will building owners invest in the energy efficiency of

Chapter 4

Will Building Owners Invest in theEnergy Efficiency of City Buildings?

Contents

Page

introduction . . . . . . . . . . . . . . . . . . . . . . . . . 99

Context for Building OwnerDecisionmaking in 1980-81..........101

W h o O w n s W h a t ? . . . . . . . . . . . . . . . . . . . . 1 0 4

Impact of Ownership on Building Retrofit. .107

Impact of Building Types on the Likelihoodof Retrofit. . . . . . . . . . . . . . . . . . . . . . .. 116

Likelihood of Retrofit in MultifamilyBuildings . . . . . . . . . . . . . . . . . . . . . . . . 117

Likelihood of Retrofit in CommercialBuildings . . . . . . . . . . . . . . . . . . . . . . . . 121

Potential for Retrofit in MarginalN e i g h b o r h o o d s . . . . . . . . . . . . . . . . . . . 1 2 6

Page

Potential for Increasing the Rate of Retrofitby Building Owners. . . . . . . . . . . . . . . .127

Information: Diminishing the Risks ofRetrofit . . . . . . . . . . . . . . . . . . . . .. ....132

Impact of Less Costly Financing on theP a c e of Retrofit . . . . . . . . . . . . . . . . . . . .133

LIST OF TABLES

Table No. Page

27. Likelihood of Retrofit by Building Typeand Owner Type. . , . . . . . . . . . . .- . . . .100

28. Types of Building Owners Interviewed. 10129. Building Types Covered in Building

O w n e r Interviews. . . . . . . . . . . . . . . . . .101

Table NO. Page30.31.

32

334

34.

35.

36.

37.

38.

39.

40.

41.

42.

43<

44.

Energy’s Share of Operating Costs. .. ..162Ownership Types Believed To Be MostCharacteristic of Various Building Types 105Ownership of Office Buildings–Atlanta, 1974, . . . . . . . . . . . . . . . . ., ..105Holders of Residential and CommercialMortgages. . . . . . . . . . . . . . . . . . . . . .. .106Retrofit Payback Criteria, HoldingPeriods, and Access to Financing andAdvice Among Different Types ofOwners . . . . . . . . . .................109Annual Heating Fuel Costs inApartment Buildings. .. .. ... ... ... ..118National Distribution of MeteringTypes of Rental Units . . . . . . . . . . . ....119Landlords’ Ranking of Reasons forDisinvestment. . .. .. .. .. ... ... .,.$.126Thirteen Types of Buildings WithSignificantly Different Retrofit Options. 128Typology of Small MultifamilyBuildings According to the Likelihoodof Major Improvement in EnergyEfficiency . . . . . . . . . . . . . . . . . . . . . . . . 128Typology of Large MultifamilyBuildings According to the Likelihoodof Major improvement in EnergyEfficiency . . . . . . . . . . . . . . . . . . . . . . . . 129Typology of Small Commercialbuildings According to the Likelihoodof Major Improvement in EnergyEfficiency. .. ..... . . . . . . . . . . . . . . 130Typology of Large CommercialBuildings According to the Likelihoodof Major Improvement in EnergyEfficiency ..,.... . . . . . . . . . . . . . . . . . 131Percentage of Apartment BuildingOwners Who Perceived Measures TheyInstalled To Be Effective. . ...........132Impact of uncertainty on ExpectedAnnual Energy Savings From aRetrofit Costing $10,000. . ...........133

Table No.

45. Building Owner Preferences forCredits or Financing Subsidies. .

LIST OF FIGURES

Figure No.

34. Comparison of Prices of Naturaland the Prime Rate, 1970-81 . . .

35

36

PageTax. . . . . . 139

Page

Gas. . . . . . 103

Frequency of Major and Minor EnergyRetrofit Among Building OwnersInterviewed .. .. ... .. ...... . . . . . 108Frequency of Retrofits Among BuildingTypes Covered in Building Owner -

I n t e r v i e w s . . . , . . . . . . . . . . . . . . . . . . , . 1 1 637. Apartment Operating Revenues and

38.

39.

40.

41*

Expenses, 1970-76. . . . . . . . . . ......118Combinations of Loan Terms and lnterestRates Which Allow the Value of EnergySavings to Exceed the Cost of BorrowedMoney the First Year. .. .. ... ... ... ..I34Cash From Operations for an 18-UnitApartment Building With and Withoutan Energy Retrofit. . . . . . . . . . . . . . . . . .136impact of Energy Retrofit Subsidies onPretax and Aftertax Cash Flow for aPrototypical Apartment Building. ..137lmpact of a Retrofit on Pretax andAftertax Cash Flow for Two otherPrototypical Apartment Buildings. ....138

BOXES

PageC. Permanent Financing: Roles of

Mortgage Banks and InsuranceCompanies . . . . . . . . . . .............,106

D. Corporations: Taxes and Accounting....... 106E. A Question of Value: How the Appraiser

Sees It. . . . . . . . . . . . . . . ............113F. Role of the Property Manager. ... ... ...113

Chapter 4

Will Building Owners Invest in theEnergy Efficiency of City Buildings?

INTRODUCTION

Virtually all types of city buildings (as is clearfrom ch. 3) can be retrofit to save a substantialportion of their energy. Some can be retrofiteasily and cheaply. Others can be retrofit onlywith difficulty and at considerable expense butnonetheless in such a way that the expensewould be justified by energy savings over thebuilding’s lifetime.

The question remains, however, will thesebuildings be retrofit? The answer given by thischapter is that city buildings will not be retrofitunless several more conditions are met beyondthe fact that the building is cost effective to ret-rofit.

If a building that can be retrofitted is to be ret-rofitted three additional conditions must bemet:

●

●

●

the building’s energy inefficiency mustcause a noticeable loss i n present or futurereturn from the building,an investment in improved energy efficien-cy is consistent with the building owner’sgoals, andthe building owner has the means—ade-quate information, decisionmaking ability,time, and financial resources—to make theinvest ment.

Furthermore, even if the building owner iswilling and able to make such an investment, itwiII not happen unless there are businessesready to recommend and install the retrofit. Thestate of the energy retrofit business is mentionedbriefly in this chapter but is discussed morecompletely in chapter 7.

For example, it should be easy (given the anal-ysis in ch. 3) to prescribe a set of very cost-effec-tive retrofits for a small frame multifamily build-ing with an old inefficient steam system in a citywith a cold climate. Yet for the identical build-ing with identical retrofit potential the chances

of retrofit range from good if it is an owner-occupied building in an up-and-coming neigh-borhood to very poor if it is owned by an absen-tee landlord, and is located in a declining neigh-borhood.

A curtain wall office building with a decentral-ized heating system of electric baseboard heatand window air conditioners has much poorerprospects for inexpensive easy retrofit than thesmall frame steam-heated building. In mostcases, only expensive retrofits are available forsuch a building, replacing the electric resistanceheaters with heat pumps or installing doubleglazed window panels. Nonetheless, because ofthe potential goals of its owners and their re-sources the chances that such a building wiII ac-tually be retrofit range from good for a corpor-ate headquarters or office building owned by aninsurance company or pension fund to poor if itis owned by a smalI local partnership for taxshelter purposes.

The likelihood that a building will be retrofitdepends both on its type of owner and on theimportance of energy costs for the purpose theowner uses the building for. Table 27 illustratesin a schematic way the general prospects for ret-rofit for different combinations of buildings andowners. In general, the chances that a buildingwill be retrofit are less likely for multifamily thanfor commercial buildings, less likely for build-ings owned for investment than for buildings oc-cupied by their owners, and less likely for build-ings owned by individual owners or local part-nerships than for those owned by institutionalowners such as pension funds and insurancecompanies, or national partnership syndicates.

In fact real estate is not quite so simple astable 27. The rest of the chapter explains someof the complexity of investment for energy effi-ciency in buildings. To date little specific re-search work has been done on the subject of

99

100 ● Energy Efficiency of Buildings in Cities

Table 27.—Likelihood of Retrofit by Building Type and Owner Type

Decreasing likelihood

Multifamily Multifamilymaster- tenant-

Owner-occupants Office Hotel Retail metered metered

Decreasing Corporation . . . . . . . . . L L L x xLikelihood Individual . . . . . . . . . . . M M M M P

Condominium. . . . . . . . X x x M M

investor-owners

Decreasing Institutional (pension,insurance). . . . . . . . . L L L L M

Likelihood Developmentcompany . . . . . . . . . . M M P P u

National partnership . . M M M M PLocal partnership. . . . . P P P P uIndividual . . . . . . . . . . . P P u P u

L = Likely.M = Moderate.P = Possible.U = Unlikely.X = There are none or very few examples of such building types owned by these owners.

SOURCE: Office of Technology Assessment

the motivation to invest in energy efficiency perse although there is voluminous Iiterature on in-vestment i n real estate.1 The chapter relies heav-ily on work done for OTA by the Real Estate Re-search Corp. (RERC) a Chicago-based consult-ing firm specializing in the investment analysisof real estate and in appraisal.

RERC conducted a comprehensive literaturereview, and interviewed buildings owners i n fourcase study cities (Buffalo, N.Y., Des Moines,Iowa, Tampa, Fla., and San Antonio, Tex.) aswell as “national” real estate owners withholdings in all parts of the country. RERC alsoanalyzed prototype multifamily buildings toevaluate the impact of rising energy costs andenergy retrofits financed in several alternativeways. In total, RERC talked to 96 buildingowners representing different types of ownersand different building uses. (The breakdown ofinterviews is shown in tables 28 and 29. ) These

1 Several other useful sources on real estate decisions and energyconservation include: Hittman Associates, PhysIca/ Charac (er-IstIcs, Energy Consumption and /7e/ated /nstI tut/oncJ Facfor$ fn theCornrnercla/ SeC tor, DC)E report, February 1977; Proceedlng~ oithe Mu/tl/am//} and Rental Housing Work$hop, Dec. 4, 5, and 6,1980, Washington, D. C., sponsored by the Federation of Amer-ican Scientists Fund prepared by Deborah L. Blevis; Alice Levine,and Jonathan Raab, So/ar Energ}, Conwrvatlon and Renta/ Hous-ing, Solar Energy Research Institute, March 1981; Mu/t/-Faml/yEnergy Conwrvatlort: A Reader , Coa l i t i on o f Nor theas tMuniclpallties, July 1981.

interviews, supplemented by extensive readingin real estate trade literature, in-house RERC ex-pertise, and OTA staff research form the basisfor this chapter.

This chapter focuses on privately owned, ur-ban commercial, and multifamily buildings–of-fices, retail facilities, hotels, and small, medium,and large apartment houses—partly becausethese form the bulk of the urban building stockand partly because these have been woefullyneglected i n the literature on investment inenergy efficiency. The chapter does not specif-ically address the motivation for investment byowners of single-famiIy houses. This subject wasfully covered in the previous OTA study on Resi-dential Energy Conservation, and other litera-ture, 2 and is addressed to some extent in otherchapters of this report Chapter 5, Retrofit for theHousing Stock of the Urban Poor and Chapter 9,The Public Sector Role in Urban Building EnergyConservation. Under some conditions the moti-vation of single-family home owners parallelsthat of the owner-occupants of small multifam-ily buildings and this will be pointed out in thetext.

2A comprehensive analysls of the potential for energy conserva-tion in single-family houses are the final report and workingpapers of the Res/dentla/ Energ}’ Ef(Ic Ienc} Standards Study sub-mitted to Congress by the Department of Housing and Urban De-velopment In July 1980.

Ch. 4—Will Building Owners Invest in the Energy Efficiency of City Buildings? ● 101

Table 28.—Types of Building Owners Intervieweda

Owner status Buffalo Des Moines Tampa San Antonio National

Individual . . . . . . . . . . . . . . . . 8 4 1 3 6Partnership , . . . . . . . . . . . . . 7 5 4 4 5Corporate . . . . . . . . . . . . . . . . 3 4 1 2 4Institutional . . . . . . . . . . . . . . 0 1 0 0 10Development company . . . . . 3 0 0 1 4Bank . . . . . . . . . . . . . . . . . . . . 4 2 4 3 —Condominium . . . ... , , . . . . 0 0 1 1 1

Total . . . . . . . . . . . . . . . . . . 25 16 11 14 30asom~ owners trrterV@W@ f-rad multiple ownership posltlons (e g., as Individual owners and members of partnerships)

Owners were tabulated on the basis of the!r prlnclpal ownership role

SOURCE Real Estate Research Corp

Table 29.—Building Types Covered in Building Owner Interviews

Building type Buffalo Des Moines Tampa San Antonio

Multifamily . . . . . . . . . . . . 10 9 3 7Retail. . . . . . . . . . . . . . . . . 2 3 3 2

Shopping centersDepartment storesRetail strip

Offices . . . . . . . . . . . . . . . 8 6 4 6Hotels . . . . . . . . . . . . . . . . 1 1 0 2

Total . . . . . . . . . . . . . . . 21 19 17 10

NOTE, The number of bulldlng types WIII not exactly correspond to the number of owner types due to multlple ownershtp andthe fact that banks were not Interviewed as owners In all cases

SOURCE, Real Estate Research Corp

The decision to make energy improvementsin response to rapidly rising energy costs isabove all a real estate investment decision. Likeother real estate decisions it is affected byoverall investment strategy, tax laws, market-ability of the property, lease terms, cost andavailability of financing, perception of risk, andmany other considerations for a particularbuilding. Furthermore, real estate is a complexand diverse industry. Markets vary sharply fromcity to city and even from neighborhood toneighborhood. ownership runs the full rangefrom the giant corporation that owns its own

headquarters building to the retired coupleholding onto their small three-story walkup astheir nest egg. The conditions under which realestate decisions are made can change drastical -Iy from year to year. The rapid increases in infla-tion and interest rates of the last few years havehad profound consequences for decisions madeby all kinds of real estate owners. (More recent-ly, the 1981 tax law has made sweeping changesin the importance of real estate as a tax shelterfor other income.) The chapter treats each ofthese influences on a building’s prospects forretrofit.

CONTEXT FOR BUILDING OWNER DECISIONMAKING IN 1980-81

Although the general goals of investment in work was done, had its particular features,real estate remain the same over years and dec- many of which continued into 1981.ades, the specific concerns of building ownersare significantly influenced by the structure of Energy is Now Important. First of all, aftercosts and opportunities in a particular place and many years of energy price increases, energytime. The year 1980, when most of the survey began to be, for many building owners, a seri-


ous concern in 1980. It was widely perceived,as reported to RERC, as having crossed athreshold of importance within the overallbalance of income and expense for particularbuildings. In its annual national survey Emerg-ing Trends in Real Estate 1981, RERC describedthis change in consciousness of energy bybuilding owners:3

In 1979, their attitude was that increased costswould simply be passed on to consumers; butthis year’s comments are less cavalier. Lendersare examining the energy efficiency of buildingsbeing purchased or developed; investors areconcerned about absolute operating costs, andnot just those they will pay themselves; and ten-ants are seriously evaluating energy costs whenconsidering space alternatives.

Although some of the building owners inter-viewed for OTA did not share this perception,most did and echoed the concern of the mana-ger of a downtown office tower in Buffalo:“That electric bill is incentive enough, believeme!”

