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The Power of SIR

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When I teach I almost always reserve a section for financial metrics.  One of the most overlooked metrics is my favorite one to use: savings-to-investment ratio or SIR.  It’s also one of the most effective to use if you frame it the right way. 

Let’s say you’re in a meeting, and you know what the savings-to-investment ratio (SIR) of your proposed project is before you start talking.  Let’s say it’s something generous, like 5:1.  You say, “Just out of curiosity: if I offered you an investment with reasonable certainty that you would make $5 for every dollar you invested today, would you want to know more?” 

A prospect would have to be crazy to turn that down.  After that it’s about showing them your financial analysis and the numbers to back it up.  In fact, you might as well be telling them your project is like an ATM that will give them $5 for every dollar they put in!  How many dollars would you put into that machine?  Probably every dollar you could get your hands on, right? 

This metric is essential when it comes to illustrating savings, but it’s often left out of major decisions.  One of our students is so fond of the metric, she wrote it on a Post-It note and stuck it to the front of her proposal so it wouldn’t be missed.  Her company’s standard proposal template didn’t include SIR, so she went the extra mile to make sure that very compelling ratio would be seen.  

The same could be said for many meetings and proposals.  If it’s a tool you can use, find a way to insert it into the discussion. 

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Tax Implications, Part 2

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Yesterday, we talked about tax deductions, tax credits, marginal tax rates, and effective tax rates. Today, we’re going to continue the discussion with a look at before- and after-tax returns.

You have to be very careful about combining before-tax and after-tax returns in your financial summary. People combine these two concepts all the time – probably unwittingly. Unfortunately, doing so can tarnish an otherwise accurate financial summary. I touched on this topic briefly in the “Calculating Costs” blog last week, and it warrants some further explanation.

Let’s assume you have a situation where a project is going to save your prospect $1,000 a year in utility bills and provide a depreciation deduction of $250. It’s not fair to say, “You’re going to get $1,000 PLUS a tax savings equal to your marginal tax rate times $250.” Why not? Because, assuming your prospect’s business deducts utilities on their tax return, they’re not saving $1,000 on an after-tax basis. They’re actually saving the after-tax value of that $1,000 expense. In other words, in the absence of your project, your prospect would continue to spend $1,000 on utilities, and assuming a 35% marginal tax bracket, they would be saving $350 in federal income tax as a result, which would mean that their after-tax utility expense would be $650.

If you were to take the before-tax savings of $1,000 and add the value of the depreciation tax shield (i.e., the $250 depreciation deduction times the marginal tax rate), you would be mixing before-tax and after-tax effects.

While we’re on the topic, whenever you’re deciding how to work this information into your financial summary, make sure that you don’t assume your prospect has a “tax appetite,” even if the organization is a taxable entity. What if they had a lackluster year and no taxable income? What if they had a bad year last year and have a net operating loss to carry forward? What if they purchased a lot of equipment this year and have a bundle of investment tax credits to use? In any of these scenarios (and many others), there may be little or no taxes owed, in which case there may be little or no incentive to secure additional tax deductions or credits.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Tax Implications, Part 1

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Over the course of the next two days, we’ll discuss taxes and tax incentives in the context of efficiency projects. I’ll concede that, of the topics we discuss on this blog, the “tax discussion” is not the most thrilling one; however, it’s important that you have a good understanding of the financial implications of taxes as they can have a significant impact on your ability to demonstrate value for your prospects. Please note that the purpose of this blog is not to give you tax advice; it’s to provide topics to be thinking about so when the time comes, you’ll be prepared to have a productive discussion with your prospects and customers.

First, let’s talk about the difference between a tax deduction and a tax credit. A tax deduction is a reduction of the income subject to tax. A tax credit is a sum deducted from the total amount a taxpayer owes to the government. A deduction and a credit are two very different things.

If you qualify for a $10,000 tax deduction as a result of something you did to your property, that’s worth $10,000 times your marginal tax rate. If you qualify for a $10,000 tax credit, it would be the equivalent of a gift certificate for $10,000 of taxes paid.

This brings us to the topic of marginal vs. effective tax rates. If your prospect is a taxable entity, you’ll want to have a clear understanding of the difference between marginal and effective tax rates so that you can properly estimate what the tax benefits of your proposed project might be.

The marginal tax rate is the rate that applies to the last (or next) unit of taxable income or spending. The effective tax rate is the rate that you pay on all of your income after all of your various tax brackets are taken into consideration.

So, if you receive a $10,000 tax deduction and your highest tax bracket is 35% (and you have at least $10,000 in taxable income in that bracket), the deduction would be worth $3,500. You would not multiply the deduction by your effective tax rate – you would multiply it by your marginal tax rate, because that’s the amount of tax the deduction is going to offset at that tax bracket.

