Project on Energy Efficiency and Property Valuation

1. Project on Energy Efficiency and Property Valuation Institute for Market Transformation (IMT) under contract to the New York State Energy Research and Development Authority (NYSERDA) December 18, 2002

2. Scope Project addresses commercial and multifamily residential sectors Commercial work will conclude December 2002; Multifamily residential work will continue through 2003. Project targets appraisers and lenders in New York Energy $martSM program territory

3. Objectives Educate appraisers on why and how to recognize energy costs as a factor affecting asset value in commercial buildings Thereby, strengthen market recognition of the value of energy efficiency

4. Returns on energy-efficiency investment Energy efficiency pays back initial investment gradually over measure lifetime Return on investment takes the form of avoided costs and non-energy benefits Many in real estate market favor immediate cash returns and low first costs Therefore, deferred, gradual, and indirect nature of payback is a market barrier

5. Energy efficiency and asset value Simple, widely used valuation approaches suggest that energy efficiency should lead directly to increased asset value Incremental asset value can mean more cash in owner’s pocket right away, through sale or mortgage financing

6. Appraised value as a function of net operating income The income capitalization approach treats the building as a source of income.Annual expected gross revenue $ 300,000Less operating expenses - 75,000Net operating income (NOI) $ 225,000Capitalization rate (Ro) 0.10VALUE (NOI/ Ro) $ 2,250,000

7. Energy’s effect on value $50,000 upgrade, 5-year simple payback.Annual expected gross revenue $ 300,000Less operating expenses - 75,000 65,000Net operating income (NOI) $ 225,000 235,000Capitalization rate (Ro) 0.10VALUE (NOI/ Ro) $ 2,250,000 2,350,000 $100,000 net increase in calculated building value

8. Energy costs are typically 10% to 25% of NOI the largest operating expense Energy costs are not just large, they’re variable Average Shares of Total Operating Cost, Downtown NYC, 1998 Energy makes a real difference in NOI

9. Appraisers often ignore the influence of energy Dismissal of energy’s importance Lack of information Lack of expertise Mistrust of data provided by owner Lack of client mandate

10. “Our job is to read the market, not to set it” Most appraisers are careful not to assign value without supporting data on market preferences in the absence of known market preferences for energy efficiency, some appraisers may be reluctant to assign incremental value even if cash flow effects are significant

11. Result: Appraisals often fail to recognize efficiency Appraisers commonly default to known averages or rules of thumb for determining energy costs As a result, energy efficiency and energy costs are treated as the same across buildings, even when they differ

12. Steps toward a solution Raise awareness of energy’s importance Educate appraisers about specific tools and approaches Conduct supporting research

13. Appraisers’ role is limited Buyers and investors ultimately determine value and make financial decisions Appraisers often work under specific instructions from lenders Lenders have ultimate discretion in financing decisions, notwithstanding appraisal results

14. Appraisers are a well-defined constituency Unlike lenders and owners, appraisers must be licensed Maintaining licensure requires continuing-education credits Appraisers also must comply with Uniform Standards of Professional Appraisal Practice (USPAP)

16. Project tasks 1. Initial survey of energy-related practices and priorities 2. Adaptation of energy-reporting guidelines 3. Promotion of enhanced energy reporting guidelines 4. Case studies of energy’s effect on value 5. Promoting linkages between energy-performance benchmarking and valuation 6. Outreach to lenders 7. Research on certification for commercial-building energy raters 8. Continuing-education seminars 9. Final market assessment

17. Task 1: Initial Market Survey Objectives confirm or refute our original hypotheses identify priorities for educational outreach define baseline conditions for future program evaluation identify possible partners for project activity Work included questionnaire, focus-group discussions (Albany and NYC), and interviews

18. Task 1, cont’d. Initial Market Survey Notable results Income-capitalization and sales comparison approaches viewed as virtually equally important Importance of energy ranked higher by appraisers in NYC and other urban areas Among proposed programs and tools, greatest interest in database on energy costs, then guidelines and continuing-ed

19. Task 2: Energy-Reporting Guidelines Small revisions and updates from previous version developed for CA the importance of energy methods for assessing energy performance energy-related benchmarking verification of owner claims Addition of a brief technical appendix This document later formed the basis of our continuing-ed curriculum

20. Task 3: Promotion of Enhanced Energy Reporting Focus on winning institutional endorsement of new energy reporting procedures Participation in national conferences of three major professional societies of appraisers Web-based dissemination

21. Task 3, cont’d. Promotion of Enhanced Energy Reporting

22. Task 3, cont’d. Promotion of Enhanced Energy Reporting Exploring possible inclusion of energy-reporting requirements in USPAP Staff and national committee members indicate that standards are for more general ethical and procedural issues, and that energy is too specific. Separate dissemination of voluntary guidelines preferred

23. Task 4: Case Studies NYSERDA building purchase Bank appraiser: building was treated as tenant-occupied (fixed energy costs for owner) though NYSERDA owns and occupies it Therefore, any cash-flow effect would have to show up as increased rents in appraisal calculation But appraiser would probably require actual rentals or other hard evidence of tenant willingness-to-pay Thus, appraisal shows no energy-related effect