For most categories of building operationsand businesses, the rapid increases in energyprices (described in ch. 2) have been faster thanincreases in other costs of doing business suchas labor or property taxes. For all except hotels(see table 30), the cost of energy was a far

3Real Estate Research Corp., “Emerging Trends in Real Estate:1981 ,“ Chicago, Ill., October 1981.

Table 30.—Energy’s Share of Operating Costs(in percent)

1970 1975 1979

Downtown office(1) . . . . . . . . . . 18.90% 19.1% 23.80/oCenter city hotel (2) . . . . . . . . . . NA 7.9 7.5Neighborhood shopping (3) . . . . 5.9 (1972) 4.2 9.1Elevator multifamily (4):

Heating fuel . . . . . . . . . . . . . . 5.5 NA 13.4Electricity . . . . . . . . . . . . . . . . 6.9 NA 13.8Gas . . . . . . . . . . . . . . . . . . . . 1.3 NA 2.7

Low-rise (12-24 units) (4):Heating fuel . . . . . . . . . . . . . . 13.1 NA 18.9Electricity . . . . . . . . . . . . . . . . 2.8 NA 8.9Gas . . . . . . . . . . . . . . . . . . . . . 1.3 NA 2.7

NA = Not available.

SOURCES: 1980, 1976, 1971, Downtown Office Experience Exchange Report,Building Owners and Managers Association (BOMA), Washington,DC.; Laventhol and Horwath, U.S. Lodging Industry, 1976, 1979,1980 reports; Dollars and Cents of Shopping Centers, 1972, 1975,1978 ULI — The Urban Land Institute, Washington, D. C.; /n-corne/Expense Ana/ysis: Apartments, Institute of Real Esta teManagement (19S0 and 1975 editions). All figures are nationalaverages.

greater share of costs in 1979 than it was in theearly 1970’s. (Vigorous conservation by hotelsappears to be responsible for holding theenergy share down. ) Further rapid increases inenergy prices since 1979, especially in heatingoil, help account for the obvious concern aboutenergy which was evident i n the interviews withbuilding owners in late 1980.

The energy retrofit business scarcely existeda few years ago, and is still in the process of get-ting organized in response to the increasing in-terest in controlling energy costs. A few long-established companies offer specialized energyretrofits such as energy control systems. Manyother companies already expert in the installa-tion and maintenance of heating, ventilating,and air-conditioning systems are acquiring ex-perience and are recommending and installingenergy retrofit measures. There are still only afew general retrofit companies that have bothexperience with mechanical systems and expe-rience with such envelope retrofits as doubleglazing, blockage of air infiltration or insulation.The current embryonic state of the private mar-ket ability to prescribe and install retrofits is de-scribed in more detail in chapters 3 and 7.Nonetheless, observers of this process believethat it will take a few more years for enoughbusinesses to acquire solid reputations in thisfield, so that the building owners’ interest that isnow manifest will be matched by a privatemarket response.

The current state of knowledge about thedemonstrated effects of retrofit on energy use isas embryonic as the energy retrofit business. Al-though proprietary information is now beingdeveloped on retrofit results for such businessesas restaurant chains and department stores,there is still very little published information, ina few years there should be more publicly avail-able information on actual retrofits from sur-veys, from demonstration projects and fromsuch programs as the federally funded programto retrofit schools and hopitals. Improvedknowledge of retrofit results, coupled withlonger track records of the now-forming energyretrofit companies will reduce the element ofuncertainty that still looms large in any decisionto invest in building energy efficiency.


Leasing Trends. Offsetting increasing ownerconcern with energy costs, is an increasingtendency for leases to be written so as to pass allor most energy costs to the tenants. The differ-ent types of leases and their implications forenergy use are described below in sections oneach building type. In multifamily buildingsowners are converting master-metered build-ings to tenant metering if technically feasibleand introducing prorata billing systems forenergy costs when it is not technically feasible.In office buildings new leases are written withpassthrough clauses in a variety of forms. In thelast decade, retail buildings (especially shop-ping centers) have almost entirely convertedfrom gross to net leases in which not onlyenergy costs, but maintenance and cleaningcosts, taxes, and a prorata share of the commonspace are passed on to tenants.

Net leases, and passthrough leases encouragetenant responsibility for sensible use of energyin their rented space. Although little has beendocumented of the impact of these types ofleases on energy use in commercial space, one

estimate of the energy savings from tenant me-tering in multifamily buildings is 5 percent forheating costs (more for electric heat, less for gas)and 20 percent for other energy costs,4 How-ever, for those buildings for which substantialinvestments in energy retrofits such as newlighting systems or more efficient central boilerswould increase their energy efficiency, the prev-alence of net and passthrough leases clearly re-duces the immediate incentive of the owner toinvest.

Over the longer term the owner of a buildingwith net leases may still invest in its energy effi-ciency but will take into account the competi-tive importance of an energy efficient buildingto his tenants in the overall market that theyoperate in. The variations among office, hotel,retail, and multifamily tenants in their concernsabout the energy efficiency of their buildingswill be described below.

4Lou McLelland, “Encouraging Energy Conservation in Multi-Family Housing: RUBS and Other Methods of Allocating EnergyCosts to Residents, ” Executive Summary, 1980, Institute ofBehavioral Science, University of Colorado, p. 8.

4 ~

2 “ .’.

!.I I I I t I I I 1 -

1970 1972 1974 1976 1977 1978 1979 1980 1981(Mar.)

Year

SOURCE : Federal Reserve Board; Department of Energy, Energy Information Administration, Annua/ Repel1980, p 119, Morrthly Energy Review, August 1981, p. 16.

‘t to Congress,


Costs of Financing. Energy isn’t the only costof doing business that has increased in the pastfew years. Since 1977, the cost of financing–forbuildings, equipment, inventories, and energyretrofits—has increased just as fast. Since 1970(as can be seen in fig. 34), the prime rate is seento increase as fast as the price of natural gas.Most energy retrofits substitute capital forenergy. The high cost of financing has been aserious disincentive to retrofits.

Traditionally, major building improvementsincluding energy retrofits were financed by refi-nancing (remortgaging) the entire building, Al-ternatively, second mortgages might be used atpremium, but not prohibitive, rates. In the cur-rent climate neither is practical. Refinancing afixed rate mortgage issued 5 years ago at 9 per-cent with a note of 14 to 17 percent or higher isneither sensible nor affordable. Furthermore, inresponse to persistent high inflation, most finan-cial institutions are moving away from fixedrate, long-term mortgage loans, which in late1980 were virtually unavailable. Instead theyare developing 5-year renegotiable mortgages,variable rate financing methods and equity par-ticipation. As a banker interviewed in Tampaput it: “This last round of madness in moneymarkets has destroyed the conventional meansof financing income property. Now they say‘give me a piece of it’. ”

Some shorter term alternatives to refinancingand second mortgages for buiIding improve-ments—such as commercial bank loans, lines ofcredit, signature loans or borrowing against per-sonal assets—are generalIy avaiIable at the sameinterest rate as construction loans, floating 2points over prime (21 percent in both the sum-mer of 1980 and spring of 1981). To be sure,banks may lend below prime to preferred cus-tomers but these generally must maintain largedeposits in exchange for prefered treatment onloans. At such high financing rates, virtually allbuilding owners will postpone building im-provements including energy retrofits unlessthey can be financed internally (see the later dis-cussion of the availability of internal funds).

Overall Context. To sum up, the year 1980-81finds several contradictory influences on thelikelihood of energy retrofit investment inbuildings. Building owners’ newly recognizedconcerns about energy costs, the gradual im-provement in the organization of the energy ret-rofit business, and the knowledge of the impactof energy retrofit all tend to increase the amountof retrofit that is likely to occur. Strongly offset-ting these influences, however, is the growingtendency toward net and passthrough leasesand the very high cost of financing.

WHO OWNS WHAT?

The prospects for energy retrofit to a parti-cular building depend on both what a buildingis used for and who owns it. Although all kindsof buildings, large and small, commercial andresidential, are owned by individuals or localpartnerships, other organizations active in realestate, such as insurance companies or nationalpartnership syndicates, tend to specialize inonly a few building types, Before proceeding toa discussion of the impact of owner types, orbuilding types on retrofit, it is important toknow who owns what.

ture and the expertise of real estate analysts andoperators. There is virtually no detailed data onownership. In some States such as Il l inois,moreover, ownership is hidden by various de-vices permissible under State law. I n only a fewcities for a few particular markets, office build-ings, multifamily, etc., have there been surveysof types of owners.

The consensus of conventional wisdom inreal estate on who owns what is shown in table31. Small buildings are usually owned by indi-viduals and partnerships, and small business

Most of what is known about ownership of corporations. Large buildings may be owned bybuildings is known from real estate trade litera- individuals and partnerships as well, but may

Ch. 4—Will Building Owners Invest in the Energy Efficiency of City Buildings? Ž 105

Table 31.— Ownership Types Believed To Be Most Characteristic of Various Building Types

Owner-occupants Investor-owners

indivi-dual or National Develop- Local

Corpo- small Condo- lnstitu- partner- ment partner-ration business minium tional ship company ship Individual

Small buildings:Multifamily

(2-9 units). . . . . . . . . . . . . . . x x xOffice buildings . . . . . . . . . . . x x xRetail strip stores . . . . . . . . . x x x

Large buildings:Multifamily (more

than 10 units. . . . . . . . . . . . x x x x xOffice buildings . . . . . . . . . . . X x x x x xShopping centers. . . . . . . . . . x x x xDepartment stores. . . . . . . . . X xHotels . . . . . . . . . . . . . . . . . . . x x x x

SOURCE” Off Ice of Technology Assessment

also be owned by insurance companies, pen-sion funds, major corporations, national part-nership syndicates, or development companies.

Partnerships are believed to be the most com-mon form of real estate ownership, because ofthe real estate tax advantages a partnership hasover a corporation. in a survey of office build-ings in the city of Atlanta (table 32), partnershipsand corporations were not distinguished. If,however, partnerships were the bulk of theowners, as predicted by conventional wisdom,then they accounted for more than half of all of-fice buildings in the city.

Table 32.—Ownership of Office Buildings—Atlanta, 1974

Number ofType of ownership buildings

Corporations and partnerships. . . . . . . . 216Savings and loans . . . . . . . . . . . . . . . . . . 19Banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17Individuals. . . . . . . . . . . . . . . . . . . . . . . . . 50Labor unions . . . . . . . . . . . . . . . . . . . . . . 3Real estate companies . . . . . . . . . . . . . . 13Insurance . . . . . . . . . . . . . . . . . . . . . . . .... . 26Real estate investment trusts . . . . . . . . . 3Nonprofit organizations . . . . . . . . . . . . . 8Uncertifiable . . . . . . . . . . . . . . . . . . . . . . . 8

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . 363

NOTE Survey Included urban structures of at least 10,000 ft’ and suburbanstructures of at least 30,000 ftz, all wlthl n the vlclnlty I Imlts

S O U R C E Cornrnercia/ Space POIICY Ana/ys/s of Profltablllty of Retrofit ofEnergy Consewat/err, Metro Study Corp , Washington, D C , June1976

Although local partnerships are still the domi-nant form of partnership in real estate, nationalsyndicates of partnerships (such as JMB, RobertMacNeil, and Balcor) have become increasinglyimportant in the last half decade. They are listedwith the Securities and Exchange Commissionand their sales are handled by such brokeragefirms as Merrill Lynch and E. F. Hutton. Nationalsyndicates select their investments with an eyeto future appreciation. A few (such as RobertMacNeil) specialize in multifamily properties;others favor the generally higher returns fromowning and leasing office buildings, shoppingcenters, and hotels.

Development companies, when they own realestate as welI as buiId and develop it, also preferoffice buildings, shopping centers, and hotelsand tend to avoid the smaller returns of smallercommercial buildings and multifamily build-ings. So do the increasingly important institu-tional investors such as insurance companies,and pension funds. These latter have traditional-ly provided the permanent financing for largermultifamily and commercial buildings, general-ly through the brokerage of a mortgage bank(see box C). Increasingly, however, these insti-tutions are becoming more active in the equityownership of buildings themselves. For pensionfunds, recent changes in the Employment Re-tirement and Security Act (ERISA) have per-mitted a more aggressive direct role in real

[, -1, , . —.

106 . Energy Efficiency of Buildings in Cities

estate. As of 1979, the eight biggest life insur-ance companies had about $3.8 billion in realestate purchases, joint ventures and incomeproperty construction, out of total assets of $215b i l l ion inc lud ing about $64 b i l l ion inmortgages. 5 Institutions are a small but increas-ing share of building owners.

Corporations tend to own buildings for theirown use partly because corporate tax laws dis-courage the use of building losses to shelterother income (see box D). They commonly ownoffice buildings, hotels, and department stores,more rarely shopping centers and almost neverapartment buildings.

As a group, the owner s o f m u l t i f a m i l y

buildings are the smallest and least organized ofall owners. About 2.7 million owners occupyone or more apartments of multifamily buildingthey own.6 The Urban Institute found in a 1976— — - —

sCrittenden Financing, Inc., 1980.‘W .S. Bureau of the Census, General Housing Character/st/cs,

U.S. and Regions 1977, 1978.

Ch. 4— Will Building Owners Invest in the Energy Efficiency of City Buildings? ● 107

study of Boston that 60 to 70 percent of themultifamily buildings were owned by individualswho owned less than 30 units. Only 10 to 15percent held buildings with 150 units or more.These findings are consistent with findings fromBaltimore and Newark.7

Condominium ownership of multifamily unitshas not yet made a large dent in the overallrental market but has become significant in afew cities where escalating property values en-courage conversion. According to a 1979 De-partment of Housing and Urban Development(HUD) study, only 1.3 percent of all rental unitshad been converted to condominiums from1970-79. In Washington, D. C., however, 6.8percent had been converted and in Denver andBoulder, Colo., 8.8 percent. In such cities asNew York where cooperative apartments aretraditional, there was a large number of conver-sions to cooperatives, rather than to condomin-iums. 8

— -—-—7La rry oza nrw ancj Ray Struyk, / Iouvng From tlw ExI}tf ng S[CJC k,

The Urban In$tltute, 1976, pp. 107-108. The Information was ob-tained by Struyk from interviews with large property managers InBoston. Results from Newark are reported in George Sternlleb,The Tenement Landlord, Rutgers University Press, 1966, and re-su Its from Baltl more are reported i n Michael Stegman, / I(juv ng /n-~e~tmwrt In the Inner CJ(Y, MIT Press, 1972.

‘Department of H OUSI ng and Urban Development, ThLI (-cm \er-von ()( Rt’n tal I Iou \f ng (() (-ondoml nl urn$ and (’o(~pefa [ I Ie$ A INa -[l~mal Stud} c)t 5( [Jpe, ( auwj and /mpac (, 1980.

Many commercial buildings are small and oc-cupied by their small business owners, who maybe individuals, partners, or small corporations.Based on information in a recently publishedEnergy Information Administration survey ofcommercial buildings, as many as 60 percent ofthe smallest buildings of up to 5,000 ft2 are likelyto be occupied by their owners.9

The structure of ownership is significant forthe prospects for energy retrofit. In general, as isexplained in the next section, the largest, mostfinancially independent and best advised own-ers (corporations, national partnership syndi-cates, development companies, insurance com-panies, and pension funds) tend to own thelarge commercial buildings. The smaller andleast organized owners tend to own multifamilybuildings.