Stay tuned for more on this topic tomorrow…

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Cap Ex Reserves

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Yesterday, we talked about the types of Profit & Loss benefits you might choose to discuss with your prospects. Today, we’ll delve into the concept of Cap Ex Reserves, a topic you should really understand when approaching an income-producing property with an efficiency project… especially one where the tenants presently pay the utility bills and would benefit from efficiency maneuvers. 

An income property owner who offers space for lease will inevitably need to address capital equipment failures from time to time. Most leases treat any expenses incurred to replace this capital equipment as the landlord’s responsibility, figuring that maintaining the infrastructure of the property is an inevitable “cost of doing business” when you earn your living renting space to others for a profit. Income properties typically maintain a Cap Ex Reserve account to handle these sorts of expenditures. 

Interestingly enough, if your prospect has Cap Ex Cost Recovery language in his or her lease (as discussed in the “Cap-Ex Cost Recovery” blog last month), it may be possible to replace that soon-to-fail equipment as part of an “energy efficiency” agenda before it actually stops working. That way, while your prospect might use Cap Ex Reserve dollars to purchase the replacement equipment, they could recoup that capital within a reasonable span of time by recapturing dollars that the tenants are presently squandering in unnecessarily high utility bills. Essentially, the landlord would assess the tenants for an amount (less than or) equal to the reduction those tenants are likely to see in their utility bills, essentially repurposing those utility savings so that they amortize the cost of the new equipment. In some cases, the lease even allows the landlord to charge a specified interest rate to cover the “carrying cost” of waiting for the principal to be fully reimbursed by the tenants. 

Years ago in New York City, former Mayor Bloomberg convened a large task force of developers to explore the opportunities for optimizing the use of this so-called Cap Ex Cost Recovery provision to accomplish energy-saving retrofits in tenant spaces in the middle of existing leases. They came up with a new arrangement called the Energy-Aligned Lease Clause. It said that if a landlord did an improvement that was projected to reduce operating expenses for the tenants, he/she could recover 80% of the projected savings in the form of additional rent and would pass the other 20% of the projected savings to the tenants. This approach would give the tenants a “buffer” equal to 20% of the projected savings in case the landlord’s engineers were overly sanguine about how much savings could be produced by the proposed retrofit. 

The advantage of doing this, of course, is that you make the tenants more willing to participate in this Cap Ex Cost Recovery exercise without overly elongating the landlord’s payback period. What would have otherwise been a four-year payback project might turn into a five-year payback project because the landlord is letting the tenants enjoy 20% of the savings. 

Still, if it increased tenant goodwill and allowed the landlord to execute capital improvements that would have otherwise hit their Cap Ex Reserve Account without any hope of reimbursement, it would certainly be worth doing.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials, prospecting | Read more

P&L Benefits

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Energy efficiency can affect many line items on a business’ Income Statement (also known as the “Profit and Loss Statement” or “P&L”). If you look at the full picture through the lens of business acumen, you’ll see how effective it can be to discuss the potential P&L benefits of your efficiency project with your prospects. The following list gives you an idea of the types of line items that you may choose to discuss: 

  • More sales: If you install attractive LED lighting in a grocery store, for example, the store will likely see an increase in grocery sales.
  • Less payroll: If your efficiency solution increases productivity (as we have discussed in previous blogs), employees may be able to do more work in less time.
  • Less repairs/maintenance: A new, high-efficiency product usually requires less maintenance than an old, soon-to-fail one.
  • Less scrap: You may recall a story I told about the aluminum windows and doors manufacturer that reduced scrap rate by 25%, effectively turning a 4.2-year payback (calculated using only the energy savings) into a 39-day payback (calculated using the aluminum scrap savings as well).
  • Lower utilities: Of course, your efficiency product will probably have a positive effect on the utility bill, so this one will be included in virtually every case.
  • Higher rental rates: With all of the added benefits of efficiency, your prospect may be able to increase rental rates without deterring potential tenants.
  • Better tenant retention: An efficient building is more comfortable, more attractive, and requires less maintenance. All of these factors help retain existing tenants who might otherwise choose to move to a building that features the high-end amenities you are offering to your prospect.
  • Better tenant attraction: As in the case above, an efficient building is more comfortable and attractive than an inefficient one. Add in an ENERGY STAR® or LEED® certification and you’ve got yourself a recipe for tenant attraction.
  • Less need for Cap Ex Reserves: This is a topic that warrants further discussion, so stay tuned for more on this tomorrow!

