Increasing Commercial Real Estate Returns With Energy Risk Management
Jerry Jackson, Ph.D.
Pesident, Jackson Associates
Texas A&M University
College Station, Texas 979-204-7821
About the Author
Jerry Jackson is an energy economist, author,Texas A&M University professor and president of Jackson Associates with over thirty years experience addressing energy industry issues. He recently authored Energy Budgets at Risk (EBaR)®: A Risk Management Approach to Energy Purchase and Efficiency Choice (John Wiley and Sons, April 2008) which shows organizations how to apply financial risk management principles to identify profitable energy efficiency investments. He is also president of the consulting firm, Jackson Associates. His consulting clients include more than 20 Fortune 500 companies, state energy agencies, the Department of Energy, and national research laboratories. He holds a Ph.D. in economics from the University of Florida. Additional information is available at http://www.energybudgetsatrisk.com/jj.htm.
Introduction
While oil prices have fallen dramatically, natural gas and electricity prices have only moderated slightly in the last year. Figure 1, below shows commercial sector energy price increases of 30, 36 and 128 percent from 2003 to the end of 2008 for electricity natural gas and fuel oil respectively. These price are unlikely to moderate much further because the price of coal, the primary electric generating fuel, remains high and natural gas prices tend to be regional markets impacted less by swings in oil prices. Figure 1. Energy Price Increases, 2003-2008alue at Risk (VaR)
Many large retail and office-building owners are paying $300,000 or more in increased electric and natural gas costs compared to for common areas compared to five years ago. In addition to reducing net operating income, these increased costs reduce the market value of real estate. With a market capitalization factor of 8, a building owner paying an extra $300,000 in energy costs is also losing $2.4 million in capital value of the real estate. These calculations become even more important as the recession increases vacancy rates and puts downward pressure on rents.
Energy cost histories of commercial space are also increasingly a consideration in lease negotiations. Energy costs of leased space, regardless of whether directly billed to the tenant through submetering, included in the rent or included as an add-on energy charge, will become more important as more energy-efficient new construction is added to the market.
Increasing emphasis on sustainability and carbon emissions will undoubtedly increase the focus on building energy use, especially as an Obama administration carbon policy is articulated.
Real estate owners have traditionally been reluctant to invest in energy efficiency. Alternative investment priorities and uncertainties concerning returns to efficiency investments generally require investments to provide paybacks of a year or less to qualify for serious consideration.
However, building owners can apply energy risk management to identify efficiency investments that reduce energy costs by more than the cost of financing the investments, providing increased cash flows and market value. Appropriate energy efficiency investments have the same bottom-line impact as increased rent revenues.
Estimates of cost-effective energy savings potentials are 30 to 40 percent or more of current energy costs in most commercial real estate. A risk management analysis provides the tools to identify which investments are most profitable and the associated risk. Rather than screening efficiency investments with a “one-size-fits-all” payback requirement designed to filter out all but “sure thing” investments, risk management analysis permits owners to consider efficiency investments with a strategy more consistent with risk considerations applied to other investments.
This paper describes Energy Budgets at Risk (EBaR)® , a facility energy-efficiency investment risk management analysis system developed by the author that provides internal rate of return and net savings (savings after subtracting amortized costs of the investment) of individual efficiency investments at alternative confidence levels that can be matched to each organization’s risk tolerance. Impacts on energy budgets and expected budget variances are also provided.
EBaR analysis is demonstrated with a case study application to an Austin, Texas office building described in more detail in Energy Budgets at Risk (EbaR)®: A Risk Management Approach to Energy Purchase and Efficiency Choice (Jackson, 2008).