9E nergy I nformat ion Ad ml nl str~tl on, Non -Re\Id(m tJa I BUI ld~ ngjEnerg}’ Con~umptl(m Sunm, 1981, table 23 B. It is harder to beprecise about larger buildings because EIA asked tt hulldlng~ wereoccupied by the owner or his agent. SI nce larger bu I Id I ng~ may beoccu pled by a manager agent of the owner, they are not tru Iyowner-occupied

IMPACT OF OWNERSHIP ON BUILDING RETROFIT

Among the types of owners interviewed, what they said about their motivation and re-there were striking differences in the extent to sources to carry out a retrofit.which they had made major energy investmentsin some or all of their buildings, minor energy The retrofit experience of the owners inter-investments (including significant operational viewed is shown in figure 35. The top levelimprovements), or, no energy investments or shows the “national ” owners with holdingsoperational changes at all. The survey of build- across the country; the bottom level shows theing owners was not constructed to be a statis- owners interviewed i n the four case study cities.tically valid sample of building owners and for The differences among types of owners is strik-this reason only tentative and suggestive conclu- ing. Out of 22 interviewed, only one individualsions can be drawn from the results; nonethe- owner, of any kind, had made a major energyless the pattern of retrofits reported by the differ- investment, although 8 had made minor invest-ent types of building owners is consistent with ments. On the other hand, 10 “national” insti-


Figure 35.— Frequency of Major and Minor Energy RetrofitAmong Building Owners Interviewed

9

8

7

6

5 E

1---Individualowners

12

11 - —10 —

9 —

8 -

7 -

6 -

5 -

4 -

3 -

2 -

1

NOTE: Minor energvestments, ”

SOURCE: Real Estat

Interviews

kPartner-ships

ith large owners with nationwide

I Buffalo, Des I

h

Institutionalowners

Moines, Tampa,

Condominiums

None

investments cost little enough that they could be handled as “expenses” and not “capital in-

Research lnterwews for OTA

tutional owners interviewed had made major ations interviewed, none had made major ener-energy investments in their buildings. Nationalpartnership syndicates, national corporations,and development companies all had eithermade major or at least minor energy invest-ments.

Significant numbers of the local individualowners and local partnerships had done noth-ing to their buildings in response to increasingenergy prices. Of the four condominium associ-

gy investments.

The results of the interviews cannot be com-pared with any statistically valid survey data be-cause none has been conducted by owner type.The. interviews did make clear, however, thethinking that goes into a building owner’s deci-sion to retrofit or not retrofit and why it is likelyto be different for different types of owners. Therest of this section explains how owners differ i n

Ch. 4— Will Building Owners Invest in the Energy Efficiency of City Buildings? Ž 109

the motivation to make energy investments intheir buildings, and, equally important, in the fi-nancial and managerial resources they can callupon to make an investment.

The Differences Among Owners’ PaybackCriteria for Retrofits. In their interviews, differ-ent types of owners were explicit and quite con-sistent in their criteria for how fast an energy ret-rofit should “pay back” i n energy savings.Almost all owners used simple payback as thecriterion, namely how many times would thefirst year’s savings have to be multiplied toequal the cost of the retrofit. Only banks (whowere generally not interviewed as buildingowners, but as financiers) reported using a dis-count rate, their borrowing cost from Federalfunds. Although building owners expected in-creases in fuel and electricity cost over the pay-back term and took this into account in a gen-eral fashion, most of them cited payback termsso short that fuel escalation would not make asubstantial difference.

The payback criteria used by owners, shownin table 34, varied from the fairly long paybacksof 5 to 7 years used by institutional owners tothe very short payback requirement of 1 year orless used by individual investor-owners. Thelonger paybacks would permit more compre-hensive retrofits to more buildings such as

Table 34.—Retrofit Paybackand Access to Financing and Advice

burner or boiler replacement, complex energymanagement systems, full window retrofits, andeven replacement of less efficient window airconditioners with more efficient air condition-ers (see ch. 3 for a full discussion). A payback re-quirement of a year or less, on the other hand,eliminates all but operational improvementsand small investments such as flow restrictors,clock thermostats, or more efficient light bulbs.

The rest of table 34 helps explain why differ-ent types of owners had such varied” criteria.owners with longer payback criteria havelonger expected holding periods for their build-ings as well as much better access to financingand professional advice. The owners withshorter payback criteria expect to hold theirbuildings for shorter periods of time and alsohave problems getting adequate financial orprofessional advice.

Among owners, there is a major distinctionamong owner-occupants and investor-owners.For business owner-occupants (large corpora-tions and smaller businesses) energy costs areone of the many expenses of doing business.Because these costs are rising so rapidly, theyhave become a major concern, but cost con-tainment is only one of many possible uses oftheir available funds. owner-occupants holdreal estate principally for their own use, though

Criteria, Holding Periods,Among Different Types of Owners

Typical Building Expected In housepayback for own holding Access to professional

Building owner type criteria use? period capital advice

Owner-occupants:Large corporations . . . . 3-5 yrs. Yes Long Good GoodSmall businesses . . . . . 1 yr. Yes Long Poor PoorMultifamily owner

occupants . . . . . . . . . 1-3 yrs. Yes Long Poor PoorCondominium . . . . . . . . No data Yes Long Mixed Fair

Investor-owners:Institutional owners . . . 5-7 yrs. No Long Good GoodDevelopment

companies . . . . . . . . . 1-3 yrs. No Short Fair GoodPartnership

syndicates . . . . . . . . 3 yrs. No Short Fair GoodLocal partnerships . . . . 1-2 yrs. No Short Poor FairIndividuals . . . . . . . . . . . 1 yr. No Mixed Poor Poor

NOTE Long holding period = more than 10 years, short holdlng period = 8-10 years.

SOURCE: Office of Technology Assessment.

110 Ž Energy Efficiency of Buildings in Cities

tax benefits may be enjoyed and appreciation inreal estate value hoped for. Residential owner-occupants who live in one unit of a small apart-ment building and condominium owners donot use their real estate to conduct a businessbut share with business owner-occupants thepoint of view that the primary purpose of thebuilding is for their own use and real estatereturn is secondary. Investor-owners, on theother hand, are not interested in buildings fortheir usefulness as buildings but for the manyforms of economic return they may obtain fromholding them. The rest of this section describesthe motivation for energy retrofit of each of theowner-occupants and investor-owners includedin table 34.

Large Corporate Owner Occupants. Largecorporations almost always occupy any build-ings that they own. Corporations are inhibitedfrom owning real estate for investment purposesby aspects of corporate tax status that reducethe return to corporations from real estate be-low what is available to individuals and partner-ships (see box D). Thus, the chief economicbenefit of corporate buildings is their efficiency

as business facilities and, in some cases, theextent to which they enhance the corporateimage.

Corporate owners of their own office facilitiesor downtown retail stores or hotels reported ininterviews that they base energy improvementdecisions on expected business return not onreal estate return. If energy-efficiency results inlower business operating expenses, greater em-ployee productivity, enhanced attractiveness topatrons or better business image, improvementsare likely to be considered in competition withalternative corporate investments in marketing,expansion or inventory control. The dilemma ofchoices among business investments was wellexpressed by the president of a departmentstore in Buffalo: “we make energy improve-ments to help control our operating costs, butthere’s a limit. Remember capital for energy im-provements does not increase sales.” At thesame time, for owner-occupants, there is noway to escape the burden of energy costs whichinvestor-owners can duck with passthroughleases. The president of a national motel chainin San Antonio said he expected to see energy

Photo credit: Steve Friedman

Energy efficient features of this building in Tampa, owned by a corporation,include double glazing, and controls on outside air mixing

Ch. 4—Will Building Owners invest in the Energy Efficiency of City Buildings? Ž 111

costs exceed mortgage costs i n the near future,“1 increase my return by controlling mycosts—now, not later. ”

Large corporations have good access to cap-ital for energy improvements. Most moderate tolarge-sized corporations have formal capitalbudgeting procedures and routinely make cap-ital investments drawing on financing from a va-riety of sources: retained earnings, corporatedebt issues, lines of credit, and commercialloans. Of the five local and three national cor-porate owners interviewed, who had made ma-jor retrofit investments, all had been financedwith internal funds.

Large corporate owners also have good ac-cess to professional advice. They have profes-sional faciIity managers as part of corporateheadquarters staff. They often can afford toemploy internal experts in energy conservationor can retain consultants. The basic corporateplanning cycle encourages explicit considera-tion of energy investments.

The corporate owners interviewed all men-tioned 3- to 5-year paybacks as the criteria theyapply to energy investments. In contrast tomany types of investor-owners this period is notrelated to their holding period for the buildingbut rather to a corporatewide business standardof return for nonmanufacturing facility invest-ments. Unlike smaller owners, corporationshave both financial and professional resourcesto make energy investments based on these cri-teria.

Small Business Owner-Occupants. Smallbusinesses may be individual proprietorships,partnerships, or small corporations. Like largecorporations, they own the buildings to use intheir businesses. Said a San Antonio shoppingcenter owner of the typical small shoestore“they’re in business to sell first and in times likethis, it’s tough to do everything you might likeor should do. ”

Information on the motivation of small busi-nesses is scanty. A few interviews were con-ducted directly with small business owners,mostly individual proprietorships. Further in-sight was provided by several brokers of smallbusiness properties.

Compared to large corporate owners of theirbuildings, small businesses have much less ac-cess to internal funding for energy improve-ments and usually limited access to outside cap-ital at reasonable rates. Such owners are partic-ularly dependent on maintaining reasonablecash flow from their businesses. Energy invest-ments with high initial costs and burdensomedebt service due to high interest rates, shortloan terms, or both (see discussion in the lastsection of this chapter) are serious obstacles toenergy conservation investments.

Small business owners also lack the time andfinancial resources to obtain good professionaladvice about energy investments. Because oftheir dependence on adequate cash flow therisks of a mistake are also much greater than forthe large corporation. For all these reasons,small business, especially individual proprie-tors, appear to limit energy investments to thosethat will pay back in 1 year or less.

Owner-Occupants of Multifamily Buildings.This category of owner is very similar to thesmall business owner, lacking time or profes-sional advice to learn about energy improve-ments and lacking sufficient cash flow to fundenergy investments from internally generatedfunds but with very limited access to outside fi-nancing at reasonable interest rates. However,because these owners also live in their buildingand pay some of its energy costs as part of theirown household expenses, there is a slightlygreater chance that they will consider retrofitswith paybacks of up to 3 years. Of the very smallnumber of multifamily buildings reported as ret-rofitted in the building owner survey, two wereowner-occupied small buildings in Buffalo.

Condominium-Owners. Owners of condo-minium apartments are responsible for energyimprovements to their own units, but the im-provements to the buildingwide systems are theresponsibility of the condominium association.Condominium association fees have been risingat rapid rates and condominium trade associa-tions have recognized the importance of risingenergy costs.

Nonetheless, for a systemwide energy im-provement to be made, the condominium asso-


ciation, in a collective process, must agree onthe improvement’s value and pay for it fromreplacement reserves, debt finance, or a pro-portionate assessment to each owner. The four’condominium associations interviewed re-ported mixed experience with lenders. Collat-eral is a problem for some because the condo-minium association does not hold title to thebuilding. For some associations their authorityto levy special assessments on owners has beensufficient to obtain loans. None of the four asso-ciations interviewed had made a major retrofitinvestment but two had made minor invest-ments. In general, condominium owners ap-pear motivated to consider energy retrofits butare handicapped by the awkwardness of theirform of ownership from making commitmentsto longer payback investments.

Investor-Owners: General. Investor-ownersown buildings only for the economic returnthey bring as real estate. Investor-ownersneither live in their buildings nor do they usethem primarily to house their businesses, al-though for convenience they are likely to havetheir own offices in one of the buildings theyown. For an investor-owner an investment inthe energy efficiency of the building must con-tribute to one or more of the three forms of eco-nomic return in real estate:

●

●

●

Cash flow. Energy retrofits may decreaseexpenses in buildings where the ownerpays all or part of the energy expenses. Forbuildings with net or passthrough leases,energy retrofits only increase cash flow ifthey allow higher rents to be charged or re-duce vacancies.Tax benefits. Many energy retrofits can bedepreciated and used to shelter taxable in-come. Interest on loans to pay for energyretrofits can also be deducted from taxableincome. Tax credits from Federal or Stategovernments may also be available to own-ers for specific energy investments.Resale value. An energy retrofit that in-creases a building’s net income will have adirect effect on its resale value as the net in-come is capitalized by appraisers at somerate typical for that type of building andlocation (see Box E.–As the Appraiser Sees

It). Appraisers usually use 3 years averagenet income to make this determination. Arecent energy retrofit without 3 years’ im-pact on net income may not have much im-pact on resale value.

The main types of investor-owners—insti-tutional, development company, partnership,and individual—emphasize different elementsof the return on real estate and thus havedistinctly different motivation for energy retrofitto their buildings. The building owner types alsodiffer in the financial and professional resourcesthey can bring to bear on energy investments.

Institutional Owners. Insurance companiesand pension funds are the major form of institu-tional owners. Typically they hold buildings forholding periods of 12 years or more, emphasiz-ing the healthy cash flow in the buildings overthe long term. For this reason, energy retrofitwhich promises to increase cash flow over thelong run is viewed as sensible. Such ownershave the longest payback criteria of all owners,5 to 7 years.

Insurance companies and pension funds haveextensive financial capacity to fund building im-provements internally. They also support a pro-fessional management and property investmentstaff to recommend and carry out investmentand management practices to increase incomefrom a property and improve its long-termvalue. Property managers (see Box F: The Roleof the Property Manager) and in-house propertyplanning staff for institutional owners haveclearly defined job performance objectives, in-centives, and capital budgets. Cost conscious-ness is rewarded. operational improvements tosave energy have been a property managementtask since 1975 and annual energy audits andbuilding energy system inventories a regularroutine, All 10 national institutional owners in-terviewed had made major capital investmentsin their buildings including full replacement ofboilers and air conditioning systems and in-stallation of sophisticated computerized energytiming and control systems.

Development Companies. The four nationaland four local development companies inter-viewed varied in their expected holding periods

Ch. 4—Will Building Owners Invest in the Energy Efficiency of City Buildings? ● 113—————. . — .

Box E.-A Question of Value: How the Appraiser Sees it

Do energy improvements enhance a property’s value? To appraisers, the answer is not atall clear. But what is clear is the importance of their response to this question in a go/no-goretrofit investment decision. The appraiser’s consideration of the impact of energy improve-ments on value can be crucial to some lending decisions if loan-to-value ratios are close to ac-cepted limits and can also be important to the return assessment of owners if the improvementis capitalized into the value of the building.

Professional appraisers should, in theory, consider the improvement to value that resultsfrom a reduction in energy costs. In income properties, this would occur through the capital-ization of the resulting higher net income. The appraiser normally does this by examining 3years’ operating results on the building understudy and operating results of comparable build-ings to arrive at stabilized income and expense data. Comparability of energy equipmentamong other things should be considered in selecting buildings for comparison.

