The Economic & Financial Options in Retrofitting Commercial Buildings

Presented by: Wally Geer go2wallyworld@hotmail.com

Special Thanks to those who made this presentation possible:

SDG&E Energy Innovation Center California Center for Sustainable Energy A special word of thanks to those organizations whose research

contributed content to today’s presentation:

California Building Commission USGBC C4 Chapter SDG&E TMC Development U.S. Small Business Administration U.S. Department of Energy The California Energy Commission

A few requests & comments

I know we all have busy lives, but please turn your cell phone off or set it on “vibrate”, thank you.

If your cell phone rings, the “Wally Rule” is in full force & effect

We will talk about a lot of facts today, but please appreciate that some subjective opinions I may voice are strictly my own and I’m not speaking on behalf of our gracious host today

Today’s Learning Objective:

It’s all about “Green”, and I don’t mean saving the Redwoods, the Whales or

the Ozone!

Agenda:

Common Myths about upgrading Commercial Properties Energy Consumption 101 Potential Benefits of Energy Retrofitting The Economic Case for Retrofitting The Legislative Case for Retrofitting (AB 1103) How can an owner reduce their energy costs? Everything you every wanted to know about Energy Audits, but were afraid to ask Financial Techniques to analyze your options Financial options to pay for your retrofit Some final thoughts + questions & answers

Common Myths about Energy Savings as it applies to Building Valuations:

“Energy costs contributes negligibly to overall value”

“Uncertainty in energy reporting methods is so high that building specific estimates are effectively meaningless”

“Energy’s impact on value, as with all other elements of value, is ultimately defined by the market”

The Reality of Energy Savings as it applies to Building Valuations:

“Although Value is ultimately defined by the market, your relative position on the Value Scale is determined by Net Operating Income”

“Every Dollar saved in Operating Costs equals an additional dollar of Profit on an owner’s bottom line.

“Many Energy Savings Retrofit Features are relatively low tech and highly cost effective”

Common Myths about Energy Savings

“Our building is already energy efficient” “Energy costs are a pass through to tenants and don’t really

effect me as an owner” “The goal of high energy efficiency really doesn’t matter on

small buildings” “We’ve been told to focus on “LEED” points and not energy

efficiency” “We don’t anticipate selling our building in the near future, so

energy efficiency really doesn’t matter to us” “Energy Providers don't really want to save us money”

“Energy 101” Facts:

Our Buildings consume 30% of all Energy Use & 60% of all Electricity

They also produce 43% of all harmful carbon emissions

Who Produces the CO2 ?

The Metrics of Building Operations:

Source: BOMA

Typical Energy Use by Category:

Source: Pacific Gas & Electric

Additional Benefits of an Energy Efficient “Healthy” Building

Properly balanced buildings with appropriate outside air sources produce a 3% lower absentee rate.

Source: U.S.G.B.C. & National Institute of Health

Potential Benefits of Energy Retrofitting:

Lower Operating Costs

Higher Employee Productivity

Lower Financing Costs

Higher Operational Profits

Higher Building Valuations

Potentially Significant Return on Investment Dollars spent if appropriate retrofitting strategies are employed

The Economic Case for Retrofitting

Although each property has its’ own unique set of financial metrics, appropriate chosen retrofitting upgrades can provide double digit R.O.I.s

Case Study: Sleepy Time Inn Source of Study: Pacific Gas & Electric & U.S. Dept. of Energy

INCOME: Pre Retrofit Post Retrofit Gross Scheduled Income $ 506,624 $ 506,624

Vacancy $ 177,318 $ 177,318

New Scheduled Income $ 329,506 $ 329,506

EXPENSES: Electricity $ 18,766 $ 10,450

Natural Gas $ 5,447 $ 2,850

Water $ 2,886 $ 2,886

Maintenance $ 17,206 $ 17,206

Operations $ 84,347 $ 84,347

Taxes & Licenses $ 64,489 $ 64,489

Reserve $ 8,232 $ 8,232

Subtotal Expenses $ 201,373 $ 190,460

Case Study: Sleepy Time Inn Source of Study: Pacific Gas & Electric & U.S. Dept. of Energy