24. Task 4, cont’d. Case Studies Bankruptcy auction of Telergy Building (DeWitt, NY) Energy analysis revealed tenant-specific electric loads; normalization of bills led to $1.2 million increase in appraised value (from $4.3 million to $5.5 million)

25. Task 5: Energy-Performance Benchmarking and Property Valuation Appraisers use “comps” (comparisons to similar buildings) to estimate overall value or individual elements of cash flow Initial survey showed more interest in databases of energy costs than any other tool or training Project sought to inform appraisers about existing benchmarking tools, and to inform tool developers about appraisers’ needs

26. EPA Energy Star Benchmarking Tool and Building Label Portfolio Manager CBECS database and query tool ORNL benchmarking tool DOE Roadmap: performance metrics Various tools from private sector Task 5, cont’d. Energy-Performance Benchmarking and Property Valuation

27. Task 6: Outreach to Lenders Initial goal: pilot projects demonstrating how energy-cognizant appraisal can affect financing Shift in focus to direct educational outreach to lenders Pamphlet on energy-related value and financing New York Bankers Association: teleconference seminar in January 2003 Energy $martSM Loan Fund participant survey

28. Task 7: Research on Certification for Commercial-Building Energy Raters Does energy-related value and financing for commercial buildings depend on the credibility of the source of the energy performance data? Initial survey data indicate that appraisers place low priority on certification of energy assessors Unlike residential sector, commercial mortgages are not sold widely on secondary market; therefore no standard requirements Commercial building stock is diverse, not amenable to robust rating systems

29. Task 8: Continuing Education 7-hour course on energy issues in property valuation Accreditation, delivery via established continuing-ed channels

30. Task 8, cont’d. Four seminars through Manfred Real Estate Learning Center Two in Kingston, two in Albany 90 attendees, including residential appraisers and brokers Case studies added by Walter Kresge

31. Task 8, cont’d. Continuing Education Additional seminar scheduled for NYU Real Estate Institute in October 2002, rescheduled to April 2003 Seminars also planned for Albany, Buffalo and Syracuse in first half of 2003 We hope that courses will become self-sustaining, either as full-day courses or as modules within existing courses

32. Task 9: Final Market Assessment Survey questionnaire via mail, parallel to initial one Separate phone interviews with seminar attendees ongoing MRELC administered its own questionnaires at end of seminars

33. Task 9, cont’d. Survey results Importance of energy ranked significantly higher than in initial survey scale of 1 to 7, new mean = 5.22, old mean = 4.82; ? = 0.05 Significantly greater fraction would recognize Energy Star Label or rating as factor affecting value 28/100 in December 2002, 12/110 in October 1999, ?2 probability = 0.005

34. Task 9, cont’d. Survey results 12 of 101 have encountered the Energy Star Building Label and/or rating in their commercial appraisals 10 more have encountered other energy tools and resources

35. Task 9, cont’d. Findings from seminar participants Generally high ratings, widespread desire for more residential content, case studies Particular interest in audiovisuals, tours of real buildings, etc. Most phone interviewees took the course just for credits, not from particular interest in energy — “mad dash for hours” Not enough data yet to gauge seminar’s effects on participant behavior

37. Summary of key outcomes Delivery of the first accredited continuing-ed seminars on energy in New York State 90 attendees, with numbers to increase through seminars already in pipeline Seminars may persist even after NYSERDA/IMT involvement ends Some indications of greater awareness and priority on energy reporting among appraisers

38. Summary of key outcomes, cont’d. Various new energy-related tools available for appraisers and other interested stakeholders Some new insight from case studies, surveys, interviews, etc. Generally, widespread interest and familiarity in energy-efficiency community with concept of energy linkages with asset value

39. Summary of unmet expectations Ineffective dissemination via Web Energy-related content is not appropriate for USPAP Partnerships with lenders and owners for case studies were very difficult to build Partnerships with continuing-education agencies fruitful, but unpredictable and prone to long delay

40. Opportunities for further work Development of energy-cost databases Continuing-ed in New York and other states Outreach to lenders Promotional efforts among owners synergy with a wide range of energy-efficiency and market-transformation programs

41. Acknowledgments Bob Sauchelli, Stuart Brodsky, Jean Lupinacci, U.S. EPA Deb Cloutier, Real Estate Technologies Group Walter Kresge, Albright-Kresge Bill Manfred, MRELC Robert Morgenstern, NYU Jerry Inda, Appraisal Institute Elisa Legg, NYBA Ian Shapiro, Taitem Engineering Greg Thomas and Mark Lorentzen, PSD Roman Kuchera, M&T Bank; Rick Baker, HSBC

42. Many thanks to NYSERDA staff Karen Auricchio, Todd Baldyga, Matt Brown, Michael Colgrove, Peter Douglas, Jennifer Ellefsen, Andrew Fisk, Pat Fitzgerald, Cindy Harrat, Ruth Horton, Kevin Hunt, Craig Kneeland, Jeff Pitkin, Priscilla Richards, Pete Savio, Rachel Winters SPECIAL THANKS to Laurie Kokkinides!

43. Contact Information Mark Chao Senior Program Director P.O. Box 3914 Ithaca, NY 14852 Phone 607-257-3348 Cliff Majersik Program Director 1616 P St. NW, Suite 612 Washington DC 20036 Phone 202-328-5149 Fax 928-447-6691