At present, several factors make it difficult for appraisers to conform to this procedure.Few buildings exist with 3 years of results of energy improvements, either to use as com-parable, or to appraise. Hence, there is little experience to use in judging indirect or directimpact on market value. As yet, no other standardized methods for incorporating energy con-cerns have been developed. The appraisal division of a commercial bank in San Antonio in-stituted Iifecycle costing as a nonstandard way to approach the issue and to serve as a proxyfor acceptable comparable.

In the face of limited information, many appraisers have responded to rapidly increasingenergy costs by, in effect, incorporating the increased risk in their valuation judgments. Thishas occurred by raising capitalization (which lowers the effective multiplier applied to incometo arrive at value). The higher rate reflects many factors, but the recent rates of inflation in in-terest rates, operating costs and energy prices are considered to be among the major factorsthat result in higher risks.

Efforts have been made by appraiser professional associations to improve their members’skills in evaluating energy conservation in real estate. In addition, many appraisers are activein local building owner and manager associations, which have become very concerned aboutenergy.

Box F.-Role of the Property Manager

Professional property managers play an im-portant role in building operations for manyowners, particularly institutions and partner-ships. Property managers have the discretionto identify and make operational energy im-provements, but only limited authority tomake capital improvements. For example, atone large office building in a case study city,the manager’s authority was limited to im-provements costing $5,000 or less.

Managers can, and often do, identify bothoperations and capital possibilities for reducingenergy costs. In some cases, such as hotels, thecompensation formula is based on net income,which actively encourages managers to seek

ways to cut costs. The presence of professionalmanagers has led to widespread adoption ofoperational improvements in larger officebuildings and to more active consideration ofenergy measures elsewhere. This is true re-gardless of who owns the property. In addi-tion, professional managers interviewed wereby far the most knowledgeable about energycosts and technical options. They felt that therewas a steep dropoff in awareness and knowl-edge among the less professional managersand owners who were not themselves activefull-time managers. There appears to be lessknowledge and less conservation where thereare no professional and/or full-time managers.


for buildings but on the whole their holdingperiods were shorter than those of institutionalowners and their payback criteria for energyretrofits were correspondingly shorter (1 to 3years). Short payback criteria can be explainedpartly by the greater difficulty of developmentcompanies in financing retrofits. Their invest-ments have been traditionally highly leveragedwith a very high ratio of debt to equity (althoughthey are now moving more toward equity fi-nancing). This leaves very little flexibility to addfurther debt. Development companies havealso tended to specialize in owning shoppingcenters with fully indexed net leases, so that theincentive to retrofit is somewhat less than that ofowners of other commercial buildings (see dis-cussion of commercial buildings below). of theeight owners interviewed, four had made majorretrofits, two had made minor retrofits and twohad done nothing.

partnership: General. The popularity of thepartnership, now the most common form of realestate ownership, is in part due to the tax statusof this form of ownership and in part due to thesmall capital requirements for entry. The part-nership is itself not a taxable entity but a taxconduit which passes on the tax advantages ofreal estate ownership fully and directly to thepartner/investor. While partnerships are inter-ested in the cash flow and resale impact of anenergy retrofit, they are very concerned aboutleaving intact or enhancing the tax benefits of aproperty. Since partnerships are formed only forpurposes of owning a particular piece of proper-ty, it is often difficult for the partners to agree onfurther capital investment once the particulardeal has been struck. The tax benefits to a part-nership diminish after 7 to 10 years as interestand depreciation deductions diminish and atthis point, the property is frequently sold.

National partnership Syndicates. These arethe most sophisticated of the partnerships andbear some resemblance to the institutional own-ers. All syndicates have a general partner,responsible for managing the property held bythe syndicate, and many limited partners whobuy into the syndicate either privately or by pur-chasing publicly placed security investments.

National syndicates maintain professionalmanagement staffs in-house and onsite. As partof the syndication, reserves are set aside forbuilding expenses sufficient to fund most im-provements including moderate energy retrofitswithout returning to the investors for extra equi-ty capital. For these partnerships, energy orother building improvements are an aggressiveway to increase building value and create morereturn for investors than passive managementwould create. As the head of a national syn-dicate’s property management department ex-plained: “Any new value we create is a sellingpoint to our customers (investors), old or new.The sophisticated investors we deal with wantquality in their product not just shelter.”

Of the five national partnership syndicates in-terviewed, three had made major energy invest-ments in their buildings and the other two hadmade minor investments. The national syn-dicates agreed on a 3-year payback as a suitablecriteria for retrofit.

Local partnerships. Local partnerships maybe formed with a general partner and limitedpartners or with conventional (equal) partners.They almost always have far more limited finan-cial and managerial resources than the nationalpartnership syndicates. Reserves set aside at thetime of creation of these partnerships are gener-ally insufficient to cover major building im-provements such as energy. It is usually very dif-ficult to raise further equity capital from theoriginal partner investors. Said a San Antoniogeneral partner: “Thirteen can put the newmoney up but two others (partners) don’t havethe cash on hand; so I can’t do it; we are simplytalking group dynamics.”

Of the 20 local partnerships interviewed, onlyfour had made major energy investments, eighthad done nothing. One or two years was thestandard payback criteria for retrofits, cor-responding to the short (7 to 10 year) holdingperiod typical of partnerships. If they are doneat all, energy retrofits are done early in the prop-erty’s holding period. As the San Antonio gener-al partner explained, “After the sixth year, I’mlooking at another building purchase and syndi-cate setup, not the one I’m about to get out of. ”


Individual Investor-Owners. Most individualinvestor-owners, like individual owner-occu-pants, are owners of small amounts of propertyand this constrains their ability to make energyinvestments in their buildings. Because most in-dividual owners lack financial depth, maintain-ing a building's cash flow is usually far more im-portant than sacrificing current cash flow for thesake of future resale value. Many individualowners also lack sophisticated property invest-ment advice that would help them evaluate theresale potential of their property. A large Buffalobroker of small property observed:

Resale value is important but requires somesophistication to be appreciated. Your Momand Pop single investor or owner who thinks hissingle unit or two is going to support his retire-ment or give him financial security is not goingto think in terms of future value, It’s hard to getthem to think of real estate as an investment. . . the way an investor where real estate is his

living would; it is a thing to be kept and kept up,not improved for investment reasons,

With today’s high cost and inaccessibility ofdebt finance, the cash flow of an individual’sproperty is threatened by substantial energy in-vestments. Most of those individual owners in-terviewed set 1 year as their maximum energyretrofit criteria. This extremely short payback re-flected their uncertainty about the risks of anenergy investment and their fears of a mistake asmuch as insistence on a high rate of return. Afew individuals personally concerned aboutenergy efficiency accepted higher. paybacksthan this; one as long as 10 years.

Conclusion. In today’s climate of high cost offinance and continued uncertainty about therisks and benefits of energy retrofit, buildingowner types—institutional owners, corpora-tions, national partnership syndicates, and de-velopment companies—with good access to in-

Photo credit Steve Friedman

The individual who owns this office building in a Northern city has made low capital cost investmentsin calking and boiler efficiency. The owner is currently unable to finance a new boiler


ternal capital funds and professional informa-tion are far more likely to retrofit their buildingsthan owners—individual and local partnerships—who are constrained by their building’s cashflow from taking on the high debt service cost ofoutside finance and who have poor access to

IMPACT OF BUILDING TYPES ON

It is not only the owner type that affects thelikelihood that a building will be retrofit, it isalso the building type—office, retail, hotel, ormultifamily. Each building type has its owncharacteristic market response to energy costs,leasing structure and balance between incomeand expense and these all affect the likelihoodthat a particular type of owner will retrofit thatbuilding rather than another type of building.

Of all the types of buildings covered in thebuilding owner survey, office buildings were by

professional advice about retrofit. Despite thesehandicaps there is somewhat more chance thatsmaller owners will retrofit their buildings if theyoccupy them than if they holdowners.

THE LIKELIHOOD OF

them as investor-

RETROFIT

far the most frequently retrofitted, followed byretail buildings and hotels (see fig. 36). Multi-family buildings were retrofitted much less fre-quently than the other types. Out of 29 multi-family buildings covered in the interviews, onlyfour had been retrofitted at all, only one of thesewith a major retrofit. This imbalance betweenretrofits of office buildings, multifamily build-ings and other buildings is also echoed in a re-cent survey of buildings with documented retro-fits and energy savings by Howard Ross and SueWhalen. Out of 220 buildings with documented

Figure 36.— Frequency of Retrofits Among Building TypesCovered in Building Owner Interviewsa

24 -

20 -

16 “

12 “

8 “

4 -

Multifamily

Key Owner-

r 1

“.

. .

Office Retail Hotel

occupiedRetrofit

lnvestor-owned

m No retrofit

I

alnterviews in Buffalo, Des Moines, San Antonio, and Tampa.



retrofits, 38 were office buildings, four were ers—individuals and local partnerships—whohotels, while there was only one shopping cen- require very short paybacks to make any retrofitter and one multifamily building.10 at all and who frequently do nothing to their

part of the explanation is that multifamily buildings in response to rising energy costs.

buildings tend to be owned by the types of own-However, the problem of retrofits to multifamilybuildings goes beyond ownership. The sections

10Howard ROSS and Sue Whalen, ‘‘Building Energy Use Com- that follow discuss the particular market charac-pilation and Analysis: Part C: Conservation Progress in Commer- teristics of multifamily and commercial build-cial Buildings” (unpublished), May 1981, revised August 1981. Tobe published in Energy and Buildings magazine, Lausanne, ings that affect their prospects for retrofit.Switzerland.

LIKELIHOOD OF RETROFIT IN MULTIFAMILY BUILDINGS

The problems of the owner types who ownthe bulk of multifamily buildings explain muchof their very low rate of retrofit. Individualowners lack access to capital and are con-strained by their dependence on the buildingscash flow from taking on high debt service topay for retrofit. Local partnerships may put capi-tal into retrofit at the time of purchase, but itbecomes increasingly difficult to obtain fundsfrom the partners after that. Both categories ofowners lack information on retrofit oppor-tunities and risk and both have much to losefrom a mistake. Multifamily buildings owned bybetter financed and informed owner types suchas insurance companies, pension funds, and na-tional partnership syndicates are somewhatmore likely to be retrofit than those owned byindividual owners and local partnerships.

The type of owner, however, does not explainall of the low rate of multifamily retrofit.Owners’ problems are exacerbated by overallproblems in the market for multifamily build-ings.

Squeeze on Cash Flow. More than owners ofother building types, multifamily buildingowners have been caught in an income squeezeboth because of rising costs and their inability toraise rents. The latter is attributable to severalfactors, including rent control, consumer re-sistance, and management efforts to minimizeturnover in tenancy. Using operating indexesfrom actual special samples of properties in onearea, a Rand Corp. study of multifamily units un-derlines the expense-revenue gap that emerged

in the 1970’s. “Generally, the evidence suggestsoperating cost increases of 8 to 10 percent an-nually, compounding to between 115 and 160percent for a decade in which rents rose by 74percent and vacancy rates (which also affectrevenue) changed only slightly.’” This trendleads to diminished rates of growth in net oper-ating income, and results both in relatively lessmoney available for debt service and in lowermarket values. In the face of recent increases inmortgage interest rates, this creates a cashsqueeze for any new owner or a relativediminution of value for a potential seller.

Energy cost increases have been a major con-tributor to this cash squeeze. As figure 37shows, increases in fuel and utility costs aloneoutpaced average rental adjustments by morethan 2 to 1 (98 to 39 percent) between 1970 and1976. The trend continued from 1976 to 1979,according to data from the Institute of RealEstate Management (I REM). Heating costs persquare foot increased over 3 years anywherefrom 62 percent for elevator apartments to 120percent for low-rise small buildings (see table35).

Average rental adjustments for multifamilybuildings have not kept pace with increases inenergy costs for reasons that elude the expertsalthough many explanations have been given.One is that traditional renters such as newly-

I I 1 ra s, Lowry, d ra f t rePort I “Rental Housing in the 1970’5:Sea rch ing for the Crlsls, ” the Rand Corp., No\fember 1980;presented at HUD Conference In Rental Housing, No\. 14, 1980.!5ee also Da\id Scott Lindsay and Ira S. Lowry, Rent lnflat~f)n In St.j(lwph Count}, Indiana, 1974-78, the Rand Corp., 1981.

118 ● Energy Efficiency of Buildings in Cities.

Figure 37.—Apartment Operating Revenues andExpenses 1970-76

II

z : “ - , ‘7

120.0

1970 1972 1974 1976

Year

NOTE: Data from 189 properties.

SOURCE: Touche Ross & Co. using data from Booz, Allen & Hamilton (May1 9 7 9 ) . Ach/evmg E n e r g y Corrservdtion In Ex/stlrrg ApartmentBuildings: Append\x D.

Table 35.—Annual Heating Fuel Costsin Apartment Buildings

Heating cost(dollars/ft 2 o f

rentablearea) Percent

Apartment building type 1976 1979 change

Elevator . . . . . . . . . . . . . . . . . . . . $0.21 $0.34 62%Low-rise (24 units +). . . . . . . . . . 0.14 0.23 64Low-rise (12 units). . . . . . . . . . . . 0.15 0.33 120Garden . . . . . . . . . . . . . . . . . . . . . 0.13 0.23 77

NOTE: Only buildings reported for 4 consecutive years,

SOURCE. /ncome Expense Ana/ysis. Apartments 1980 Editton, Institute of RealEstate Management.

weds, single households, and empty-nestors, inresponse to rapid appreciation in property val-ues and the tax-deductible status of mortgageinterest, have been shifting to single-family orcondominium ownership for investment as wellas housing, and are leaving the rental market toa larger proportion of lower income people,who are less able to adjust to increases in rent.There is also some evidence, however, that

lower income renters have increased the qualityof their housing over the decade without in-creasing their average rent. Finally, some of thelag in rents can be explained by a preference ofsome multifamily building owners to reducevacancy ratios and retain long-term tenants byholding back rent increases. Some observerspracticing strict market economics believe thatthe overall explanation for the possibility of alag in rents relative to expenses may be thatthere is an oversupply of multifamily houses.12

Careful studies have shown that this indeed maybe a cause of abandonment of multifamilyhouses in certain areas (see discussion in ch. 5).

The potential for rent adjustment to coverutility costs varies greatly from strong rentalhousing markets to weaker ones. Among thecase study cities, owners in Buffalo and DesMoines perceived the rental market to beweaker and the potential poor for raising rentssufficiently. Several owners expressed a strongsense of crisis in the interviews, foreseeing grimfutures as real estate apartment owners unlessthey “got out soon” at a decent sales price or byconverting to condominiums even when theyacknowledged that the market for condomini-ums was poor in their cities. Apartment ownersin the stronger markets of Tampa and San An-tonio were more optimistic. Even in thesemarkets, however, institutional owners and na-tional syndicates expressed an intention toreduce the amount of investment in multifamilyproperty.

Most important of all, an apartment owner’sability to avoid the squeeze on cash flowdescribed above depends directly on whetherthe owner pays for heat and electricity orwhether tenants do.