Scheduled Income $ 329,506 $ 329,506

Expenses $ 201,373 $ 190,460

Net Operating Income $ 128,133 $ 139,046

Cap Rate 8.75% 8.75%

Opinion of Value $ 1,461,958 $ 1,586,678

Effect of Energy Retrofit $ 124,720

Cost of Energy Retrofit $ 65,000

Case Study: Source of Analysis: Greymar Associates & U.S. Small Business Administration Cost of Retrofit Features: Approximately $ 75,000

YEAR Estimated Monthly Savings Estimated Annual Savings

2010 (Base Year) $ 1,232.73 $ 7,396.38

2011 $ 1,282.04 $ 15,384.47

2012 $ 1,333.32 $ 15,999.85

2013 $ 1,386.65 $ 16,639.84

2014 $ 1,442.12 $ 17,305.44

2015 $ 1,499.80 $ 17,997.65

2016 $ 1,559.80 $ 18,717.56

2017 $ 1,622.19 $ 19,466.26

2018 $ 1,687.08 $ 20,244.91

2019 $ 1,754.56 $ 21,054.71

TOTAL: $ 170,207.08

Case Study: Source of Analysis: Greymar Associates & U.S. Small Business Administration Cost of Retrofit Features: Approximately $ 75,000

Item: 10 Year Cost Savings Energy Savings $170,207 Loan Origination Fees $315,000 Loan Spread Savings $ 78,000 TOTAL $563,207

Case Study (Adjusted): Source of Analysis: Greymar Associates & U.S. Small Business Administration Cost of Retrofit Features: Approximately $ 75,000

Item: 10 Year Cost Savings Energy Savings $170,207 Loan Origination Fees $115,000 Loan Spread Savings $ 78,000 TOTAL $363,207

The Legislative Case for Retrofitting

1978: What happened in California?

2004: California Green Building Initiative (aka EO S-20-40): This legislation mandated a 20% reduction

in state-owned buildings by 2015 2006: Global Warming Solutions Act (aka AB 32): This legislation mandated State CHG emissions to

1990 levels by 2020 October 2007 – AB 1103 is passed and signed by the Governor

AB 1103 The Commercial Building Benchmarking Law

AB 1103 is a “scoring system” with the intent of estimated the energy efficiency of an existing commercial building.

The scoring system is based on the EPA’s “Energy Star Rating System” as estimated by “Portfolio

Manager” software.

Energy Star Benchmarking Scores

Based on a 1 to 100 scale (100 being the most energy efficient building, 1 being a building that leaks

more than the 1959 Volkswagen convertible I went through college with)

The score estimates an “energy use intensity level” (measured

in kBtus / Sq. Ft. / Year)

Any building that scores 80 or higher is eligible for the Energy Star rating, but the rating is NOT a requirement of AB 1103

Why the Energy Star Rating System?

Free & Secure software that creates consistent benchmarking results

Based on over 140,000 buildings that have been benchmarked to date

Based on benchmarking data from over 20 different commercial building types

“Energy Star” is recognized by over 75% of Americans (according to the EPA)

AB 1103

Based on a “roll out” schedule, AB 1103 will apply to all non-residential buildings being sold, leased or refinanced if they are:

Owner Occupied > 5,000 Sq. Ft. Non-Owner Occupied > 50,000 Sq. Ft. Non-Owner Occupied > 10,000 Sq. Ft. Owner Occupied > 1,000 Sq. Ft. All Non-Residential building > 5,000 Sq. Ft.

AB 1103 A Brief History

October 2007: AB 1103 is passed by the California Legislator & signed by the Governor

January 2009: Utility companies must provide consumption data upon request by customer

October 2009: AB 531 is passed by the California Legislator & signed by the Governor which provides the CEC to establish the roll out schedule of AB 1103

December 2009: Roll out schedule of AB 1103 is established and Phase 1 is to commence on Jan. 1, 2012

January – December 2011: Roll Out Schedule is modified, modified and modified !!

AB 1103 Most Recent Proposed Roll Out (as of Sept. 2011)

July 1, 2012: All building’s > 50,000 Sq. Ft.

January 1, 2013: All building’s > 10,000 Sq. Ft & < 50,000 Sq. Ft.

