Building Value Through Energy Efficiency
If you’re selling efficiency solutions in the built environment, you may find yourself being asked by your prospects, “Will this energy efficiency upgrade increase the value of my building?” This can be a difficult question to answer because it varies from situation to situation. The first thing you should do is determine whether you’re dealing with an owner-occupied building or a non-owner-occupied building.
In an owner-occupied building, there are at least two ways to connect enhanced energy efficiency to increased value. The first approach relates to the value of the real estate itself. If an appraiser notices that the building has been outfitted with state-of-the-art energy-efficient equipment, he/she should assign the building a higher value per square foot. Those improvements insulate the purchaser from deferred maintenance, technological obsolescence, future regulatory imperatives, occupant comfort issues, and similar concerns. The “cost approach” to appraisal should consider the quality of the installed systems. Moreover, the “market comparison approach” to appraisal should give the appraiser ample justification for adjusting the value per square foot higher when recently sold similar properties are used for comparison.
The other way to connect the dots between enhanced efficiency and higher value focuses on enterprise value rather than the real estate itself. Let’s assume you’re a publicly traded company whose stock price is conditioned on earnings per share and the price-to-earnings ratio that the market has presently assigned to the company based on a variety of factors beyond the scope of this blog. If energy efficiency lowers operating expenses, earnings increase…which means earnings per share increase…which means (at a stable P/E ratio) the share price increases…which means (at a constant number of shares outstanding) the market capitalization of the enterprise increases. Admittedly a lot of dots to connect; however, the positive correlation between enhanced efficiency and higher enterprise value can be described… and this analysis doesn’t even consider the earnings increase an enterprise may enjoy as a function of the non-utility-cost financial savings (e.g., productivity benefits resulting from improved thermal comfort, indoor air quality, etc.).
In income-producing buildings, connecting efficiency solutions to improved building value is a whole lot easier. The appraiser will be focused on a number called “net operating income,” abbreviated as “NOI.” When the appraiser feels comfortable with that number, he or she is going to divide it by a market-considered capitalization rate. The higher the NOI, the higher the value of the building, assuming a stable cap rate. Perhaps you secured that higher net operating income by raising the rent (because the building is now more comfortable or the tenant’s operating expenses are reduced). Perhaps the building enjoys higher occupancy (because the building is now more attractive to occupy, or more people renewed their leases). Perhaps you reduced the landlord’s share of operating expenses. As long as the NOI is higher, the appraisal should reflect a higher value at a stable cap rate. That's what you need to do: increase NOI before the appraiser evaluates it. You needn’t worry about whether the appraiser has the technical background to recognize a magnetic bearing chiller or variable frequency drives or whatever your efficiency enhancement(s) might have been.
Keep all of the above in mind and you’ll be better prepared to demonstrate how your efficiency solution might generate higher property value and/or enterprise value.
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