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials, prospecting | Read more

Calculating Savings

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Yesterday, we discussed the costs that should be included in your financial summary. Today, we’ll dive into the savings portion of the equation:

Utility tariff: Which utility tariff did you use to calculate the savings? I’m always surprised to see financial summaries that fail to take into consideration off-peak, on-peak, and critical-peak power pricing. In some territories, this is not as relevant since utilities there may charge the same amount per kilowatt-hour regardless of the time of day or year.  However, in many other regions (such as parts of California), you could see a difference of 10-to-1 (sometimes as high as 20-to-1!) between off-peak-power pricing and critical-peak-power pricing. You have to be really careful to take into consideration when exactly the savings you are projecting will occur and what the cost per kilowatt-hour will be at that particular time.

The start of the savings: When are the savings going to start for your prospect? If the implementation process is long, the savings may not start for many months – and this has an effect on the financial landscape of the project.

Interaction between the measures: If you're putting in a more efficient lighting system, that's one thing. However, what if you were to layer on lighting controls that decrease the time that those lights would be illuminated by 50%? You have to make sure that measure interactions are taken into account.

Savings: In keeping with yesterday’s blog on calculated costs, you need to consider who will be benefitting from the calculated savings. Is it the landlord? Is it the tenants? Is it both? The landlord and the tenants should both understand how the leases are written, what loads are connected to which meters, who pays for those meters, and ultimately, how the savings will be allocated after the retrofit.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Calculating Costs

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As I’m sure most of you know from reading this blog, compelling (and accurate) financial analysis is a key component in selling efficiency effectively. So what exactly is financial analysis? Most people would probably agree that it’s the accurate cost/benefit analysis of a proposed investment. Before you can have accuracy in this analysis, you have to actually ask yourself, “Where do the costs and the benefits come from?” Today, we’ll discuss the costs that should be included in the financial summary of any efficiency project.

Local labor and materials figures: Are you estimating the cost of labor and materials based on the national average or are you taking into consideration the actual costs based on the location of the project?

Prevailing wage considerations: If it’s a government job, did you remember to incorporate the proper assumptions regarding prevailing wage?

Demolition, recycling, and disposal costs: These are often overlooked in financial summaries. Don’t forget to include them, because they can have a significant impact on the cost of the project.

Soft costs: Did you remember to include any potential soft costs, such as architectural engineering and consulting fees?

Contingency: I've been in this business for over 30 years and I don’t think I can remember a time when a vendor included contingency in the financial summary. Why? Perhaps because they're worried about doing a limbo dance under the simple payback period “maximum threshold” that the customer told them about, and they don’t want to risk any cost increase. That really doesn't do any justice to the customer in the end, so be sure to disclose a contingency amount upfront.

Rebates and incentives: Rebates and incentives have a tendency to reduce first cost, so any savvy sales professional would be sure to include estimates for these in the analysis.

Tax benefits: Be sure to separate these from the rebates and incentives. Rebates and incentives can be before-tax or after-tax and so can tax benefits (think “tax deduction” versus “tax credit”). It bothers me when someone says, “You’re going to save a thousand dollars per year in energy bills, and in addition to that, you're going to get a five-hundred-dollar tax credit.” Think about that. If you save a thousand dollars in energy bills, assuming that you're a business and you can write that energy off as a cost, you’re really not saving that whole thousand dollars. Rather, on an after-tax basis you're saving a thousand dollars multiplied by “one minus your marginal tax rate.” So be careful how you present rebates, incentives, and tax benefits in your analysis.

Payment: Who is actually going to be paying for the first cost of the project? We talked about this in the blogs that addressed doing upgrades in landlord/tenant settings. It’s important for you to know who is paying and to demonstrate how this affects the project from a financial standpoint.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Cap-Ex Cost Recovery

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On Tuesday, we discussed the landlord/tenant dynamic and the metric to focus on when presenting an expense-reducing capital project to a landlord. Today, I’d like to delve into a bit of bonus landlord/tenant content that I cover in the weeklong Efficiency Sales Professional™ Certificate Boot Camp.

Here’s the question: Could the landlord use a “capital expense cost recovery” clause and have the tenants repurpose wasted utility dollars to help improve the building? The short answer is “in many cases, yes,” and in the next several paragraphs I’ll review this often-overlooked lease provision and how you might leverage it in your future efficiency projects.

The cap-ex cost recovery clause is something that most experienced real estate operators will know about. Many of them, however, are really financial engineers who authorize the capital to buy buildings. They may not have really read many of their leases cover to cover. They may not know that the ability to claw back savings that you generate for your tenant by investing in expense-reducing capital projects is usually hidden in a definition of operating expenses. It’s a provision that's not often called out in a separate section of the lease.

The lease will describe various categories of operating expenses that are customarily passed through: roads and grounds, housekeeping, security, repairs and maintenance, administration, utilities, etc. The description of operating expenses will typically prohibit the landlord from passing through capital expenses.