July 1, 2013: All owner occupied building’s. Owner Occupied Buildings of < 5,000 Sq. Ft. would be exempt

How Can an Owner Reduce their Energy Costs ?

Start with a professional energy audit and analysis

The complexity of your energy audit should match your needs and budget

Think “Retrofit” First & “New Technology” Second

Focus on Value versus Cost & chose your analysis savings format wisely

Find a balance between your goals and your budget Think “Life Cycle”, NOT “Initial Cost”

OK, Sounds good, but “What’s next?”

1.) PRIOR TO INITIATING AN ENERGY AUDIT: Identify your energy saving objectives Define the metrics to be used in the analysis Research potential funding sources & funding strategy Research incentive programs

2.) PERFORM THE ENERGY AUDIT BY: Determining the type of Audit you require Energy Audits are a “Team Sport” Document existing conditions & analyzing existing systems Identifying energy saving opportunities

OK, Sounds good, but “What’s next?”

3.) ANALYZE THE NUMBERS AND FINANCIAL IMPLICATIONS: Set Cost & Saving Targets Determine financial techniques to base your financial decisions on Calculate Returns Analyze financing options

4.) AFTER YOU HAVE PERFORMED ALL OF THE ABOVE: Define a game plan that fits your budget and financing options “Just do It”

1.) Prior to Starting an Energy Audit

Identify your energy saving objectives

Define the metrics to be used in the analysis

Research funding source & funding strategy

Research incentive programs

Identify your energy saving objectives

Improve cash flow as a result of lower energy costs

Create higher building valuation to prepare building for sale

As part of a refinancing strategy

As part of a marketing strategy

To accommodate tenant needs

Define the Metrics to be used in the Analysis

Energy Star scoring system Title 24 or CalGreen documented format Specific metrics formula required for incentive programs (cash

or tax incentives) Metrics specifically required by lending agencies Metrics required by Code Authorities

Research potential funding source & funding strategy

Cash

Conventional Bank Loans

Non-traditional Lenders (i.e. SBA, State & Federal lending programs, etc.)

Energy Service companies (ESCOs)

Leased improvements

Other Options

Research Incentive Programs

Utility Company Incentives

State sponsored programs administered by Utility Companies

State & Federal (non-tax based) incentives

I.R.S. & State of California Tax Incentives

Vendor Incentives

The Energy Audit: Part Science / Part Black Magic

Projected Performance does NOT equal Actual Performance

2.) PERFORM THE ENRGY AUDIT BY:

Determine required level of audit Energy Audits are a “Team Sport” Document existing conditions & analyzing existing systems Identifying energy saving opportunities

Determine the type of Audit you require

Preliminary Audit

Case (or technology) specific Audit

Goal Specific Audit

Comprehensive Audit

Preliminary Audit

Generates a rough estimate of potential cost savings

Identifies primary categories of energy savings that should be potentially further studied

Provides a preliminary analysis of economics that might justify further studies

Generally produces a limited amount of projections & metrics

Case (or technology) Specific Audit

Provides detailed analysis of specific technologies & systems Provides no energy management plan May potentially miss high value non-targeted energy saving opportunities

Are only as valid as the operating engineers running & evaluating the system

Goal Specific Audit

Generally performed as a result of a specific need related to financing, leasing or building certification

Generally requires specified metrics and formats to achieve the desired goal

Could be produced by a specific vendor trying to sell his (her) technology and retrofitting services

May potentially miss high value non-targeted energy saving opportunities

Can produce a desired result, but in regards to energy savings, can result in a “tail wagging the dog” implementation strategy

Comprehensive Audit

Analyzing all major building systems & how they work within a synergistic system

Considers on site and / or cogeneration of energy

Includes highly comprehensive energy cost savings projections

Includes estimates of the cost of retrofits suggested

Analyzes returns based on owner’s financial goals and criteria

Energy Audits are a “Team Sport”

Prior to starting your Energy Audit & analysis, assemble your team:

Building Owner (if privately held small company) CEO, COO, CFO, CTO in larger companies Director of real estate and facilities management Building level maintenance & operational staff Major vendors & service providers Major tenants that influence building’s operation

Document existing conditions & analyzing existing systems

Building Design, construction type, square footage, insulation type

Site plan, building orientation, windows and other fenestrations & other glazing

Ventilation & mechanical systems

Building hours of operation & building use

Document specialty how power consumption uses (i.e. server farms, high power manufacturing equipment, etc.)