Prospects for Retrofit When Tenants PayUtilities. Almost one-half of the multifamilyapartment units in the country are fully tenant-metered (see table 36). If structurally feasible,multifamily owners have converted to tenantmetering as the first and often final response to

lzThis debate is set forth in several papers prepared for the No-vember 1980 HUD Conference on Rental Housing, AnthonyDowns, “The Future of Rental Housing–Overview;” Ira Lowry,“Rental Housing in the 1970’s: Searching for the Crisis. ”


Table 36.—National Distribution of Metering Typesof Rental Unitsa

Type of rental unit Percent of total

Master (full) . . . . . . . . . . . . . . . . . . . . . . . 19 ”/0Tenant (full) . . . . . . . . . . . . . . . . . . . . . . . 46Mixed (tenant pays electric but not

heat or hot water) . . . . . . . . . . . . . . . . 29Miscellany b . . . . . . . . . . . . . . . . . . . . . . . 6

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 ”/0aTwo or more unitsbSy5tems too mixed to Categorize

SOURCE Natlorral Inferfm Energy Consurrrpflon Survey 1978.79, Departmentof Energy, Off Ice of Consumption Data.

escalating energy costs, even though conver-sion costs were clearly capital investments(costing from $125 to $1,600 per apartment unitwith a median of about $1 ,600). ’ 3 Yet paybackis very rapid, depending on how the base rent isadjusted: paybacks of 1 year or less are not un-usual, although the average simple payback is 1to 2½ years. There are several benefits oftenant-metering, in addition to sheltering thelandlord from the full impact of energy in-creases:

● Many buyers, particularly national syn-dicates and institutional investors, are un-willing to consider purchase of multifamilyproperty unless tenants pay the full cost ofutilities. Conversion to tenant metering,therefore, creates resale value in itself.

● Banks are more willing to refinance or lendto tenant-metered building owners.

● professional journals, particularly the wide-ly read Journal of Property Management,have taken an advocacy stance toward ten-ant metering with clearcut articles describ-ing investment return mechanics and own-er benefits, including resale value, fromtenant metering. There is practical adviceon such topics as tenant counseling tech-niques during remetering.

● Many States, particularly in the South andSouthwest, have made tenant electricalmetering in new buildings and sometimesexisting ones a mandate of State conserva-

I ]jeffrey M . Sel sler~ “Escaping the Energy Bite: ConvertingMaster Meters,” journal o(Property Management, May/June 1980.

tion policy law.14 Five out of seven apart-ment owners interviewed in San Antoniohad tenant-metered buildings partly be-cause it is required by law.

Owners interviewed in both the case studyand national interviews described little negativemarket impact as a resuIt of conversion. Tenantshave not reacted against tenant-metered build-ings during sellout or in existing buildings dur-ing remetering. To the contrary, some ownersnoted that tenant metering successfully trans-ferred to the utility companies the “bad guy”image that owners formerly bore for energy in-creases in gross rent.

In the opinion of most landlords interviewedfor the study, tenant metering has createdgreater and more reliable savings in energy con-sumption than any other improvement theycould have made because tenants make behav-ioral adaptations as a result. Savings from tenantmetering have also been documented. A bestestimate is 5 percent for heating and as much as20 percent for other energy.15 At the same time,tenant metering may result in higher per unitenergy costs for tenants i n utility areas wherelarge users pay significantly lower rates thansmall individual users. (See ch. 5 for morediscussion of this point.)

For all its advantages in inducing energy con-servation behavior by tenants, tenant meteringprovides virtually no incentive for apartmentowners to invest in greater efficiency of theirbuildings. There is no incentive to improve in-sulation levels, add storm windows, or improveheating system efficiencies (usually of decen-tralized systems since central heating and cool-ing systems cannot be tenant metered exceptwith great difficulty and expense). None of theowners of tenant metered buildings had madeenergy investments except to make operating

1 dMeterlng: States banning al I master metering include Califor-

nia, Florida, Maryland, Michigan, North Carolina, oklahoma,Rhode Island. States banning master metering for electricity in-clude Louisiana, Massachusetts, Minnesota, New Jersey, NewYork, Oregon, and Texas. Source: Steven Ferrey & Associates,Fo>ter~ng fquj(} jn Urban Conservation. Utf//ty Me[er/ng and UfJ/-

Jty Fjnarrclng, to be published as a working paper to this report.15LOU MC Lelland, op. cit.


improvements in the heating and cooling andlighting of the building’s common areas.

In theory, energy conservation investmentscan enhance the value of the property by per-mitting the owner to charge a higher rent,allowing for the lower utility cost to the tenant.In theory, if everyone else in the market alsomade energy efficiency investments, or therewere substantial new energy-efficient competi-tion from new buildings, an owner would beforced to improve in order to compete. Also intheory, if no one else improves, the ownercould improve his competitive position if hecould market the necessarily incremental rentadjustment.

To obtain the higher rent, however, requiresboth a sound market and marketing skill. Thetenant must be convinced that the total oc-cupancy cost will still be comparable to thelower rent competition. Given the fragmentednature of multifamily ownership, levels of pro-fessionalism, traditional tenant-landlord rela-tionships and tendency to hold rents down toreduce turnover, it is unlikely that this logic willbe readily adopted by the typical multifamilybuilding owner. Some sophisticated nationalsyndicates and management organizations in-terviewed for the study, however, are makingthe link between conservation and value. It isconceivable that over the long run, the adop-tion of such a strategy by a few large operatorsi n each market or the advocacy of such an eco-nomic rationale by one of the trade informationsources might stimulate such a perspective.

Prospects for Retrofit If the Owner Pays theUtilities. Although multifamily owners are con-verting to tenant metering whenever possible asa reaction to the rising cost of energy, it is notpossible to convert all types of heating systems,(especially central air systems, central steamand hot water systems, ) to tenant metering ex-cept at great expense. As the above table 36showed, more than one-half of all rental unitsare fully master metered or master metered forheat and hot water and tenant metered for elec-tricity.

Multifamily owners whose buildings have notbeen or cannot be fully tenant metered are

aware of and concerned about rising energycosts. They have a strong incentive to containcosts that are rising faster than other expensesand threatening to become uncontrollable,However, they are limited to actions which canbe paid for within the confines of their own cashflows since financing is either too costly and/orunavailable. An individual owner of over 200apartment units in Buffalo commented: “Iwould normally want to spend $5,000 to save$2,000 a year, but not when I can’t afford toservice the $5,000. ” A large apartment ownerand broker in the Southwest bluntly summa-rized a basic constraint for city apartment own-ers in today’s economic environment: “Apart-ment managers must conserve capital in the

Photo credit: Steve Friedman

Retrofits to this HUD-subsidized apartment building forthe elderly in Tampa included improved chiller efficiency

and a shift from incandescent to fluorescent lights

Ch.4—Will Building Owners Invest in the Energy Efficiency of City Buildings? ● 121

early years. They are not going to want to touchthe cash flow. ” Only if the building owner hasaccess to government property rehabilitationfunds (see ch. 9) is he likely to be able to servicethe debt within the building’s cash flow.

For most multifamily building owners, theonly benefit of energy retrofit is cost savings.There is no discernible marketing advantage;the level of tenant demand for rental units thatare energy efficient (and which might thereforehave more controlled future rent increases) islow. The tenants’s rental decision is first linkedto location and the size and appearance of theapartment, regardless of energy features.

Energy retrofit for resale value is also not animportant motivation for the large share ofmuItifamily buiIding owners who are individualowners, especially those with small amounts ofproperty. Such owners do not generally havethe planning time, staff or perspective to make

an energy investment for return “down theroad .“ The concept of future return throughenhanced resale value as a result of energy im-provement seems nebulous. In multifamily mar-kets with many weak spots, such as Buffalo andDes Moines, a building’s future, even if viablenow, might be uncertain.

To sum up, although an owner of a master-metered multifamily building has strong motiva-tion to curb the increase in his expenses by con-trolling energy costs, the constrained cash flowof many multifamiIy buildings (coupled with un-certainty about retrofit results) makes it ex-tremely hard to expect to pay for a retrofit out ofretained earnings or to service a loan to pay forit. The uncertain long-term viability of multi-family buildings constrains an owner’s motiva-tion to invest in the energy efficiency of multi-family buildings for its resale value.

LIKELIHOOD OF RETROFIT IN COMMERCIAL BUILDINGS

Commercial buildings have been retrofit farmore frequently than multifamily buildings, ac-cording to the partial data available. To someextent this is explained by the better financed,better informed owner types which own com-mercial buildings. Many commercial buildings—office, retaiI and hotel—are occupied by theirowners which are large corporations, able toplan and carry out a retrofit.

Within the category of commercial buildings,however, there are significant differencesamong office buildings, shopping centers, de-partment stores, and hotels in the sensitivity ofowners and tenants to rising energy costs, therewards for retrofit and the resources for makingenergy investments. The sections which followdescribe these differences.

Office Buildings. Office buildings appear tohave been retrofit in greater numbers than otherbuilding types. Out of 27 interviews with officebuilding owners in the case study cities, 20 hadretrofit their buildings. Retrofits by and largewere carried out by corporations who owned

their own buildings and by institutional and na-tional partnership syndicate owners. Retrofitsmentioned included installation of task lighting,heat pumps, new boilers and timing and controlsystems. Two of the retrofits of corporate head-quarters buildings were carried out as part ofoverall modernization programs. In both mod-ernization cases, in Des Moines and Buffalo, thedirectors of facility planning reported that suchenergy improvements might have been madeanyway, but “only very gradually. ”

For other kinds of owners, limits on energy in-vestments in office buildings are typically setwithin the constraints of the buiIding’s cash flowbecause the extremely high cost of outside fi-nancing eliminates the possibility of borrowingto pay for a retrofit. Fortunately office buildingsoffer many opportunities for low-cost/no-costretrofits (see Chapter 3: The potential forBuilding Retrofit). Many building owners inter-viewed had made low-cost investments such as:installing timer devices to turn systems andlights off from 6 p.m. to 7 a.m. when the build-


Photo credit: OTA Staff

Retrofits to this office tower owned by a bank in Tampaincluded elimination of mixed cooling and reheat,reflective film, computerized temperature controls,

and high-efficiency fluorescent lights

ing is not in use; reducing lighting levels and in-stalling more efficient bulbs and making manydifferent adjustments and improvements to thebuilding’s heating ventilating and air-condition-ing systems.

Mentioning the need to stay within the build-ing’s cash flow, several building owners saidthat any capital investment in energy retrofit lessthan 25 cents per square foot would be consid-ered feasible. A 25- to 50-cent-per-square-footimprovement cost would bring more scrutiny.Fifty cents per square foot was the basic costcutoff point for the office owners interviewed.Alternatively, another cutoff measure was thebuilding’s total energy bill. An office owner in

Des Moines observed: “The building costs$40,000 a year in total energy bills. No matterwhat I think about the future, I have a hard timelaying out a capital investment costing morethan my bill, which is what a window retrofitwould do to me. ” The office owners inter-viewed for this study acknowledge they arebasically on the “last round” of the low-cost/no-cost improvements for controlling energy costand would have to make capital improvementsnext.

passthrough Lease Disincentive. For investor-owners of office buildings, by far the greatestdisincentive to retrofit is the prevalence of thepassthrough lease in existing class A and mostclass B offices. passthrough lease terms vary.Escalators include direct operating costs, aver-age of costs i n other buiIdings, operating cost in-creases above the base year, and CP1-indexedleases. In class B offices, some gross leases stillexist, but owners are gradually rolling themover to passthrough leases that include anenergy escalation clause. Lease terms for smalltenants are also getting shorter, down from anaverage of 7 to 10 years in older office buildingsto an average of 3 to 5 years.

passthrough leases allow the owner to recov-er utility and other expenses but are usuallywritten to prohibit passthrough of debt serviceto cover the capital expense of an energy retrofitinvestment. With passthrough leases the chiefincentive for energy retrofit by an investor-owner is to curb the costs of energy for the com-mon spaces that can average 40 percent of thetotal energy bill for a high-rise office building.

There are signs, however, that new kinds ofpassthrough leases are being developed to per-mit energy efficiency investments. Large ownerssuch as insurance companies are starting to in-stitute a new uniform passthrough in theirleases, This provision would allow the owner topass through to the tenant the capital costs ofenergy improvements that benefit only the ten-ant until the investment is paid back by energycost savings. At that time, any future savingsbenefits would accrue directly to the tenant.Owners pioneering this type of lease feel thatalthough tenants need to be convinced of the

Ch. 4— Will Building Owners Invest in the Energy Efficiency of City Buildings? Ž 123

merits, such a lease adjustmentowner an incentive that doeswhile offering tenants a savingpassthrough Iease never would.stitutional owners interviewedtroduced this type of lease into

Energy Retrofit to Improve

would give thenot now exist,that a standardNone of the in-had as yet in-their buildings.

Marketing. Incurrent markets for office buildings, tenantsrarely seem concerned about total occupancycosts including energy passthroughs although afew office owners in Buffalo mentioned a grow-ing tendency for lease competition to be basedon quoting comprehensive rent including utili-ties. More typical is the situation cited by anexecutive for a national housing firm. “Tenantsdon’t seem to care in general; they still look, asthey have traditionally, to the quoted rent, notthe escalators. ”

All office owners acknowledged that tenantconcern about the energy costs in passthroughleases might become a market factor in thefuture especially in a stagnant economy whereoffice users would tend to be more zealousabout every cost-cutting opportunity (despitethe relatively small cost energy represents to atypical office user). Even owners with shortholding periods would probably invest in ener-gy efficiency if the market called for it. Ownersinterviewed cited four market conditions whichmight spur such a change.

● For tenants “shopping” with expectationsof rising costs, lower cost will improve anowner’s marketing position. Managers areaware of this.

● Significantly improved energy efficiency ofnew buildings can reduce the effective rentspread between new and energy efficientexisting buildings, especially in a softmarket. Managers of older buildings mayhave to look for ways to protect their com-petitive position, especially vis a vis somenew hotels and office buildings that arebenefiting from subsidized financing orother government programs such as indus-trial revenue bonds, tax abatement and ur-ban development action grants.

● New office construction i n many down-towns has been substantial, creating strong

●

competitive pressures on existing offices.As yet, there has been little overbuilding,but with the economy weak, in some citiesoffices may become temporarily overbuilt.If this occurs, it will put a downward pres-sure on rents and hence provide greater in-centive to control costs (and therefore totalrents) to keep or attract tenants.Office owners and managers generally un-derstand that the long-term value of theproperty can be enhanced or at least pre-served by controlling energy costs.

In summary, operational improvements andlow-cost investments are the main response torising energy costs in office properties. Whilelarge corporate owner-occupants (and to somedegree, banks) may make capital improve-ments, other office owners are less motivatedand prefer to pass energy costs on to the tenant.For those with the interest, poor access to fi-nancing and good technical information con-tinues to be a substantial barrier.

Retail Owners and Energy Investments. Ex-cept for some owner-occupied departmentstores and small stores, most retail buildings areowned by investor-owners. Shopping centerswithin cities are commonly owned by real es-tate development corporations that may or maynot be subsidiaries of major retail corporations,by institutional owners and by large partner-ships, including national syndicates. Urbanretail strips or freestanding small retail stores aregenerally owned by individuals or small localpartnerships. Downtown department stores areowned by their corporate owner-occupants, asare generally the department store anchors ofshopping centers. Type of retail ownership is afactor in decisions to retrofit, but the most criti-cal variable for retail owners is lease standards.

