payback 9 Years
IMPROVEMENT
TOTAL
SAVINGS TOTAL COST
Energy Retrofit Package $1,000,000 $5,000,000
Payback 5 years
CORE BUILDING SYSTEMS
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A building with 5 tenants, all modified gross leases with base years.
TenantsSquare
Feet Lease TypeLease End
DateCapital Expenditure
Sharing
A 200,000Modified
Gross 1/1/2013 Useful Life
B 200,000Modified
Gross 1/1/2015 None
C 200,000Modified
Gross 1/1/2017 Useful Life
D 200,000Modified
Gross 1/1/2019 None
E 200,000Modified
Gross 1/1/2021 Useful Life
CORE BUILDING SYSTEMS
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A building with 5 tenants, all modified gross leases with base years.
TenantsSquare
Feet Lease TypeLease End
DateCapital Expenditure
Sharing
A 200,000Modified
Gross 1/1/2013 Useful Life
B 200,000Modified
Gross 1/1/2015 None
C 200,000Modified
Gross 1/1/2017 Useful Life
D 200,000Modified
Gross 1/1/2019 None
E 200,000Modified
Gross 1/1/2021 Useful Life
CORE BUILDING SYSTEMS
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A building with 5 tenants, all modified gross leases with base years.
TenantsSquare
Feet Lease TypeLease End
DateCapital Expenditure
Sharing
A 200,000Modified
Gross 1/1/2013 Useful Life
B 200,000Modified
Gross 1/1/2015 None
C 200,000Modified
Gross 1/1/2017 Useful Life
D 200,000Modified
Gross 1/1/2019 None
E 200,000Modified
Gross 1/1/2021 Useful Life
CORE BUILDING SYSTEMS
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$0
$1,000,000
$2,000,000
$3,000,000
$4,000,000
$5,000,000
$6,000,000
0 1 2 3 4 5 6 7 8 9 10
E
D
C
B
A
Cumulative
Tenant 1 2 3 4 5 6 7 8 9 10
A $ 110,511 $ 110,511 $ 110,511 $ 225,102 $ 231,855 $ 238,810 $ 245,975 $ 253,354 $ 260,955 $ 268,783
B $ - $ - $ - $ - $ - $ 238,810 $ 245,975 $ 253,354 $ 260,955 $ 268,783
C $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 253,354 $ 260,955 $ 268,783
D $ - $ - $ - $ - $ - $ - $ - $ - $ - $ 268,783
E $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511 $ 110,511
Total $ 331,532 $ 331,532 $ 331,532 $ 446,123 $ 452,876 $ 698,643 $ 712,971 $ 870,573 $ 893,375 $ 1,185,644
Recovery 7% 13% 20% 29% 38% 52% 66% 84% 101% 125%
As leases turn over, the landlord recovers the savings, but still the recovery takes 9 years.
CORE BUILDING SYSTEMS
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29
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In other words.
The landlord drives one of these…
…and you pay for the gas.
But what motivation is there for a landlord to buy one? CORE
BUILDING SYSTEMS
One of these will do the job just fine.
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Sustainability Investment
Energy Savings ≠↑ Net Operating Income to Pay
for Capital Cost
This cost allocation problem is called the split incentive.
CORE BUILDING SYSTEMS
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• Incentives affected by the type of metering
TENANT SYSTEMS
• Incentives driven by the type of lease, e.g. gross, modified gross, net
CORE BUILDING SYSTEMS
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Cost allocation for tenant systems is independent of lease type, and usually carried by the tenant.
TENANT SYSTEMS
• Tenant pays utility directlyDirect Meter
• Owner bills tenant based on private submeter reading, usually marked up 2-12%
Submeter
• Per sf estimate of tenant electric costs included in the rent
Electric rent inclusion
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Under Electric Rent Inclusion, there is no connection between actual tenant usage and tenant electric bills.
Tenant Electric Charge
TENANT SYSTEMS
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An exercise: who pays, who benefits.
Submeter
Improvement Capital Cost
Savings
High Efficiency Boiler
Ventilation Fans
Tenant Lighting
Landlord Landlord
Landlord Landlord
Tenant Tenant
CORE BUILDING SYSTEMS
TENANT SYSTEMS
Full Service Gross Lease
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An exercise: who pays, who benefits.
Improvement Capital Cost
Savings
High Efficiency Boiler
Ventilation Fans
Tenant Lighting
Landlord Landlord
Landlord Landlord
Tenant Landlord
Electric Rent Inclusion
MISMATCH
Submeter
CORE BUILDING SYSTEMS
TENANT SYSTEMS
Full Service Gross Lease
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An exercise: who pays, who benefits.
Improvement Capital Cost
Savings
High Efficiency Boiler
Ventilation Fans
Tenant Lighting
Landlord Tenant
Landlord Tenant
Tenant Tenant
Modified Gross LeaseFull Service Gross Lease
MISMATCH
MISMATCH
Submeter
CORE BUILDING SYSTEMS
TENANT SYSTEMS
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An exercise: who pays, who benefits.
Improvement Capital Cost
Savings
High Efficiency Boiler
Ventilation Fans
Tenant Lighting
Landlord Tenant
Landlord Tenant
Tenant Landlord
Electric Rent InclusionSubmeter
MISMATCH
MISMATCH
MISMATCH
Modified Gross LeaseCORE BUILDING
SYSTEMS
TENANT SYSTEMS
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An exercise: who pays, who benefits.