Gather existing utility data

Identify Energy Saving Opportunities Step 1

Start by focusing on the “low hanging fruit” items first:

Lighting

Heating & Air Conditioning

Building Shell / Glazing & Insulation

Identify Energy Saving Opportunities Step 2

Provide an in-depth analysis of: Lighting & control systems HVAC Building Envelope Domestic Hot Water On site energy generation Hours of operation as the effect peak usage energy costs High Power consumption operational equipment

3.) ANALYZE THE NUMBERS AND FINANCIAL IMPLICATIONS:

Set Budgets & Saving Targets

Determine financial techniques to base your financial decisions on

Calculate Returns

Analyze financing options

Set Cost & Saving Targets

Cost & Savings Analysis SYSTEM COST Annual

Savings Metric

Basis of Return

Funding Source

Cross Contingency

Lighting & control systems

HVAC

Building Envelope

Domestic Hot Water

On site energy generation

Hours of operation as the effect peak usage energy costs

High Power consumption operational equipment

Set Cost & Saving Targets Typical Example

SYSTEM: COST Typical Annual Savings

Metric Basis of Return

Funding Cross

Source Contingency

Lighting & control systems $ 17,000 $ 3,850 IRR

HVAC $ 49,000 $ 2,880 LCCA

Building Envelope $ 5,000 $ 350 IRR

Domestic Hot Water N.A. N.A. N.A. N.A. N.A.

On site energy generation $ 48,000 $ 3,000 PV

Hours of operation as the effect peak usage energy costs

Zero $ 5,600 IRR

High Power consumption operational equipment $ 4,000 See “On Site”

PV "On Site Power”

Determine financial techniques to base your financial decisions on

Simple Pay Back Period (SPP)

Return on Investment (ROI)

Discount Rate (Not a stand alone metric)

Present Value (PV)

Internal Rate of Return (IRR)

Life Cycle Cost Analysis (LCCA)

Simple Pay Back Period (SPP)

“Simple Pay Back Period” is the amount of time it takes to recover the initial cost of the improvement.

“Simple Pay Back Period” is calculated by taking the cost of the

improvement and dividing it by the year one savings. For example, if an improvement cost $10,000 and returned $2,500 its’ first

year, the SPP would be 4 years SPP is generally expressed in years & months

Simple Pay Back Period Pros & Cons

Pros: Considered by some a good “quick check” for comparisons

Easily understandable by “non-financial” types

It can potentially be used in negotiating cost savings with tenants

Simple Pay Back Period Pros & Cons

Cons: SPP does NOT take into account the time value of money or the cost

of debt service to service those improvements that were financed

SPP does NOT factor in life cycle cost or operational costs

There are many preconceived myths and prejudices about what is a “good” Simple Pay Back Period

Summary: SPP is a VERY POOR metric to compare retrofitting options with

Return on Investment (ROI)

“Return on Investment” is the reciprocal of Simple Pay Back Period

“Return on Investment” is calculated by dividing the year one

savings by the cost of the improvement. For example, if an improvement saved $2,500 the first year and

the cost was $10,000, the ROI would be 25% ROI is generally expressed in a percentage value

Return on Investment Pros & Cons

Pros: ROI is simple and easily understandable

Is easily compared to owner’s cost of capital (an independent metric)

Is a good metric when doing lender, investors & potential buyer

presentations and justifying a higher building valuation and CAP rate.