Except for owner-occupants of freestandingdepartment stores, owners of retail buildings to-day generally charge their tenants rent on a netlease basis with a duration, except for those ofanchor stores, often averaging 3 to 5 years. Inolder shopping centers or retail strips in cities,gross lease standards and longer term contractsof the past still exist but for retail owners the netlease has become standard at lease-up or re-


newal. In fact, one of the ways a buyer can addvalue to an older shopping center purchase is toconvert gross leases outstanding to net leases.The net lease has made a shopping center oneof the most valuable and coveted real estate in-vestments because of the long-term security itprovides.

Net leases operate essentially like pass-through leases in offices; a wide range of totalnet costs are charged to tenants, but energycosts in a retail lease are generally borne by thetenant. The owner is responsible for whatevercommon area energy costs may exist, such asmall or arcade lighting and HVAC. The netlease, according to retail owners in case studyand national interviews, is the single key invest-ment disincentive for energy retrofit of thesebuildings by the owners. It is a bigger disincen-tive for retail owners than the passthrough leaseis to office owners. I n contrast to office tenants,retail tenants on whom the passthrough burdenfalls cannot “shop around” and exert marketpressure on owners. Retail tenants have to gowhere the goods will sell, first and foremost.

None of the small number of investor-ownersof retail buildings interviewed had made opera-tional improvements in older city retail shop-ping centers and retail strips on net leases.Although new centers are being outfitted withenergy efficiency components such as compu-terized energy management systems as a mar-keting lever, this type of retrofit for an older cen-ter or strip is very costly, and difficult to imple-ment architecturally without disturbing the ten-ant. In these retail buildings, lighting reductionsand savings in the common areas are the prin-cipal response to the energy conservation issue,with tenants making whatever improvementsthey see fit and find affordable for their ownstores.

For retail owner occupants, such as down-town department chain stores, on the otherhand, energy savings are direct business sav-ings. Energy costs have been targeted by down-town department store chain owners as an areafor cost-cutting. Sears recently reported at anenergy conference that it had set up demonstra-tion stores in which potential energy retrofit

Photo credit:. Steve Friedman

For owner-occupied department stores, energy savings aredirect business savings

products could be pretested before national ap-plication. Its overall energy conservation pro-gram was estimated to save the nation’s largestretailer $37 million annually. Another nation-wide retailer with many urban outlets regularlydirected stores to examine energy savings de-vices. It too has local tests of equipment beforeordering widespread use.

For owner occupants of downtown stores in-terviewed for the report, energy improvementshave been funded in conjunction with the an-nual capital budget. Improvements are Iinked topayback and to demands on capital for otherpurposes. The 3-year payback period for onechain was the same as that traditionally used forlabor saving devices. Improvements such aslighting level adjustments are limited to thoseconsistent with the competition as well. For themost part, the level of investment per store ap-pears to be in the 25 to 50 cents per square footrange or less ($25,000 or so). This level has notresulted in problems of competition for capital,but higher levels have not yet been tested.

Hotel Owners and Energy Investment. Cityhotel ownership has changed over the lastdecade as hotel chain corporations have fre-quently sold their buildings to private investorswhile maintaining a franchiser and sometimes amanagement role. The private owners typicallyare partnerships of various sizes. Recently, in-stitutional owners have begun to increase hotel


holdingsthe hotelsomewhatby inflation

in their portfolios, partly because ofindustry’s ability to adjust rates

to counter rising costs brought about

Despite a shift to investor ownership, hotelsare being retrofitted for improved energy effi-ciency. In hotel operations, energy costs are ex-perienced directly by the operators and energysavings directly enhance net income margins.The standard contract for hotel managers in-cludes a bonus incentive for net income per-formance. Hotel owners and managers find adefinite economic incentive for energy invest-ment in this type of city building and the resultcan be dramatic. “My costs per room this yearare less than last year due to energy improve-merits, ” a motel chain president emphasized.

Hotel operators analyze energy investment inthe context of their primary business objec-tive—renting rooms and other facilities—andthe alternative investments owners make to im-prove rent revenues—such as promotional cam-paigns. Hotel owners will not consider an im-provement that causes significant tenant dis-comfort.

The degree of energy improvement is usuallydependent on the hotel’s capacity to fund themfrom internal moneys. Outside financing is con-sidered neither feasible nor traditional. Hotelowners and operators are often uncertain aboutwhat could be done technically to a hotel inorder to save energy i n a cost-effective manner.This energy information problem is now beingtackled by the hotel industry’s main trade asso-ciation, the American Hotel & Motel Associa-tion, which is using a Department of Energy(DOE) grant to study prototypical hotels andconsumption patterns and to disseminate in-structional and technical information resultingfrom the study to the industry.

The consensus of hotel owners concerningenergy retrofit investments is nevertheless aclear one: energy savings and owner expensesavings have a one-to-one relationship despitethe theoretical prospect that rates could be ad-justed daily to recover costs.

Photo credit: OTA staff

Retrofits to this hotel building in a Northern city includedimproved boiler efficiency, a shift from incandescent to

fluorescent lights and radiator valves

To sum up, hotel buildings are likely to beretrofitted because energy costs directly affectprofit margins and hotel operators are given in-centives to reduce them. Office buildings arelikely to be retrofit to a low level which can pro-duce substantial savings given the usage pat-terns of the building. Retrofits beyond a lowlevel will occur in owner-occupied office build-ings and in tenant occupied buildings if marketconditions change to make total occupancycosts important. Finally, retail shopping centersare unlikely to be retrofit beyond a low level ofretrofit to the common areas. Owner-occupiedlarge stores are likely to be retrofit within thelimits of cash flow, competition and client com-fort.


POTENTIAL FOR RETROFIT IN MARGINAL NEIGHBORHOODS

For owners of both commercial and multifam-ily buildings in low-income and risky neighbor-hoods, increases in energy costs create severeeconomic pressure. Although property taxesand debt service on such properties are low,rents are even lower and there is no cash flowmargin to absorb the escalating energy costs. Anowner faced with such a situation must chooseamong a series of bad alternatives: covering theescalating energy costs by undermaintaining thebuilding in other ways, providing inadequateheat and utilities to the building, obtainingenough funds in some way to retrofit the build-ing, or abandoning the building altogether.

There is considerable evidence that rapidly in-creasing energy costs are the last straw on top ofa set of burdens that causes owners to “disin-vest” in their buildings. Studies of disinvestmentbehavior among owners in the South Shore areaof Chicago, Cleveland, and Newark explicitlyshow the importance of energy costs to ownersin their ranking of “disinvestment variables”(see table 37). In both 1975 studies, energy costswere ranked as important immediate causes ofdisinvestment, while in the 1971 study ofNewark (before the 1973 oil embargo) energywas not a factor. It is important to note that inthe South Shore study, energy cost increasesranked equal to tenant and neighborhood prob-lems. Under the pressure of severe winter de-mands for regular oil heat deliveries it is easy fora vicious cycle to begin in which the landlordcuts back on heat, or fails to heat the building

altogether, the tenants leave the building orwithhold their rent in response, and the land-lord finds his income stream drying up. Suchvicious cycles have been described by city offi-cials in New York City, Jersey City, and Hart-ford. The issue of abandonment of housingis discussed further in Chapter 5: Retrofit forthe Housing Stock of the Urban Poor.

Despite the severe economic pressure causedby energy costs, there are many reasons whyowners of commercial and multifamily build-ings in marginal neighborhoods are unlikely toretrofit their buildings, The most important ofthese is that owners are reluctant to “throwgood money after bad” if the property has littlecash flow, if tenants and market rents in the areawill not support recovery of costs, and if neigh-borhood conditions do not promise at leaststable property values. The problem is a littledifferent in revitalizing neighborhoods whereowners, expecting future improvement in prop-erty values, may defer minor improvements un-til they are ready to make a major investment oruntil they sell to another owner for rehabilita-tion.

It is unlikely that owners of buildings indeclining neighborhoods will be able to raiserents to recover energy retrofit costs. Suchowners also face much more severe financingproblems apart from the economics of theirbuildings. Historically, lenders have tended tolimit their role in such areas because of their

Table 37.—Landlords’ Ranking of Reasons for Disinvestment

South ShoreChicago, 1975( la) Cleveland, 1975(2a) Newark, 1971(2a)

Energy cost increases Tenants Tax levelTenants a Neighborhood problems Neighborhood problemsNeighborhood problemsa TenantsMaintenance Energy cost increases Building inspectionTax level Building inspections Mortgage costsInsurance Tax level InsuranceJanitorial costs InsuranceLack of housing programs

and bank financingaRanked equally.

SOURCES: 1“) Management Firm Interviews, 10 sample properties from Robert Giloth, Dish’westrnent in South Shore’sLarge Rental Properties, June 1978.

2“) Real Estate Research Corp. Rea/ Estate Review, spring 1976, p. 65.

Ch. 4—Will Building Owners Invest in the Energy Efficiency of City Buildings? . 127

perception of high risks. Both strict qualifyingterms and higher rates are often used to dis-courage borrowing. Insurance rates for housingor commercial structures in marginal areas havelikewise been very high; coverage often is avail-able only through high risk pools.

Typically owners of properties in such margi-nal areas may be unable to afford to service newdebt and if they refinance, it is often to convertlong-term equity into cash. Because they lackaccess to more conventional financing, suchowners often have to buy and sell using extra-institutional personalized securities, such ascontract-for-deed and seller/purchaser money

mortgages. This makes investments in improve-ments all the more costly and risky.

In short, energy conservation retrofit in mar-ginal areas is part of the broader issue of reha-bilitation and reinvestment in marginal neigh-borhoods. Simply because energy costs are the“last straw” does not mean that energy-causeddisinvestment is inevitable. If a particular ownerwould have otherwise retained the property, ifthe neighborhood is stable or revitalizing, or ifsignificant public actions are under way tostabilize the area, it may be possible to facilitateinvestment in energy conservation.

POTENTIAL FOR INCREASING THE RATE OF RETROFITBY BUILDING OWNERS

Some buildings are relatively easy to retrofit;some buildings can be retrofit only with con-siderable difficulty and expense. As has beenclear from this chapter some owner types arewilling to retrofit their buildings even at con-siderable expense; others are not motivated toinstall even low-cost energy conservation retro-fits. The likely pace of retrofit for a particularbuilding, whether rapid or slow, depends onboth the building’s physical characteristics andon the resources and motivation of its owner.

The significant differences among physicalcharacteristics of buildings are summarized intable 38 based on the extensive analysis inchapter 3. Buildings for which substantial en-ergy savings are available for low capital cost(less than 2-year payback) include all types ofsmall framehouses, moderate or large multi-family buildings with central air or water sys-tems and commercial buildings except thosewith central water systems and window air-conditioners. On the other hand, retrofits ofmoderate capital cost compared to savings (2 to7 years payback) are required for substantialsavings in small masonry rowhouses, moderateor large multifamily buildings with decentral-ized heating and cooling systems and commer-cial buildings with central water systems andwindow air-conditioners.

Given these physical types of buildings andthe owner types discussed in this chapter it ispossible to classify buildings into those that arevery likely to be retrofit, those that are moder-ately likely and those that are very unlikely.Sooner or later the market will take care of abuilding that can be retrofitted at low capitalcost by an owner who is strongly motivated toretrofit. The prospects are dim indeed for abuilding that requires moderate capital cost in-vestments for any substantial energy savings byan owner who is unwilling to retrofit.

Small Multifamily Buildings. Three ownertypes and two physical types can account for alarge share of the small multifamily buildings inU.S. cities (see table 39). The most likely smallmultifamily building to be eventually retrofittedfor improved energy efficiency is the owner-occupied frame building with a central air orwater system. Such buildings are common in allNew England cities, and many cities elsewherein the United States. The long-term perspectiveof the owner and his need to pay his own ener-gy costs, coupled with the relatively low costand ease of insulating such buildings and im-proving the efficiency of their heating systemsall make it likely that market incentives willeventually bring about a retrofit.


Table 38.—Thirteen Types of Buildings With Significantly Different Retrofit Optionsa

Retrofit optionspredominantly

Low ModerateBuilding type and Mechanical capital capitalwall type system type Costb Costc

Small house with framewalls (single family or 2-4 units)

SameSame

Small rowhouse with masonrywalls (single family or 2-4 units)

SameSame

Moderate or large multifamilybuilding (masonry or clad walls)

SameSame

Moderate or large commercialbuilding (masonry or clad walls

SameSameSame

Central air systemCentral water systemd

Decentralized system

Central air systemCentral water systemDecentralized system

Central air systemCentral water systemDecentralized system

Central air systemCentral waterComplex reheat systemDecentralized system

xxx

xxx

xx

x

xx

xx

asee Ch. 3 for a discussion of retrofit OptiOnS.bcompared t. savings, See ~h, 3 for a definition, Approximately defined as retrofits with a 2.year payback Or 10SS.ccompared t. savings, Approximately defined as retrofits with a 2- to 7-year payback.dOTA,s assumption is that this building type has a central water system and air-conditioners.


Table 39.—Typology of Small Multifamily Buildings According to the Likelihood ofMajor Improvement in Energy Efficiency

Retrofit options

Likelihood Owner’s predominantly

of major willingness LowOwner type/

ModerateBuilding improvement in to invest capital

meter type typecapital

energy efficiency in retrofit Costa Costa

Owner-occupant Frame Moderate Willing— xtype low capital

cost only

Owner-occupant Masonry Unlikely Willing— xwail low capital

cost only

Absentee owner Frame Unlikely Unwilling xmaster-metered wall

Absentee owner Masonry Unlikely Unwilling xmaster-metered wall

Absentee owner Frame Unlikely Very xtenant-metered wall unwilling

Absentee owner Masonry Very unlikely Very xtenant-metered wall unwilling

aCompared to savings.SOURCE: Office of Technology Assessment.


The least likely building to be retrofit is the ful-ly tenant-metered masonry-walled rowhouseowned by an absentee landlord. Such buildingsare the dominant form of urban housing in theMiddle Atlantic States and are also quite com-mon in cities of the Southeast. Usually moder-ate paybacks are required for substantial savingsin such buildings. With tenant metering,absentee landlords under most circumstanceshave no incentive to retrofit them, regardless ofthe payback.

Owner-occupied masonry-walled buildingsand absentee-owned frame buildings are inter-mediate cases, the former because retrofit is fair-Iy expensive, offering only moderately fast pay-back and the latter because the owner is likelyto be fairly unwilling to retrofit even with lowcapital cost measures offering a fast payback.Both of these categories might be susceptible toprivate or public programs which reduce therisk and financing cost of retrofit.

Large Multifamily Buildings. Two physicaltypes and three owner types can explain muchof what is likely to happen i n the retrofit of largemultifamily buildings (see table 40). The mostlikely buildings to be retrofit are the relativelyrare buildings with central air or water heating

systems owned by institutions such as pensionfunds or insurance companies. (As explainedearlier in the chapter, institutions are trying toreduce their holdings of multifamily property orat least to give preference to tenant-meteredbuild ings.) The least likely to be retrofit are largebuildings with tenant-metered decentralizedsystems owned by individuals or local partner-ships. Such buildings can be retrofit only if own-ers are willing to accept moderate paybacks.Under current conditions of capital cost andretrofit uncertainty such owners are willing toinvest only in retrofits of very low capital costwith very fast paybacks.

