By Robert Watson, PE, CEM Principal
NOI Engineering, Dallas
rwatson@noi-engineering.com

As large amounts of apartment assets trade hands through foreclosure, new buyers are increasingly forced to invest more capital to renovate vacant or down units. Compared to the last downturn in the early 1990’s, many of these buyers are more sophisticated and are trying to identify ways to achieve higher returns on investments by analyzing and responding to every line item. Reducing the on-going utility costs not only helps the annual Net Operating Income (“NOI”), but hedges against escalating utility rates and increases value at the eventual sale or exit. However, the seemingly obvious strategy to increase NOI by installing more efficient equipment such as newer air conditioning systems, lower flow faucets or higher performance windows do not always lead to improved results.

First, professionals need to consider who will actually be paying for utility costs in units and common areas, and more importantly, weather these costs are effectively passed on to residents without impacting the ability to raise future rents. Markets have an effective ceiling on what renters can, or will, pay for fully loaded housing costs. Since most of the foreclosed products to date are comprised of the lower-end buildings (a.k.a. “workforce housing”), renters may not initially focus on utility costs when signing a lease. However, when they start receiving hefty bills from utility companies or RUBS providers, it will dramatically affect renewal rates and the ability to raise rents. For example, lower-end rents may be $500 a month in many Southeast markets while the utility costs (in warmer months) may run beyond $100. While not necessarily an exact science, resident utility savings may provide the landlord with an opportunity to raise rents in the future.

Professionals should also consider the examination of prevailing energy rates (regardless of regulated/deregulated markets), local climate, and various incentive programs. First, in regions such as California and the Northeast where utility rates are higher, efforts to install more energy efficient equipment generally makes sense. However, for properties elsewhere, the savings may not be as significant. Obviously, a location with a $0.16 per kWh rate will provide a quicker return on investment than a location with a rate of $0.07 per kWh. Second, local climates should be considered thoroughly since higher performing air conditioning equipment will yield smaller savings in a mild climate such as in San Francisco compared to warmer climates such as in Dallas. Although related, pursuing environmental stewardship does not always provide the reduced operating expenses most investors seek. For example, installing a higher efficiency air conditioner will likely reduce overall energy consumption regardless of the amount of use. However, the return on investments (“ROI”) will be a strict function of local energy rates, incentives, and climate, which may only allow for limited savings and therefore not appeal to those seeking reasonable returns on investments. Therefore, it’s just as important for decision makers to clearly define the desired outcome; reducing operating expenses versus showing environmental stewardship.

In addition to equipment upgrades or replacements, opportunities such as “Green Branding” using Energy Star labeling or LEED certification is becoming increasingly popular. Although Energy Star benchmarking for multifamily properties is not yet available and LEED certification is only limited to low-rise structures, their prominence in the multifamily industry is on the rise. For instance, EPA representatives within the Energy Star program have indicated that insufficient data on multifamily energy usage has limited their ability to provide benchmarking against peers. Consequently, they are addressing this issue by embarking on a campaign to persuade multifamily owners and institutions to voluntarily supply their utility data. Their ultimate goal, of course, is to acquire sufficient information to enable Energy Star benchmarking and labeling akin to commercial office buildings. Similarly, the (“USGBC”) has instituted a midrise multifamily pilot program to allow for eventual LEED certification. Although these programs are not likely to roll out in the immediate future, energy conservation measures implemented over the short term should yield higher “scoring” on properties, thereby facilitating their eventual labeling or certification.

In order to pursue these opportunities, real estate professionals must strategically arm themselves with useful and sufficient data in order to make reasonable improvement decisions. Third party auditors should be carefully scrutinized, especially those who claim to provide “Free Energy Audits.” As with manufacturer representatives claiming boastful equipment performances, there are an equal number of Energy Audit providers either new to this increasingly popular field or, in the case of the “Free Energy Audit,” simply equipment salesmen guised as consultants.

The trend of enhancing property performances by reducing utility consumption has not gone unnoticed by manufacturers, as evidenced by an overwhelming number of “green”, “sustainable”, or “energy efficient” products flooding the market. Not only should such claims be examined thoroughly, but their performances with respect to local climate and utility rate structures must be considered. Qualified consultants can provide value and should readily acknowledge and use terms such as “Bin Data” and “Degree Days” in their payback analysis. Otherwise, there’s a strong probability that the resulting calculations and recommendations will not be accurate or appropriate in reducing unnecessary capital expenses instead of improving performances. A well executed analysis should provide managers with several improvement options (broken down by ROI) while factoring in utility rates local climate, and incentives.

Therefore, with appropriate steps and investments, tangible bottom-line improvements can be readily achieved. These opportunities should not only be viewed as prudent to the standard of care most asset managers practice, but also, an area of fertile investment opportunity with significantly low barriers-to-entry in these difficult times.

About the Author
Robert Watson is a Principal and Founder of NOI (Net Operating Income) Engineering. NOI is primarily focused on adding value to our client’s “bottom-line”, whether economic, environmental, or social. Our initiative has been tailored to assist building owners, managers, and lenders to understand the ramifications of “green” or “sustainable” building design or retrofit features (or the lack thereof). We leverage a property’s existing systems by profiling historic energy demands to optimize building operations and ultimately the property value at disposition. NOI’s team possesses a variety of professional accreditations including licensed Professional Engineers, Certified LEED Accredited Professionals, and Green Building Engineers. NOI Engineering has trademarked the term “Energy and Sustainability Due Diligence” in a effort to entrench our interest in this pursuit but also distinguish our services from that of other firms.