How do you get the owner of an older building and their tenants, who frequently have a triple-net lease, to come to an agreement when deciding how to pay for cost-saving facility upgrades?
E3 Prime Environment’s President, Curt Monhart, had to address that question while completing the company’s latest energy efficiency upgrade proposal.
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The 60 year old building has outdated, energy inefficient lighting with old fixtures and less than ideal light quality for the production and retail operations housed within. The HVAC equipment is at the end of it’s projected life expectancy. In addition to being energy inefficient, it’s costly to maintain.
The tenant’s goal was to keep utility costs-which is their financial responsibility due to the triple net lease-to an absolute minimum by having the most efficient building infrastructure (HVAC, lighting, doors/seals, lighting, insulation, etc). The infrastructure, which is the financial responsibility of the building owner, was long overdue for upgrades. But the owner needed to keep costs, and debt, to a minimum to maintain NOI (net operating income).
This situation is referred to as the “split-incentive” problem where the tenant and owner do not equally benefit from an energy efficiency upgrade. Tenants desire an energy efficient building since it directly reduces their total cost to rent. However, owners are hesitant to make any major upgrades since, with a triple net lease, the tenants pay the utility bills. They don’t see a return on the investment.
“The project was ready to launch because the needs of the tenant, as well as the needs of the property owner, had been met using a unique financing solution”
Monhart overcame the split incentive obstacle on this project by introducing Property Assessed Clean Energy, or PACE, to the decision-makers. PACE is a relatively new and innovative financing option for funding energy efficiency improvements having many advantages over traditional financing options. Typically for a term of 15 to 25 years and always at a fixed interest rate, the loan is paid for by a special assessment on the owner’s property tax bill, similar to those levied for streets, sidewalks, sewers and other improvements.
Resulting from the advantages of PACE-funding, the project is now getting ready to launch as the needs of the tenant, as well as the property owner, have been met. It calls for new HVAC units, replacing the existing lighting with LEDs and installing a solar array on the large flat roof. The array eliminates a significant portion of the tenant’s electric bill improving overall profitability. And with its onsite generation of electricity,an important step towards sustainability.
The tenants will see lower energy costs. And while a triple net lease will increase their apportioned property taxes to accommodate the special PACE assessment, utility costs will be less than the assessment therefore realizing a lower total cost to lease.
How does a solar array benefit the building owner when it ultimately only reduces the tenants electric bill?
The owner ends up with a more valuable property with the latest energy-consuming technologies, and a more profitable one. Energy efficiency upgrades-especially HVAC and lighting-result in a more comfortable environment. This leads to easier tenant acquisition, higher occupancy rates and often increased lease rates. And there’s a great PR benefit. With the solar panels clearly visible to all passers-by, it sends a clear message the owner is being a good steward of the environment. This is truly a win-win for both parties as well as the environment.
“Getting building owners and tenants together to reach agreement on the scope of needed upgrades and how they are going to be financed is significantly easier with the Property Assessed Clean Energy program. PACE can finance needed upgrades using the money saved through greater efficiency and benefits both parties while actually improving cash flow.
Here’s a summary of the benefits to both building owners and tenants when using PACE to fund energy efficiency upgrades:
- Upgraded property with cutting-edge energy efficiency technologies
- No debt added to balance sheet thereby maintaining future borrowing power (PACE is considered a tax and not debt)
- No capital outlay since PACE provides 100% funding
- Improved NOI resulting in higher property values
- Satisfied tenants, higher occupancy and lease rates
- Financing paid for by tenant due to triple net lease
- Demonstrated environmental stewardship
- Reduction in energy use lowering the total cost to lease
- Automated lighting controls including occupancy sensors and improved light quality
- More comfortable workspace
- Improved retail space appearance with state-of-the-art lighting
- Improved cash flow (savings are greater than the added PACE special assessment
- Reduced maintenance and repair costs with the new HVAC units and lighting
- Greater energy independence with onsite generation capabilities.
“The cost obstacle can now be overcome through the use of innovative financing options!”
Outcomes which are financially agreeable to both the building owner and the tenant are much easier to launch and move towards completion. The Property Assessed Clean Energy financing option takes the needs of the building owner, as well as those of the tenant, into consideration and creates a win-win solution. This will be an exciting project to watch as it unfolds.
Free report: Property Assessed Clean Energy (PACE) For Driving Commercial Real Estate Financial Performance DOWNLOAD