Energy performance in commercial property: research and practice challenges

Citation

Dixon, P.T. and Mallaburn, P.S.B.a.D.P. (2014), "Energy performance in commercial property: research and practice challenges", Journal of Property Investment & Finance, Vol. 32 No. 4. https://doi.org/10.1108/JPIF-04-2014-0021

Energy performance in commercial property: research and practice challenges

Article Type: Guest editorial From: Journal of Property Investment & Finance, Volume 32, Issue 4

Background

Commercial property (which includes retail, offices and industrial space) plays a vital economic role in the UK economy but the sector also has a substantial environmental impact. Commercial property produces 10 per cent of the UK's greenhouse gas emissions and consumes 7 per cent of UK energy, but there is an increasing concern that the rate of progress in tacking energy inefficiency in existing commercial stock is too slow (Dixon et al., 2014).

In the UK, recent work by the Westminster Sustainable Forum/Carbon Connect (2013) suggested that, despite rising energy costs and the potential cost-savings involved, many businesses continue to fail to recognise the strategic value of energy efficiency, and that there are a number of internal barriers to take-up that must be overcome, not least the fact that energy efficiency projects often have to compete with what are considered to be more “important” capital investment projects inside an organisation. Other internal barriers may also include a lack of strategic leadership and skills and understanding inside the organisation or poor communication across departments or costs centres internally. We also need to recognise the importance of SMEs or smaller organisations in this sector, for who many of these internal barriers may prove difficult, if not impossible, to overcome.

There are also other important barriers inhibiting progress in the sector: the investment costs of new technology are high compared to energy savings; market failures can be created by “split incentives” (i.e. the pattern of leases by which tenants pay energy bills, but landlords control the properties); restrictive wording in leases, particularly in relation to improvements and recovery of costs through services charges; the short-term nature of the majority of commercial leases (meaning that tenants have no financial incentive to invest in energy-saving equipment as the pay-back periods frequently exceed tenants’ interests); organisational inconsistencies, with differing parts of an organisation placing different values on rates of return used to assess financial viability; and poor communication between landlord and tenant communities (Langley and Stevenson, 2007; HM Treasury, 2005; Carbon Trust, 2009; Dixon et al., 2009).

Despite this, recent research has shown an emerging and increasing demand for sustainable buildings by corporate occupiers (Dixon et al., 2009; Pellegrini-Masini and Leishman, 2011; Levy and Peterson, 2013) and there are similar findings from both the USA and Australia (Newell, 2008; Eichholtz et al., 2009). This is being driven not only by legislation (in the UK, e.g., the Carbon Reduction Commitment and the Energy Act) but also by the perceived cost advantages that more energy-efficient commercial property can offer tenants and the apparent potential for increased rentals for landlords from green or sustainable buildings (see, e.g. Kats, 2003; Dixon et al., 2009; Eichholtz et al., 2009; Fuerst and McAllister, 2011). This has also been underpinned by changes in corporate attitudes towards environmental issues and sustainability, with many companies now recognising the commercial benefits of sustainable business practices and processes. This has been characterised by leading companies competing to be seen as “the greenest” in response to legislation aimed at reducing carbon footprints, increased public pressure, the development of new business opportunities and the shift towards greater corporate accountability. This is also because many companies have recognised the benefits of “going green”, driven by the desire to highlight corporate social responsibility credentials (Nelson, 2008; Pivo, 2008; Axon et al., 2012).

Set against this backdrop we have seen the emergence of two key themes in research and practice, which are highlighted in a number of papers in this special issue.

First, a large amount of corporate and academic research has attempted to answer the “holy grail” question: can the business case for green buildings be proved, and if so what are the real market and rental value impacts? Moreover, are such buildings more attractive to tenants and occupiers? Are employees occupying greener buildings more productive? (World Green Building Council, 2013). This is not unique to the UK: research from the USA, Europe, Australia and elsewhere has attempted to prove this. But often the research focus has (in relative terms) been on new build rather than existing buildings, whereas the act of undertaking “energy efficiency projects” at least suggests a more specific context of retrofit (or refurbishment) of some kind as applied to older buildings which are already occupied (Dixon et al., 2014).

Of course there may also be a cost premium associated with energy efficiency projects. Research by Cyril Sweet (IPF, 2012) showed that on average the cost premium for a retrofit with “enhanced energy efficiency improvements” was in the range of 0.3-40.0 per cent more than the “market standard” counterpart, with the highest premium associated with an Energy Performance Certificate (EPC) rating improvement from an E to a B. As regards value, much of the evidence that has emerged from US LEED-based studies has shown that green buildings do tend to have higher asset values than their conventional counterparts (see Fuerst and McAllister (2011), for example). This translates into higher sale prices which may also be related to higher rental/lease rates; lower operating costs; higher occupancy rates and lower yields (World Green Building Council, 2013). Other studies have showed varying results, which are often dependent on available data and inbuilt model assumptions (Chegut et al., 2014).

