Analyzing capital allocation for energy efficiency improvements by commercial real estate investment managers

Abstract

Numerous studies have shown that retrofitting an office building with energy efficiency improvements can significantly reduce operating costs, yet many existing office buildings have not been retrofitted. The objective of this paper was to explore the incentives and motivations of various parties throughout the real estate management chain to better understand why investments in energy efficiency are not more prevalent. The paper focuses on investor-owned multi-tenant office properties. The authors explored the question from a qualitative and quantitative methodology. The qualitative study consisted of interviews with key players in the real estate management chain including property managers, asset managers, portfolio managers, and institutional owners. The quantitative study consisted of a financial model to compare competing alternative capital investments. The competing investments consisted of a cosmetic improvement which was modeled to either increase rents or decrease leasing costs and an energy efficiency improvement which was modeled to decrease utility costs. Multiple permutations were tested in each scenario in order to gauge the sensitivity of returns in each scenario. Both methods were designed to understand how industry participants allocated capital to energy efficiency improvements. The study determined that financial considerations are the primary drivers behind real estate investment decisions. Secondary factors that drive investments in energy efficiency improvements include fostering a positive public image, winning new business, and focusing on environmental responsibility.

(cont.) Recommendations to increase investment in energy efficiency conclude the paper. Increased investment in energy efficiency will result if managers recognize that energy efficiency projects can decrease the volatility of returns, and that these returns are maximized by making the investment in energy efficiency prior to significant lease rollover.