ROI may serve as a required metric for some lending and financial scenarios

Return on Investment Pros & Cons

Cons: ROI assumes a consistent annual rate of savings ROI does NOT factor in life cycle cost or operational costs ROI is NOT based on a specific time period analysis for the savings

Summary: Although ROI is a potentially useful metric to make “Like for Like”

comparisons of vendor proposals, ROI shares the same problems that SPP has

Although ROI may be a good starting place, it is generally NOT a good metric to solely make significant financial decisions with

Discount Rate

“Discount Rate” is the minimum rate of return required by an investor

“Discount Rate” is the metric that is used when analyzing retrofit

options in the format of “Present Value” The HIGHER the perceived risk of an investment, the HIGHER the

“Discount Rate” The HIGHER the “Discount Rate”, the LOWER the “Present Value”

There are 2 Types of Discount Rates

“REAL Discount Rates” do not consider inflation as a factor “NOMINAL Discount Rates” take an assumed rate of inflation into

account when creating the value of an improvement

Discount Rates Pros & Cons

Pros: Discount Rates serve as the basis for “Present Value” calculations. You

CANNOT determine “Present Value” (PV) without a “Discount Rate” based on your own financial situation

Cons: Discount Rates are based on past and present financial information, which can

change in the future and therefore make the Discount Rate highly inaccurate and subjective.

Discount rates can be influenced by the cost of money (i.e. interest) and the leverage of debt used to make the improvements.

Summary: Discount Rate is NOT a stand alone metric to base decisions on, but is an

important number that must be used to calculate Present Value analysis

Present Value (PV)

“Present Value” is the value that a particular cash flow is worth in TODAY’S dollars.

“Present Value” is based on the concept that money earns interest or

income. Cash Flow Present Value = ______________________ (1 + Discount Rate) @ Day 1

If $0.91 (Ninety One Cents) were invested at a 10% return within one year, the “Present Value” of that $0.91 would be $1.00 (One dollar) at Day 1 of the investment.

Present Value (PV) 3 Year Example

Assume a $1.00 (One Dollar) Investment’s Present Value @ 10% over a three year period

Year 1 Value = $0.91

Year 2 Value = $0.83

Year 3 Value = $0.75

Present Value (PV) Pros & Cons

Pros: PV is simple and easily understandable

PV is a widely accepted standard by lenders, investors & Financial

Advisors

PV, when properly used, acknowledges the ups and downs of cash flow related issues

Present Value Pros & Cons

Cons: PV is based on a constant Discount Rate, but the Discount

Rate can be an inaccurate projection of the FUTURE based on data from the PAST.

If you are going to use PV as a metric to base decisions on, there must be an “End Date” to your Present Value Decision.

Summary: PV is a highly effective tool to base decisions on assuming your

Discount Rate is realistic and proves to be accurate

Internal Rate of Return (IRR)

IRR is a valuation method used to estimate the attractiveness of an investment or capital expenditure

IRR is sometimes referred to as “Economic Rate of Return” (ERR)

IRR takes into account the return of your capital as a declining

balance and bench marks it against an averaged Internal Rate of Return of the outstanding principal

Internal Rate of Return (IRR) Pros & Cons

Pros: IRR is a widely accepted standard by lenders, investors & Financial

Advisors

IRR is an accurate reflection of return versus Cost of Capital

IRR recognizes to ups and downs of cash flow

IRR is a good tool for an investor or building owner to compare a potential investment against their own cost of capital

Internal Rate of Return (IRR) Pros & Cons

Cons: IRR requires an end date to be calculated. The projected end

date can significantly influence the IRR IRR assumes that all cash flow is reinvested at the IRR Can prove to be inaccurate when based upon “annual” as

opposed to “monthly” savings

Summary: IRR is an excellent metric for sophisticated owners and

investors, but is only as good as the base line assumptions that are made to calculate it (i.e. “garbage in, garbage out”)

Life Cycle Cost Analysis (LCCA)

“LCCA” calculates total cost, versus savings, of the life of a specific piece of equipment or technology

“LCCA” is a significant metric when making long term, major

capital improvements or retrofits, including: Initial Cost Operational, maintenance & repair costs Financing costs Serviceable life of the equipment or technology Salvage Value at “end of life” (if any)

Life Cycle Cost Analysis (LCCA) Pros & Cons

Pros: Can prove to be an excellent metric when evaluating high ticket

installations of new equipment and systems

Incorporates the time & value of money into it’s analysis

Can be used as an additional set of metrics to further refine ROI & IRR calculations

Life Cycle Cost Analysis (LCCA) Pros & Cons

Cons: Not widely understood Requires a number of assumptions & variables that may or may not

come to pass in the future Can often be based on vendors claims, that are NOT warranties

Summary: For financially sophisticated owners & investors, LCCA is an excellent

metric, but is only as good as the base line assumptions that are made to calculate it (i.e. “garbage in, garbage out”)

Financing Options “Show Me the Money!”