Between the extremes, decentralized build-ings owned by condominiums and institutionsare only moderately likely to be retrofit becauseof the expense. Central system buildings ownedby individuals and local partnerships may offeropportunities for substantial retrofit but suchowners generally require extremely fast pay-backs.

Small Commercial Buildings. Four combina-tions of owner and physical types can character-ize most small commercial buildings (see table41). Most of such buildings in cities have mason-ry or curtain walIs which are expensive to in-

Table 40.—Typology of Large Multifamily Buildings According to the Likelihood ofMajor Improvement in Energy Efficiency

Retrofit options

Likelihood Owner’spredominantly

of major willingness Low ModerateOwner type/ Building improvement in to invest capital capitalmeter type type energy efficiency in retrofit Costa Costa

Institution Central air or Very likely Very willing xmaster-metered water

system

Institution Decentralized Likely Willing xtenant-metered system

Condominium Central air or Likely Willing— xmaster-metered water low capital

system cost only

Condominium Decentralized Unlikely Will ing– xtenant-metered system low capital

cost only

Individual or small Central air or Moderate Willing– xpartnership water low capitalmaster-metered system cost only

Individual or small Decentralized Very unlikely Unwilling xpartnership systemtenant-metered

wompared to savings.



Table 41.—Typology of Small Commercial Buildings According to the Likelihood ofMajor Improvement in Energy Efficiency

Retrofit options


of major willingness Low ModerateBuilding improvement in to invest

Owner typecapital

typecapital

energy efficiency in retrofit Costa Costa

Owner-occupant Air system or Moderate Willing— xdecentralized low capitalsystem b cost only

Owner-occupant Water systemc Unlikely - Willing— xlow capitalcost only

Absentee owner Air system or Unlikely Unwilling xdecentralizedsystema

Absentee owner Water systemb Very unlikely Unwilling x

%ompared to savings.bElectrlc resistance baseboard heat and window air-conditioners. S00 ch. 3.cwater or steam central heat and window air-conditioners. S00 ch. 3


sulate. Retrofit opportunities are limited toheating and cooling systems and lighting. Mostsmall commercial buildings are owned by an in-dividual or local partnership.

The most likely building type to be retrofit isoccupied by its owner and has a central airheating and cooling system or decentralizedheating and cooling. Such owners are willing toinvest in low capital cost retrofits because theenergy savings can directly increase theirbusiness profits. Buildings with central airsystems or decentralized heating and coolingcan achieve substantial energy savings withretrofits of low capital cost.

The least likely building to be retrofit is ownedby an absentee owner and has a water or steamheating system and window air-conditioners re-quiring at least moderate capital investment forsubstantial energy savings. Individual or localpartnership absentee owners, short of cash andwith little access to good information on retrofitpotential, are very unlikely to retrofit, but in-stead will try to avoid the burden of energy costsby passing them on to tenants using net orpassthrough leases.

Large Commercial Buildings.–Due to thegreater variety of owner types, six combinationsof owner type and physical type are necessaryto explain much of the predicted variation

among large commercial buildings (see table42). There are many opportunities for lowcapital cost retrofits among commercial build-ings with central air systems, complex reheatsystems, or decentralized systems; if they areowned by owners with long holding peri-ods—corporate owner-occupants or institu-tional investors—it is likely that retrofit hasalready occurred.

On the other hand, older commercial build-ings with central water or steam systems andwindow air-conditioners are fairly expensive toretrofit. If such buildings are owned by individ-uals or local partnerships with short holdingperiods, constraints on cash flow and poor ac-cess to financing and information, they are veryunlikely to be retrofit. Other large commercialbuildings fall between these extremes eitherbecause they are fairly difficult to retrofit orbecause their owners are unwilling to under-take retrofit regardless of the payback.

As with all simplifications, readers shouldavoid applying the categorization describedabove to any particular building. Any givenbuilding may easily have prospects quite dif-ferent from these for quite individual reasons.These categories are to help distinguish thebuildings most likely to be retrofit from thoseleast likely and identify the large group in the


Table 42.—Typology of Large Commercial Buildings According to the Likelihood ofMajor Improvement in Energy Efficiency

Retrofit options


of major willingness Low ModerateOwner type/ Building improvement in to invest capital capitalmeter type type energy efficiency in retrofit Costa Costa

Owner-occupant Air, complex Very likely Very willing xor institutional reheat orinvestorb decentralized

system

Owner-occupant Water system Likely Very willing xor institutionalinvestor

National partner- Air, complex Likely Willing— xship or develop- reheat or low capitalment company decentralized cost only

system

National partner- Water system Moderate Willing— xship or develop- Iow capitalment company cost only

Individual or local Air, complex Unlikely Unwilling xpartnership reheat or

decentralizedsystem

Individual or local Water system Very unlikely Unwilling xpartnership

aCompared to savings.bE * pension fund, Insurance company.


m i d d l e w h i c h a r e m o s t l i k e l y t o b e i n f l u e n c e d

b y a g g r e s s i v e m a r k e t i n g a n d o u t r e a c h b y p r i -

v a t e s e c t o r e n t r e p r e n e u r s o r p u b l i c s e c t o r p r o -grams.

Buildings that are likely to be retrofit withincurrent private sector practices include:

Ž Large commercial buildings with centralair, complex reheat or decentralized heat-ing and cooling systems owned by cor-porations, other large owner-occupants,institutional owners, national partnershipsyndicates, and development companies.

Ž Large master-metered multifamily build-ings owned by institutional owners andnational syndicates.

● Small owner-occupied commercial build-ings with central air or decentralized heat-ing and cooling systems.

Buildings which are very unlikely to be retrofit

due both to owner unwillingness and difficultyof retrofit include:

● Small masonry walled multifamily build-ings by absentee owners.

Ž Large tenant-metered multifamily build-ings owned by individuals or local partner-ships.

● Smal l commercial bui ldings owned byabsentee owners.

● Large commercial buildings with centralwater or steam heat and window air-conditioners owned by individuals or localpartnerships.

All of the other building types have prospectsfor retrofit that are less than very likely andmore than very unlikely. Whether they are actu-ally retrofit will depend in part on the owner’sknowledge of retrofit opportunities and the riskof retrofit and also on the owners access to fi-nancing, Each of these is discussed below.


INFORMATION: DIMINISHING THE RISKS OF RETROFIT

For all building types, in all locations, a majorconstraint on investment is the uncertaintyabout the performance of energy conservingmeasures. Except for a few small studies there isalmost no data on the actual performance ofretrofits. This is especially true for buildingsother than single-family houses.

This lack of information is a substantial barrierto retrofit for smaller owners who lack thetechnical capacity to evaluate conservationalternatives and the financial wherewithal to ex-periment. For smaller operators–the dominantgroup of real estate owners—there is notenough leeway in a building’s cash flow to beable to afford a costly mistake. And althoughlarger owners have resources at their disposalthey also want to be very sure that energy con-servation is indeed the best use of their invest-ment funds. The most sophisticated ownerswith the best engineering staffs at their disposalsaid in interviews that they test the equipmentfirst to establish its performance in actual ap-plications. They reported that much of the ex-perience with these tests has not matched eithermanufacturers’ or official expectations owing tothe effects of previous measures or operationallimitations.

Building owners who have installed retrofitmeasures report mixed results. I n a 1979 surveyby Booz Allen of apartment building owners,only half the owners, who had installed energyefficiency measures, were satisfied that insula-tion and furnace modifications were effectivemeasures and only a third were satisfied thatweatherstripping was effective (see table 43).

In the most comprehensive survey of docu-mented retrofits done to date, (described in ch.3) researchers Ross and Whalen obtained dataon retrofit results in 222 buildings,16 Their dataillustrates the uncertainty of predicting savingsfrom a retrofit:

. 10 percent of the buildings failed to haveany savings at all.

. Although those buildings which savedenergy saved an average of 22 percent, the

16ROSS and Whalen, op. cit.

Table 43.—Percentage of Apartment BuildingOwners Who Perceived Measures They Installed

To Be Effective

Percentage of owner-installers perceivingthe measure to be

Measure installed effective a

Insulation , . . . . . . . . . . . . . . . . . . . 540/0Furnace modification . . . . . . . . . . 50Individual metering or

submetering. . . . . . . . . . . . . . . . 43Storm windows . . . . . . . . . . . . . . . 39Clock thermostats. . . . . . . . . . . . . 38Weatherstripping . . . . . . . . . . . . . 31 %aThe Sum of the percentages is greater than 100 because OwnerS couid Identify

more than one measure as being effective,

SOURCE. National Apartment Assoclatlon Survev and Booz, Allen & Hamilton.

●

●

op. cit., exhibit D-6.

s a v i n g s r a n g e d ( w i t h i n a s t a n d a r d d e v i a -

tion) from 7 to 37 percent.For 60 buildings for which predictions ofsavings were available as well as savings,there was a substantial difference betweenpredicted and actual savings. Sometimessavings were much better than predicted (agroup of schools in Maine), sometimes theywere much worse (another group ofschools) and sometimes they varied widelywithin a similar group of buiIdings (a groupof community centers in Columbia, Md.).For 15 buildings, with more than 1 year’sdata after the-retrofit, 60 percent savedmore in the years following the first yearafter the retrofit, but 40 percent saved less.

On the other hand, the Ross and Whalensurvey is evidence that, on average, energyretrofit brings a large return on investment. For65 buildings with good retrofit cost data, almosthalf had paybacks of less than 1 year. All butseven had paybacks of 3 years or less.

To be effective, information on actual retrofitsis most useful when available through the chan-nels which building owners turn to for advice.One of the best are trade associations, The pro-gram referred to earlier between DOE and theAmerican Hotel & Motel Association to retrofitand document six different types of buildings isan excellent example. Restaurant trade associa-tions might be able to do the same kind of


testing in conjunction with various restaurantchains. Another possible channel is the localchamber of commerce which might cooperatewith local energy retrofit businesses to make in-formation available on documented retrofits.

Impact of Risk on Building Owner’s PaybackPreferences. For many reasons discussed in thischapter some owner types, especially individ-uals and small partnerships, cannot toleratelarge cuts in the cash flow from their buildings.The next section illustrates the cash flow cutscaused by retrofits with moderate paybacks of6, 7, and 9 years. Given the uncertainty of at-taining audit predictions of savings, such own-ers must avoid moderate payback retrofits be-cause of the risk that they will turn into verylong payback retrofits with devastating impacton the building’s cash flow.

Table 44 illustrates the impact of predictabledeviations in savings from audit results. A 5-yearpayback retrofit will become a 17-year paybackretrofit if actual savings are 70 percent belowpredicted, a figure perfectly consistent with thecomparison of audits and actual savings above.A building owner unable to cope with an actualpayback longer than 3 years must avoid allpromised paybacks longer than 1 year, if hewishes to allow for the risk that savings might be70 percent less than predicted.

Improved private sector or public sector infor-mation on retrofits could reduce the likely riskthat actual savings would be less than audit

Table 44.—impact of Uncertainty on Expected An-nual Energy Savings From a Retrofit

Costing $10,000

Annua l Expectedsavings payback

Case 1: 3-year paybackPredicted by an audit . . . . . . . . . . . $ 3,300 3 years50°/0 below prediction . . . . . . . . . . 1,650 6 years70°/0 below prediction . . . . . . . . . . 990 10 years50°/0 above prediction . . . . . . . . . . 4,950 2 years

Case 2: 5-year paybackPredicted by an audit . . . . . . . . . . . $ 2,000 5 years50°/0 below prediction . . . . . . . . . . 1,000 10 years70°/0 below prediction . . . . . . . . . . 600 17 years50°/0 above prediction . . . . . . . . . . 3,000 3½ years

Case 3: l-year paybackPredicted by an audit. . . . . . . . . . . $10,000 1 year50°/0 below prediction . . . . . . . . . . 5,000 2 years70% below prediction . . . . . . . . . . 3,000 3½ years50% above prediction . . . . . . . . . . 15,000 8 months

SOURCE Off Ice of Technology Assessment

predictions. As table 44 shows, for an ownerunable to tolerate more than a 5-year payback,an improvement in downside risk from 70 per-cent to 50 percent will allow that owner tomake a predicted 3-year payback investment.

Better documentation of safe retrofits whichreduces the risk of a retrofit would be of mostuse to cash-starved individual owners and smallpartnerships. With reliable information in hand,they might be willing to consider retrofits withpaybacks beyond the strict 1-year payback theynow insist on.

IMPACT OF LESS COSTLY FINANCING ON THE PACE OF RETROFIT

For some building types, long-lasting retrofitsare available which will, if successful, earnsubstantial returns in improved net income andbuilding resale value over the life of the meas-ure. Two such measures are installing more effi-cient air-conditioners in a large building withcooling from window air-conditioners, andreplacing the roof of a flat-roofed building andadding roof insulation. Such measures wouldnot be expected to payback for 6 to 10 years.Since they will last 20 years or more, however,

both would be sound long-term investments fora building.

A major obstacle to making such investmentsattractive to many building owners without in-ternal sources of funds is the high cost of debtservice in the early years as a result of the tradi-tion of amortizing loans in equal annual pay-ments of interest and principal repayments.

Simple Relationship Between Debt Serviceand Payback. Without examining all the com-


plexities of real estate finance with depreciationschedules and tax deductions of energy costsand interest, it is useful to examine the simplerelationship between debt service and energyretrofit payback, shown in figure 38. For energyretrofits with a 2-year payback, there are manycombinations of interest rate and loan term thatwould allow energy savings to exceed the costof borrowed money the first year. The financingoptions are far fewer for a retrofit with a 5-yearpayback. Only 10-year loans at interest rates ofless than 10 percent per year or 20- or 30-yearloans with interest rates as high as 18 percent

Figure 38.-Combinations of Loan Terms and Interest

would keep debt service costs the first yearbelow energy savings.

For most building owners interviewed wholacked access to internal funds for retrofits, theonly option for borrowing money was a com-mercial loan at 2 points over the prime rate(which in the summer of 1980 and the spring of1981 was 21 percent). The best available out-side financing mentioned was a 5-year loan at16 percent.

Given such financing options, especially withthe very short terms of loans available from

Rates Which Allow the Value of Energy Savings toExceed the Cost of Borrowed Money the First Year

Case 1: Energy savings from a 2 yearpayback retrofit (maximum paybackconsidered by an individual or localpartnership owner)

Dollar valueof energy savings= $ 2 , 0 0 0

Dollar valueof energy savings= $1.000

3 7 10 13 16 2022

Annual interest rate on loan(percent)

Case 2: Energy savings from a 5 yearpayback retrofit (criteria used bycorporations, insurance companyowners)

3 7 10 13 16 2022

Annual interest rate on loan(percent)

Case 3: Energy savings from a 10 yearpayback retrofit (maximum paybackcriteria of any owner interviewed)

Key:


commercial banks (often less than 2 years), it isnot surprising that only 2 of the 33 major build-ing retrofits reported i n the building owner in-terviews were financed through outside bor-rowing. All the rest were funded from internalcapital resources. It furthermore is no surprisethat a building owner, without internal fundingand with limits on the extent to which he cancut into a building’s cash flow, would limit con-sideration of retrofits to those with short pay-backs of 1, 2, or 3 years.