Second, we have seen the emergence of a range of toolkits and pan-industry guidance designed to help shape, inform and “mainstream” the rollout of solutions to the barriers identified above. For example, pan-industry “influencer” groups in the UK such as Better Buildings Partnership and UK Green Building Council have carried out a lot of work around identifying solutions, often in the form of “best practice” or “toolkits”, which have promoted low-carbon buildings or green leases, for example, as ways of overcoming conservatism in the sector or, more specifically, the split incentive issue (Dixon et al., 2014). Alongside this we have also seen financial innovation to fund energy efficiency projects with such devices as “energy performance contracts” (EnPC).

Research and practice challenges

The focus on the two themes outlined above raises research and practice challenges for the property industry and the valuation profession. These challenges revolve around three key areas.

Data availability and valuation practice

More and better data is needed to enable us to not only assess the actual energy performance of commercial buildings, but also improved building level data on age, type and refurbishment details of individual buildings. We also need better data to enable us to assess the real contribution of certification and energy labelling on building value at a range of certification measures, and how this plays out in arriving at value. Of course, as the RICS (2013) Guidance on Commercial Property and Sustainability points out, valuers cannot “lead” markets, rather they should “reflect” them, but they should also be aware of sustainability features and the implications these could have on property value in the short, medium and longer term. Better and more transparent data in the UK and internationally would help underpin the research that is needed to understand value impacts. Perhaps there are signs of a sea change in the UK with potential DECC data on non-domestic energy use starting to take off, and with Valuation Office data becoming more “open access” in nature.

Understanding emerging practices: EnPC and green leases

If we are to understand how to help shape a more sustainable future for commercial property, we need to understand how organisations behave and how they take decisions on the funding and leasing arrangements which underpin energy efficiency projects. The emergence of EnPC is a case in point. EnPC is a form of financing for capital improvement which enables energy upgrades to be undertaken through cost savings. Under an EnPC, an external energy services company (ESCO) undertakes an energy efficiency or renewables-based project for a client, and the stream of income from the costs savings or the renewable energy produced, is used to repay the costs of the project, including the costs of investment (European Commission, 2013). EnPC offers an alternative to service charge financing or secured borrowing and the RE:FIT scheme in London is an example of a guaranteed EnPC. The purpose of RE:FIT, which is currently run by the Greater London Authority, is to assist public bodies in London to significantly reduce carbon emissions from their buildings which will help London achieve its overall target of cutting carbon emissions by 60 per cent by 2025 (as set out in the Mayor's draft Climate Climate Change Mitigation and Energy Strategy) (Dixon et al., 2014).

Another way of facilitating capital improvement is by altering standard lease clauses to enable landlords to recover the costs of capital works through a special amortisation charge applied to the rent. Subject to the improvement not causing an increase in the tenant's overall outgoings, the landlord can carry out a green improvement after a consultation period. The Australian property company, Investa, has been using a lease clause along these lines for a few years (Bright and Roussac, 2012), and PlaNYC (2011) has developed model lease language in the form of the Energy Aligned Lease that works in a similar fashion. These types of clauses address the “split-incentive” problem, but they are not common and are not found in UK leases. One of the challenges with retrofit in leased buildings is that the lease language constraints what can and cannot be done, and generally takes no account of the potential need for alterations that promote better energy efficiency. There are a number of ways in which the language of leases can be altered so as to enable energy efficient projects to be carried out in tenanted properties. Although there is still not a large take up “green leases” that acknowledge that landlord and tenant may have the shared goal of improving the environmental sustainability of the property, some of the larger property companies are beginning to adopt them. Typically these leases will make involve some level of commitment, even if only in “good faith”, to agree some form of environmental management plan, and may allow the landlord (or tenant) to make alterations to the property with the goal of improvement in environmental performance (Bright and Dixie, 2014).

Learning from international best practice

Often in the case of green buildings and related energy efficiency we can draw on successes from other jurisdictions. The National Australian Built Environment Rating System (NABERS, 2014) scheme, which measures environmental performance of buildings, is a prime example of this. NABERS started as a voluntary scheme in 2000 in New South Wales, going nationwide in 2008. It used a five-star rating, with best practice set at 4.5 stars and median performance at 2.5 stars. Market impact was tracked so that the scheme could be adjusted to reflect changing market conditions and correct problems. NABERS was designed to focus on rewarding the best performers, with the worst buildings getting no attention. In 2004 the government introduced minimum procurement standards for the public estate, and industry standards began to be linked to NABERS, with the influential Property Council of Australia “A” asset grade requiring a NABERS rating of four stars or better. As take up accelerated still further, industry support grew. Government was then able to change the emphasis of the scheme so that it began to drive the market rather than simply reflecting it. This, in time, enabled a relatively smooth introduction of mandatory performance disclosure to address the bottom end of the market.

NABERS is now part of the mandatory Commercial Building Disclosure programme. NABERS rated buildings now cover 60 per cent of the Australian office stock (14.5 million m2), and the programme has been so successful in transforming the market that another star has had to be added to segment the very top of the performance range. The UK and other countries can learn from this experience given that Display Energy Certificates are not mandatory in UK commercial property.