However, you may very well see that certain capital expenses CAN be passed through as long as they meet one of the following criteria:

  • The capital improvement is mandated by government regulation 
  • The capital improvement is motivated by life safety concerns 
  • There is a reasonable expectation that a capital improvement will generate operating expense savings for all tenants, in which case the landlord could pass the capital costs through to the tenants using a reasonable amortization schedule. 

The lease usually has some language as to whether or not they can charge carrying cost while the debt is being amortized. In some cases, the lease may also mention that the pace and magnitude of the savings that the capital expenditure(s) produce will determine the pace and magnitude of the tenant assessments.

If you don’t already sell to non-owner-occupied properties, I recommend you consider adding them to your list of potential targets. The last time I looked, the Department of Energy's Commercial Buildings Energy Consumption Survey (CBECS) estimated that 38 to 40 percent of the built environment in the office and retail sectors is non-owner-occupied real estate. That's a big slice of the market pie that certainly merits getting smart on how to best position your efficiency solutions in landlord/tenant settings.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

NOI Drivers

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Today, we’re going to discuss the metric that you should focus on when presenting an expense-reducing capital project to a landlord. 

For most landlords, one of largest controllable operating expenses is the utility bill. Payroll for the chief engineer, porter, doorman, and so forth may make up a portion of the landlord’s controllable operating expenses; however, these costs generally pale in comparison to the utility costs. 

Your task is to convince the landlord that a reduction in operating expenses for his or her building through energy savings will result in an overall increase in his or her Net Operating Income (NOI). NOI is the mother's milk of real estate investors. It's why they get up and put their pants and dresses on in the morning. 

In a case like this, there are three drivers of higher Net Operating Income: 

  • Higher rent
  • Lower vacancy/less tenant churn/better tenant retention or attraction
  • Lower landlord share of operating expenses 

If you want to sell energy efficiency effectively in the commercial real estate environment, you have to explore these drivers, determine which ones might have the greatest positive effect on your prospect’s NOI, and then make a credible connection between your offering and the driver you’re aiming to improve.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more

Shortcomings of Simple Payback Period

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It will come as no surprise to anyone who has experienced one of my efficiency-focused professional selling or financial analysis workshops that I recommend migrating the conversation away from Simple Payback Period (SPP) when discussing the merits of a proposed expense-reducing capital project. 

Payback period tells you how long it will take to recoup your first cost, and there are actually several varieties of that calculation, some better than others.  The most simple payback calculation doesn’t take into account time value of money or the potential for irregular cash flows over time, opting instead for an overly simplistic calculation that divides the first year savings into the first cost. 

Some practitioners recognize the shortcomings of using only the first-year cash flow in the denominator, so they calculate “cumulative payback” – how many years’ cash flows would you need to capture before totally recouping your first cost. 

The least inadequate payback period calculation uses a similar approach, except this time it uses discounted cash flows that take into account the fact that dollars are worth less the farther away from today they are received.  It’s called “discounted payback.”  Even this least offensive variety of payback is seriously lacking though.  For example, it says nothing about how long the investment will actually continue producing savings beyond the payback period, nor does it take into account the actual value of those additional cash flows. 

Another big problem with any of the above varieties of payback period is that most practitioners don’t remember to quantify and monetize the non-utility-cost financial benefits, opting instead to limit the calculation to the utility-cost financial benefits.

I remember hearing a story about a metal manufacturing shop that made aluminum windows and doors. They were interested in improving the lighting of the shop and the retrofit they were considering had a simple payback period of 4.2 years. (If you’ve ever tried to convince someone to approve a project with a payback period of more than four years, you know that this is not an easy task). After the lighting retrofit was completed, some enterprising foreman realized that the shop’s aluminum scrap rate was trending about 25% lower than usual!  Apparently, the higher lighting quality allowed their employees to see what they were cutting, screwing and drilling!  Once the value of the avoided metal scrap was added to utility cost savings, the payback of the investment was no longer 4.2 years – it was now 39 days! In this case, the non-utility-cost financial benefits (in the form of reduced scrap) far outweighed the utility cost benefits.

This little story offers no less than four take-aways:

  1. This is just one of many examples that demonstrate the importance of discovering, quantifying, and monetizing the non-utility-cost benefits… and the importance of working those non-utility-cost financial savings into any capital budgeting proposal. 
  2. Don’t be surprised if the non-utility-cost financial benefits are many times larger than the more obvious utility-cost financial benefits (like lower utility bills, rebates and incentives).
  3. The salesperson who sold the original job never would have known about this unanticipated benefit of decreased scrap had he not followed up with the customer after the installation to ensure that the job had gone smoothly.
  4. Once you know that unanticipated benefits have been realized by your customer, you need to capture those data points so that they can be related to your next prospect in a similar industry.

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By info@SellingEnergy.com (Mark Jewell, President of Selling Energy | www.SellingEnergy.com) | | financials | Read more
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