The term of a loan matters more than the in-terest rate in reducing annual debt service costsbelow energy savings. For retrofits with longlifetimes such as new boilers, air-conditioners,new lighting fixtures, or new insulation all ofwhich should be expected to last 20 years ormore, building owners might well accept fairlylong-term financing, even at moderate to highinterest rates, if it were available.

Unfortunately, two programs that help makelong-term property improvement loans avail-able to single-family homeowners have notbeen available to owners of multifamily or smallcommercial buildings. Title 1A loan insurancehas helped stimulate 7- to 10-year property im-provement loans for single-family homes (1 to 4units) since World War Il. However, its com-panion program, title IB, for multifamilybuildings has been very little used. Similarly,the Federal Home Loan Mortgage Corporationlaunched in 1981 a pilot program to purchasehome improvement loans for single familyhomes from savings and loan associations. Theloans must be secured by a second trust andmay be on amounts up to $30,000 and haveterms of up to 15 years. There are no plans tocreate a secondary market for property im-provement loans for multifamily or commercialbuildings.17

Adding Complications: Return on a Retrofitfor a Prototypical Building. For a more realisticappraisal of the impact of a retrofit on particularbuildings, OTA developed information on sixprototypical buildings from published average

. 1 zTh~ i “format Ion in rhj5 Pdrdgrdptl is based on presentations by

Michael Ehrman of HUD and Mark Shaefer of the Federal HomeLoan Mortgage Corporation at a community energy workshopmeeting on flnanclng held at HUD on Oct. 29, 1981.

expense and income data in particular localitiesas well as appraisal data.18 The prototypes illus-trate some of the variations in income and ex-penses in multifamily buildings: large and small,master and tenant metered, low rent structure,and moderate rent structure.

For one such building analyzed, a mediumsmall building with 18 units, in a cold climatetypical of St. Paul, Minn., but in a moderate rentarea where both rental income and taxes aresubstantial, a specific retrofit investment wassimulated. It was a fairly large package of retrofitmeasures, costing $22,303 or $1.45 per squarefoot. It saved 30 percent of the buildings energyuse or about $2,500 the first year. Such a retrofitwould be typical for a masonry-walled buildingfor which wall and roof insulation is expensive,and would payback in 9 years, well beyond theplanning horizon of the building owners inter-viewed for this study.

There would be substantial benefits to theowner from such a retrofit. After all tax benefitsfrom interest and depreciation were taken intoaccount there would be a substantial increase innet income from the building.

Fi rs t year F i f th year

Energy savings. . . . . . . . . . . . . . . . $2,500 $4,480Increased net Income. . . $1,459 $4,452

s u c h a n i n c r e a s e i n a b u i l d i n g ’ s n e t i n c o m e

s h o u l d b e t r a n s l a t e d d i r e c t l y i n t o i n c r e a s e d

r e s a l e v a l u e f o r t h e p r o p e r t y , i f g e n e r a l e c o -

n o m i c c o n d i t i o n s f o r t h e b u i l d i n g r e m a i n t h e

same. For a building in a stable neighborhoodwith the moderate rent structure describedabove, an appraiser would capitalize the net in-come at 9½ or 10 times in order to assess thebuilding’s resale value (see box E above). After 5years such a building should have an increasedresale value more than $40,000 higher thanwith no retrofit.

Fifth year value without retrofit. . . . . ... .. .$402,133Fifth year value with retrofit. ... ... . .$442,601

Increased value. . . . . . . . . . . . . . . . . . . . . . . + $40,468Percent increase in value. . . . . . . . . . . . . . . . . . . . . + 10.4%

Such an increase in value would be almost dou-ble the cost of the retrofit.

I13A descrj ~ltlon of the methods used to analyze the prototypical

buildings and presentation of the results will be published in work-i ng papers to th IS report.


Although there are clear long-term benefits tothe owner of such a building from undertaking aretrofit with a fairly long payback, there areserious short-term reductions in the building’scash flow as a result of the high cost of conven-tional debt service. If the retrofit is paid for witha 16 percent 5-year loan (which was the most fa-vorable conventional financing available to anybuilding owner interviewed) there is a sharpdrop in cash from building operations from thefirst year all the way through the fifth year (seefig. 39). If the building owner survives until thesixth year, debt service to pay for the retrofitends and the increase in net income is com-pletely retained.19

Subsidy Options. Given the loss in buildingcash flow from a substantial retrofit financedwith a 16-percent interest loan, OTA comparedthe impact of two different financing subsidieson the building’s cash flow. The two subsidies,one a tax credit and the other a financing sub-

I gFor a discussion of the impact on cash flow of an even longerpayback solar retrofit see Arthur J. Reiger, “Solar Energy: The Mar-ket Realities,” Rea/ Estate Rewew, vol. 8, winter 1979.

Figure 39.—Cash From Operations” for an 18-UnitApartment Building With and Without an Energy

Retrofit b

1979 1980 1981 1982 1983 1984 1985

Year

apretu ~hll~ functioning as a tax shelter and after tax once it starta Oener-atlng an after-tax profit.

bRetrof~t ~osting $22,3cQ with about a 9Year payback

SOURCE: Office of Technology Aaeessment.

sidy, are of comparable cost to the Treasury.The first of these is a tax credit of 30 percent thatOTA (somewhat arbitrarily) defined as substitut-ing for the first 30 percent of depreciation takenon the retrofit. The cost to the Treasury of such asubsidy would be $6,690 the first year but itwould be offset over the first several years by areduction of the same amount in depreciationdeductions. For building owners in the 50- per-cent income tax bracket such a depreciationdeduction would be worth $3,345 over severalyears of depreciation deduction. Thus, the nettax loss is only half of the $6,690 or 15 percentof the retrofit cost.

The other subsidy, of approximately equal orslightly less cost, is a loan subsidy designed bothto reduce the effective interest rate on theretrofit loan and to increase the loan term. Theinterest rate subsidy is straightforward. A lump-sum payment of about $2,200 deposited in abank in the first year of a loan is the presentvalue equivalent of a reduction in interest from16 to 13 percent and an increase in loan termfrom 5 to 10 years. This amount is only about 10percent of the cost of the retrofit. A significantlylarger subsidy, however, would be needed toactually induce banks to increase loan terms.This could take the form of loan insurance(about 2 percent of a loan’s value) and adminis-trative and financial support for a secondarymarket for retrofit loans. For this reason OTAestimates the total cost as comparable to the 15percent of retrofit cost for the net impact of thetax credit.

The impact of the two subsidies is comparedin figure 40. The tax credit restores or slightly in-creases aftertax cash flow the first year butleaves a large reduction in the pretax cash flow.The fifth year, however, both pre and aftertaxcash flow are reduced from their no retrofitlevel. With the loan subsidy, the building’s pre-tax and aftertax cash flow are both slightlyreduced the first year from the no retrofit situa-tion, but by the fifth year, both pretax and after-tax cash flow exceed the no retrofit situation.

Impact of Retrofit on Two Other Prototypi-cal Buildings: Low Rent and Tenant Metered.Two other prototypical buildings illustrate some


Figure 40.— Impact of Energy Retrofit Subsidies on Pretax and‘Aftertax Cash Flow for a Prototypical Apartment Building

Building A: 18-units, moderate rent, moderate taxes, master-metered

$15,0001- 1

Retrofit

7Tax

creditFinancesubsidy

I

dFirst year

(aftertax cash flowexceeds pretax cash flow)

Key

w

Pretax cash flowAftertax cash flow


i n t e r e s t i n g v a r i a t i o n s o n t h e k i n d o f i m p a c t s d e -

scr ibed above. Both are i l l us t ra ted i n f igure 41 .

Building B is a small multifamily building withlow rents and low taxes and substantial energycosts, based on rent and cost structures found inSt. Louis. A retrofit costing $34,809 is simulated.It saves $4,979 in energy costs the first year for asimple payback of 7 years. This building hasvery poor cash flow to begin with. The first yearpretax cash flow is essentially wiped out by aretrofit with a 7-year payback. Aftertax cash flowthe first year suffers considerable but lessdamage than pretax cash flow; it is reduced byabout half. By the fifth year an unsubsidizedretrofit or one subsidized with a tax credit hasstill reduced aftertax cash flow way below whatit would have been. A retrofit with a financingsubsidy on the other hand has increased boththe building’s pretax and aftertax cash flow. Al-though a retrofit is very damaging to this build-ing’s cash flow, it also has a very beneficial im-pact on its resale value which increases byalmost 27 percent.

retrofit No – subsidy

n subsidy TaxI credit

Fifth year(pretax cash flow

exceeds aftertax cash flow)

Building C (also shown in fig. 41) is at the op-posite extreme from building B. This large build-ing is tenant metered with moderate rents andtaxes based on income and cost structuresfound in Tampa, Fla. The owner makes a retrofitonly to save on energy costs in the commonareas, which are a small fraction of building ex-pense. The energy retrofit costs the owner$41,794 and saves $6,975 in energy costs thefirst year for a simple payback of 6 years. Such aretrof i t i s nei ther very important t o t h ebuilding’s resale value which increases by only3.9 percent, nor is it very important to the build-ings pretax or aftertax cash flow which does notchange much with either an unsubsidized orsubsidized retrofit. Such a building has ade-quate cash flow to cover this retrofit easily.

A conclusion to be drawn from this compari-son of prototype analyses is that a retrofit is mostbeneficial to the overall return of a low-rentbuilding with high energy use but it is also mostdevastating to its cash flow. Under such circum-stances, a financing subsidy (as opposed to a tax


Figure 41 .—Impact of a Retrofit on Pretax and Aftertax Cash Flowfor Two Other Prototypical Apartment Buildings

] Building B: small, low rent, I 1— Retrofit 1

I low taxes, master-metered

10,000t R e t r o f i t No

retrofit

First year Fifth year

Financesubsidy

C: large, moderatetenant-metered

subsidy credit subsidyl

RetrofitNo~ Retrofit 1

Tax Financesubsidy credit subsidy

First year Fifth year

_ Pretax cash flow= Aftertax cash flow


credit) will have a most beneficial impact to pre-vent sharp cash flow losses the first year andeven increase cash flow by the fifth year.

Building Owners’ Preferences for Subsidies.Building owners interviewed in the four casestudy cities preferred subsidized financing ofretrofits to a subsidy in the form of a tax creditby a 3 to 1 ratio for reasons that are consistentwith the prototype analysis (see table 45). A fi-nancing subsidy assists the building’s cash flowover several years while a tax credit doesn’t

assist the building’s cash flow at all the first yearand actually decreases the aftertax cash flowafter 5 years.

The not quite 25 percent of the building own-ers interviewed who preferred tax credits, didso because tax benefits were important to themin the return from their real estate holdings.Most of these owners were partnerships. A fewwere corporations which had adequate internalsources of finance for retrofit but welcomed atax benefit.


Table 45.— Building Owner Preferences forTax Credits or Financing Subsidies

Case study city Financing Tax credit Total

Buffalo . . . . . . . . . . . . . 18 5 23Des Moines . . . . . . . . . 13 3 16Tampa . . . . . . . . . . . . . 7 4 11San Antonio. . . . . . . . . 10 3 13

Total . . . . . . . . . . . . . 48 (76.20/,) 15 (23.80/o) 63

SOURCE Off Ice of Technology Assessment

Summary: Likely Impact of Risk Reductionand Financing on the Pace of Retrofit in CityBuildings. How willing owners are to retrofittheir buildings depends on several conditionsapart from the ease of retrofitting theirbuildings:

IS energy retrofit important to the owners’goals for the building and consistent withthem?IS the risk of retrofit and the cost of financ-ing it tolerable to the owner?

Owners can crudely be divided into four cate-gories on the basis of the product of these fourconditions.

Importance of reducing energy

and abso rb r i s k W i l l i ng and ab le Able but unwillingowner can’t tolerate risk

and/or lacks financing........ Willing but Unwllllng andnot able unable


Public and private programs designed to re-duce risk or lower the cost of financing retrofit(a variety of such programs are described in ch.11) are likely to have the greatest impact on thegroup of owners who are willing and even anx-ious to retrofit but who lack the financial flex-ibility to finance retrofits at reasonable cost andto absorb the costs of a mistake. Such ownersinclude:

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Owner-Occupants of small multifamilybuildings.Small business owner-occupants of theirbuildings.Individual and small (local) partnershipowners of master metered multifamilybuildings.

● Individual and partnership owners of officebuildings in markets that have become sen-sitive to energy costs.

Programs to reduce risks and/or lower financ-ing costs can take a wide variety of forms, in-cluding:

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Private market investment and assumptionof risk through leasing or guaranteed sav-ings.Private- or public-sponsored programs totest retrofits for specific kinds of buildings,e.g., several current restaurant and hotelprograms.Financing by private utilities, insurancecompanies, or any level of government de-signed to increase loan terms and lower in-terest rates.Tax credits, although these are relativelyless helpful to most building owners thanthe same amount of government money inthe form of a financing subsidy.

For building owners who are able to retrofitbut not highly motivated to retrofit because it isnot consistent with their goals for the building,the long-term operation of the market mayeventually have an impact. Such owners in-clude:

● Well-financed owners (such as nationalsyndicates and development companies) oftenant-metered multifamily buildings.

Ž WelI-financed owners of office buildings i ntight markets that are insensitive to energycosts.

● Well-financed owners of shopping centersin retail markets that are insensitive toenergy costs.

In some governmental jurisdictions there maybe political support for requiring energy retrofitfor certain categories of these buildings, espe-cially tenant-metered multifamily buildings.Such requirements might be imposed at thetime a master-metered building were convertedto a tenant metered one, or at the time of sale.In response to such a requirement, well-financed building owners will be able to makethe retrofit. Whether they can recoup the in-vestment over time will depend on the nature ofthe rent structures in the building’s market area.


By contrast, building owners who are bothunwilling to retrofit and unable to finance ortolerate the risk of a retrofit, are not likely to beable to respond to a requirement to retrofit un-less some financing and risk reduction assist-ance is provided. Such owners include:

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Small individual or partnership investorowners of tenant metered multifamilybuildings.Small individual or partnership investorowners of retail or office space with net orpassthrough leases.Owners of buildings in marginal areas.

Any political jurisdiction wishing to speed upthe pace of retrofit by regulation of such build-ings would have to see to it that financing andrisk-reduction assistance were available. It is at

least possible that local private utilities and leas-ing and energy savings guarantee companieswould be active enough in a particular city thatno public program would be needed,

Owners of buildings in marginal areas are aspecial case. For these, retrofit makes sense onlyin the context of the potential resale value ofbuildings in the entire neighborhood or district.For such buildings, programs to speed up ener-gy retrofit only make sense in the context ofoverall rehabilitation programs designed to en-courage general owner investment in theirbuildings (in structure, facade, wiring, plumb-ing, and energy efficiency) and to increase con-fidence in the area by potential building pur-chasers and the financing community.

will building owners invest in the energy efficiency of

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