Improvement Capital Cost
Savings
High Efficiency Boiler
Ventilation Fans
Tenant Lighting
Landlord* Tenant
Landlord* Tenant
Tenant Tenant
Modified Gross LeaseNet Lease
Submeter
CORE BUILDING SYSTEMS
TENANT SYSTEMS
* Landlord may be able to share capital cost with tenant – depends on degree of “net”
ENERGY EFFICIENCY AND BUILDINGS
THE SPLIT INCENTIVE
HOW TO FIX IT
WHAT’S IN IT FOR TENANT AND LANDLORD
NEXT STEPS
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The simplest solution to the split incentive – a full service gross lease.
Landlord
Retrofit Cost
Energy Savings
Management Responsibility
CORE BUILDING SYSTEMS
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If “modified gross” with a base year is unavoidable, lease must adjust capital recovery.
Operating Expenditure Clause
1. Additional rent may include amortization of capital items that save operating costs.
2. Amortization can bundle cost and savings of retrofit items (i.e. will notfollow GAAP “useful life” method).
3. Landlord may amortize the expense in an amount equal to total savings.
CORE BUILDING SYSTEMS
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And consider adding an “expense stop” to isolate energy use from other operating.
compels more careful measurement
savings not subsumed by rise in other operating costs
incentive for landlord to save to get below base year
CORE BUILDING SYSTEMS
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On the tenant side, submeter (!).
TENANT SYSTEMS
46TENANT SYSTEMS
If a submeter is infeasible, a landlord’s annual electric survey MUST:
Increases in rates
Additional electric systems
ENERGYSTAR
Daylighting
AC retrofits
BUT
REWARD
NOT JUST
PENALIZE
ENERGY EFFICIENCY AND BUILDINGS
THE SPLIT INCENTIVE
HOW TO FIX IT
WHAT’S IN IT FOR TENANT AND LANDLORD
NEXT STEPS
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If the landlord does not implement the project, there are no savings anyway.
Tenant retains savings
Project payback>5
years
Landlord cannot finance
project
No retrofit occurs
Landlord and tenant overpay for inefficient
building
X
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Retrofit may prevent rising usage and repair costs from increasing “Additional Rent” to the tenant.
Retrofit arrests rising cost of declining systems
Annual Operating Costs
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A good retrofit leads to better tenant comfort and operations.
• New technologies allow better control over temperature
• Fewer hot/cold callsTemperature
• New central building systems allow integration with tenant systems for smoother operations
Systems Integration
• Fixing inadequate building ventilation improving fresh air flow and tenant health
Ventilation
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$2,000,000
$2,500,000
$3,000,000
$3,500,000
$4,000,000
$4,500,000
Historical energy costs vs Post-retrofit costs
Year
Historical energy usage
Post-retrofit usage
After the project is amortized, it may generate a rent decrease for existing leases.
Used to pay for project
Shared between landlord and
tenant*
* Degree ofsharing depends substantially on turnover/renewal schedule
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Possible reduction in carbon offset requirements.
Tenant Operating
Contribution
Major Green Renovation
Reduced Emissions
Lower carbon offset
expense
• Tenants effectively pay for emissions reduction instead of high utility usage
• Fulfills corporate sustainability policies
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In return, tenants should expect reports on success of energy efficiency – they helped pay for it.
What is being expensed to me?
• An absence!
• LACK of energy use
What does that mean?
• Have to assess a counterfactual
• What would have happened if there were no retrofit
How do I do that?
• Compare real energy usage data from before and after
• Adjust for weather, occupancy
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Not all measurement methods are created equal.
• Measurement using manufacturer’s specifications (stipulated savings)A
• Measurement of new equipment operation in isolation from rest of building systems.
B• Measurement based on comparison
of actual “before and after” bills to reflect interactivity.
C
D • Savings measured based on actual “after” bills and a simulated “before.”
Leases should require disclosure of overall building resource use and ENERGYSTAR score.
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Tenants should ask for rigorous measurement and reporting of energy efficiency projects.
Ap
pro
ach Whole
building, before and after, actual metered usage
Met
ho
do
logy IPMVP Option
C and ASHRAE Guideline 14
Co
st < 5% total project cost and <7.5% savings
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Building Master Meters
Tenant Direct
Meters
And tenants should provide landlord with any separately metered usage.
ENERGY EFFICIENCY AND BUILDINGS
THE SPLIT INCENTIVE
HOW TO FIX IT
WHAT’S IN IT FOR TENANT AND LANDLORD
NEXT STEPS
60
Apply these three principles.
1.Landlord should operate the building and tenant its premises as efficiently as is feasible.
2.Responsibility for capital expense and benefit of savings should reside with the same entity.
3.Consumption and demand for resources throughout the building should be measurable and transparent to both Landlord and Tenant
All of the savings from a system improvement should be available to pay for the improvement
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What can you do now?
1. Get buy-in from senior leadership to apply these principles.
2. Look for opportunities to change leasing approaches – upcoming renewals, new leases.
3. Ensure the term sheet for new space specifically calls out capital recovery equal to savings.
4. Consider adjusting an existing lease for these issues alone.
OBJECTIVES
1. To clearly identify the nature of the “split incentive” in commercial leasing.
2. To show in economic terms how the split incentive inhibits building retrofits.
3. To explain how to fix the split incentive.
4. To convey the importance of measurement and verification for purposes of fairness and building efficiency.
5. To establish the benefits for tenants of adjusting traditional approaches to capital and operating costs in commercial leasing.
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