Cash Cash Rebates from Utility Companies Tax Rebates Conventional Bank Loans Leased Improvements Energy Service Companies (ESCOs) Non-traditional Lenders (i.e. SBA, State & Federal lending

programs, etc.) Your Flaky Brother in Law whose never worked a day in his life and who just won the Lottery

Energy Service Company (ESCO)

An Energy Service Company (aka “ESCO”), is a business that develops, installs, and arranges financing for projects designed to improve the energy efficiency and maintenance costs for facilities over a seven to twenty year time period.

ESCOs generally act as project developers for a wide range of tasks and assume the technical and performance risk associated with the project. Typically, they offer the following services:

– Develop, design, and arrange financing for energy efficiency projects

– Install and maintain the energy efficient equipment involved – Measure, monitor, and verify the project's energy savings – Assume the risk that the project will save the amount of energy

guaranteed.

Energy Service Company (ESCO) Pros & Cons

Pros: Guarantees your energy costs for an extended period of time

Serves as a potential hedge against rising energy costs not

caused by your facilities operation

A properly negotiated contract can also integrate total life cycle costs which can stabilize cash flow projections

Removes the burden of energy management from the building’s owner

Energy Service Company (ESCO) Pros & Cons

Cons: Requires sophisticated owner or facility manager to participate in the

decision of selecting and contracting with an ESCO Is based on two parties (the building owner & the ESCO) “betting” on

the cost of energy in the future Can be costly if the ESCO fails (i.e. bankruptcy) in the future Summary: A potentially excellent option for major facilities who want the stability

of fixed expenses in relation to their future energy costs. Is only as good as the management & financial strength of the ESCO

How to evaluate if an ESCO is right for you?

Develop a facility profile

Set energy cost goals and priorities

Create an RFP for services

Invite ESCOs to visit you facility

Select an ESCO based on your RFP

Negotiate a long term contract that achieves your goals

Enjoy the benefits

SBA 504 Green Loans

The U. S. Small Business Administration is one of the largest lenders in America for privately held companies that own their own real estate

SBA loans can produce 90% Loans to Value (LTVs) as compared

to conventional lenders who are currently making loans at 70% to 80% LTVs

Under certain circumstances, energy upgrades and retrofits can be

financed in part, or in whole, at a lower rate than conventional lending.

SBA 504 Green Loans Pros & Cons

Pros: Can produce higher Loan to Values than conventional lenders

are currently offering in the market place

Rewards the owner with fewer origination fees and better rates if their building is retrofitted to a appropriate energy standard

Can apply to new construction, acquisition of an existing building, or refinancing of an existing building

SBA 504 Green Loans Pros & Cons

Cons: Only applies to business owners who operate in their own

facility and occupy at least 51% of the total building (the remaining 49% can be rented).

Requires strong credit and a documented track record of the operating company

Requires working with a conventional bank and a CDC (i.e. SBA Lender) that really understand the program.

Summary: An incredible program if your business and financial situation

matches the criteria of the program.

Some Final Thoughts:

There is no “One Solution Fits All” answer to reducing your energy costs and needs. Every building & every owner has their own unique set of needs & goals

Do your homework, work with qualified professionals Work with metrics you understand

Avoid first generation “Latest & Greatest” technology

Respect “single source vendors”, but take them with a grain of

salt. After all, they have a hammer

Some Final Thoughts:

You don’t have to be a tree hugger to embrace energy retrofitting, it just makes economic sense!

DO IT FOR THE DOLLARS, but know that you just might be doing others some good in the process

It’s Question & Answer Time

“Mr. Geer, may I be excused, my brain is full”

On behalf of the SDG&E Energy Innovation Center, the California Center for Sustainable Energy and myself,

THANK YOU FOR ATTENDING

May the Force and Lower Energy Bills Be with You!