Special issue

In the first paper of this special issue Jeremy Gabe's paper uses a unique data set drawn from lease contracts on office space in central Sydney, Australia to test the hypothesis that tenants pay increased accommodation costs for space in energy-efficient office property. The paper concludes that no significant price differentials emerged as a function of energy performance, or, in other words, that tenants are not willing to pay for energy efficiency. Tenants are likely indifferent to energy costs because the author demonstrates that energy efficiency lacks financial salience and legal obligation in Sydney. This means that split incentives between owner and tenant are not a substantial barrier to energy efficiency investment in this market.

Graeme Newell's paper also analyses office data, but focuses on a larger data set for Australia. Using a portfolio of over 200 green office buildings benchmarked against a comparable portfolio of non-green office buildings, the level of energy rating premiums in the property performance of green office buildings in Australia is empirically evaluated. This paper is the first published property research analysis on the detailed determination of energy rating premiums across the energy rating spectrum for green office buildings in Australia. In contrast to Gabe's findings, Newell shows that energy rating premiums for green office buildings are evident at the top energy ratings and energy rating discounts at the lower energy ratings. The added value “top-end” premium of the five-star vs four-star NABERS energy rating category is clearly identified for the various property performance parameters, including office values and rents.

Continuing the international flavour of the special issue, Pan Lee's paper investigates the current market development of EnPC in Hong Kong and Taiwan. This study identifies market-related motivators and deterrents as experienced by ESCOs in implementing EPC projects in two developed Asian economies.

John Morrisey's paper investigates the functioning of value creating configurations and stakeholder interactions in networks of organisations of the retrofit industry for commercial buildings. The research uses a value approach to develop a model of retrofit activities and finds that the sustainability of energy efficiency retrofit processes is as important as the sustainability of project outcomes. Understanding value creation in retrofit processes is therefore crucial to successfully harnessing the available energy-savings potential from the built environment.

Richard Greenough's paper identifies the factors present in successful energy efficiency investments that might indicate how to resolve the landlord-tenant dilemma in existing and new commercial property. Using a case study approach (a UK University and a construction company) Greenough's paper explores the nature of landlord-tenant relationships and the importance of policy and standards of building performance. Interestingly, in neither case did landlord-tenant issues constitute barriers to investments in energy efficiency, and the difficulties of implementing the Green Deal in the sector are highlighted in the paper.

Kathryn Janda's paper looks at an under-researched area, namely SMEs, in a wider group of non-domestic properties. Based on survey work the paper develops a new segmentation model that identifies six different combinations of energy and organisational conditions. SMEs and other minor players are generally data poor, lack energy managers and have legacy metres that are read only annually or quarterly; some rent via leases that inhibit permanent alterations to the premises, including the metre. This paper presents a new conceptual framework for future research and new empirical data on understudied groups.

Finally, Tim Dixon's practice paper suggests provides a definition of “retrofit”, and compares and contrasts this with “refurbishment” and “renovation” in an international context. The paper summarises key findings from recent research and suggests, drawing on international practice (including NABERS) that there are a number of policy and practice measures which need to be implemented in the UK for commercial retrofitting to succeed at scale. These include improved funding vehicles for retrofit; better transparency in actual energy performance; and consistency in measurement, verification and assessment standards. The paper suggests that policy and practice in the UK needs to change if large-scale commercial property retrofit is to be rolled out successfully. This requires mandatory legislation underpinned by incentives and penalties for non-compliance.

Conclusions

Taken as a whole, this special issue highlights a number of important issues.

First, we need to have a clear understanding of retrofit and what it encompasses, and this is important because of the value implications of different types of retrofit and refurbishment and renovation and their understanding nationally and internationally.

Second, available data sets and assumptions in modelling can impact on findings and can create differences in end results. It is therefore important to ensure that in all studies we have a clear sense of the way in which models have been constructed and their limitations. Further work is needed in the commercial property sector to enable the transferability of methodologies so that improved consistency in approach can be obtained in analysing value impacts.

Third, further research work is needed on emerging financial models, such as EnPC, which underpin energy efficiency projects, so that we can understand better how to scale up our response to commercial property energy efficiency projects.

Fourth, the sector contains a range of different organisations which vary in culture and engagement with energy efficiency. The importance of the SME sector should not be overlooked and we need to have a much clearer focus on understanding organisational and behavioural change, and how this is influenced and shaped by legislation and other factors.

In conclusion, it is fair to say that over the past 40 years, the poor uptake of energy retrofit technologies has resulted in both an “energy efficiency gap” and an “energy performance gap”, revolving around how buildings perform in “theory” and in “practice”. Examining the reasons for this and helping understand how the sector can change is vital. So, in understanding energy efficiency projects in commercial property, we will need to bring together a range of different disciplines to analyse the complex inter-relationships between technology, economics, value, legal issues and behaviour that exist in this arena. Only in this way we will be able to help inform the debate, and create a more reflexive, proactive and problem-oriented response in the sector.

Professor Tim Dixon
School of Construction Management and Engineering, University of Reading, Reading, UK
Professor Susan Bright
Oxford University, Oxford, UK
Dr Peter Mallaburn
Institute of Energy and Sustainable Development, De Montfort University, Leicester, UK

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