The due diligence process focuses on identifying building deficiencies and managing financial risk. A typical property condition assessment uncovers these deficiencies and includes capital reserves for building repairs and upgrades that can impact the negotiation process.
While identifying building deficiencies is a critical component of due diligence, evaluating building operations may reveal additional risks and opportunities that are not captured in the property condition assessment. Analyzing benchmarked utility data and underwriting low-cost operational improvements are two strategies that can reduce your client's financial risk and quickly increase net operating income and asset value.
to Manage Risk
20 to 35 percent of average annual operating costs, according to BOMA, utility
costs are the most variable operating expense for commercial office buildings
and can significantly impact NOI and asset value. While many benchmarking tools
exist, the Environmental Protection Agency’s Energy Star Portfolio Manager is the national standard with 40
percent of U.S. commercial building space benchmarked in the tool.
Manager is a no-cost, online program that rates building performance on a 1 to
100 scale and compares it with similar buildings across the country. An Energy
Star score of 50 represents the national average, while a score of 75 indicates
that a building is performing in the top 25th percentile of similar buildings
across the country and is eligible for the Energy Star certification, the
industry-wide standard for energy-efficient properties.
the Portfolio Manager program is not a perfect solution, it utilizes the
largest data set and provides an apples-to-apples comparison, allowing real
estate owners to compare the energy performance of their buildings with similar
buildings in their portfolio and across the country. It should be noted that
Portfolio Manager compares the end result, energy used per square foot, also
known as energy use intensity or EUI, and there are many factors that
contribute to a building’s
ever-increasing number of cities and states across the country, including
California; Washington State; Austin, Texas; Philadelphia; San Francisco; and
Seattle require the disclosure of Portfolio Manager-generated utility
consumption and cost data during real estate transactions and refinancing.
Disclosing energy performance data shows the buyer, lessee, and lender whether
the property they are buying, leasing, or lending on is an energy hog or a high
performer. This information provides a detailed history of property performance
that may uncover hidden risks or opportunities and add value to the
benchmarking utility data in Portfolio Manager or a similar tool does not
guarantee data accuracy. Potential buyers should request the trailing
one-to-two years’ worth
of utility bills and compare with the utility costs reported on the seller’s balance sheet.
value of this analysis is supported by the risk of under-reporting utility
costs and the direct impact on NOI and asset value. For example,
under-reporting annual utility costs by $90,000 in a 400,000-square-foot office
building with full-service tenant leases at a 6 percent capitalization rate
artificially inflates asset value by up to $1.5 million.
confirmed, annual utility costs should then be compared with tenant utility
income on the balance sheet to confirm that utility costs are recovered in
accordance with tenant lease requirements. This will minimize potential risks
associated with over- or under-recovering tenant utility costs.
Star scores are a strong indicator of property performance. In general, the
lower the score, the greater the opportunity for utility cost reductions. The
due diligence period provides a window of opportunity to underwrite low-cost
operational improvements to ensure the projects are funded and increases in NOI
and asset value are realized. Targeting operational opportunities that improve the
performance of existing building equipment, rather than capital-intensive
equipment replacements, often provides the greatest returns for potential
energy savings opportunities during due diligence simply accelerates NOI
reductions before operating and capital budget restrictions are in place. While
this approach won’t make
or break a transaction, it adds value to the deal — the icing on the cake.
determine where to look for operational savings, it is important to first
understand your client’s
investment goals. If the property is a short-term hold and your client has
limited capital to invest in improving building operations, look at those
improvements with payback periods of less than one year to immediately increase
NOI and asset value. If the property is a long-term hold, consider expanding
the list of opportunities to include improvement projects with one- to
three-year payback periods and the replacement of electrical and mechanical
equipment nearing the end of its life expectancy.
utilities offer generous incentives for energy efficiency upgrades that can
reduce project costs by up to 100 percent, significantly improving your client’s returns. For example, Duke Energy, AEP Ohio,
and Entergy Arkansas all install compact fluorescent lamps and high efficiency
faucet aerators and showerheads in apartment units at no cost. This project can
improve client returns by lowering the cost of occupancy, increasing resident
retention, and reducing lamp replacement and labor costs that typically fall
under the operating budget.
high performing buildings with Energy Star scores greater than 75, a qualified
professional can typically identify improvement opportunities that reduce
property utility costs between 5 and 20 percent with minimal capital. Early in
the due diligence process, engage an engineering or operations consulting
company to perform a detailed operational assessment of the property. This
assessment may be an addendum to the condition assessment, or may be performed
by an operations consulting company with expertise in enhancing building
evaluating companies to perform the operational assessment, it is important to
clearly communicate your client’s investment goals and request case studies and references to
ensure the company selected has expertise in reducing utility costs through
operational improvements, as many companies target capital-intensive equipment
owners are wary of additional consulting fees and the capital required for
building improvements, but a qualified professional can typically identify
savings in many multiples of their fees, even if the building is a high
performer. Before signing a contract, provide the consulting company with
building drawings, maintenance records, utility benchmarking data, and other
supporting documentation. Request that they demonstrate the business case for
their engagement based on past experiences with similar buildings. Select a
company that can look beyond the physical condition of the building and
identify operational improvements.
operational assessment is complete, identify no-cost operational improvements
for immediate implementation and those to underwrite into the transaction.
Request that the consulting company develop a detailed project implementation
schedule that is aligned with your client’s investment goals. This strategy will ensure project funding and
implementation, quickly increase NOI and asset value, and may improve rental
rates, tenant comfort, and retention.
Building operations should not be overlooked
during the due diligence process. Analyzing property utility performance and
underwriting low-cost operational improvements can provide significant value to
buyers across all stages of the ownership cycle. Including this strategy in
your pool of resources can differentiate your services and build long-term
value for your client beyond the transaction.
owners and managers are continuously looking for ways to set their holdings
apart from competitors, whether by including unique amenities or touting
location. In recent years the corporate real estate sector has incorporated
sustainability in their portfolios, which has the potential to improve energy related
cost savings and also appeals to tenants and their employees. To help determine
what energy efficiency upgrade options exist, the U.S. Department of Energy has
developed the Building Energy Asset Score
(www.energy.gov/eere/buildings/building-energy-asset-score), which assesses the
physical and structural efficiency of a building at no cost to the user.
“We developed the Asset Score to fill a critical gap in the market —
helping building owners figure out how efficient their building is compared to
others, based upon its construction and installed equipment,” says Roland Risser, director of DOE’s Building Technologies Office.
“With the Asset Score, people buying a building now have the same
knowledge as people buying a car. Our goal is to empower both building owners
and potential buyers with the information they need to make smart investments
in energy efficiency.”
January 2016, the Asset Score has been used to evaluate the energy efficiency
of 825 commercial and multifamily residential buildings totaling more than 83
million square feet in more than 30 states. Buildings totaling an additional
155 million sf are in the process of utilizing the Asset Score.
nationally standardized tool, the Asset Score generates an energy efficiency
rating based on building data related to its underlying energy assets such as
the building envelope, lighting, hot water, and HVAC systems. These features
have a substantial impact on building performance despite operational and
occupant behavior modifications. The Asset Score runs a sophisticated
whole-building energy simulation and generates a report that provides an energy
efficiency score ranging from 1 to 10. A complement to the U.S. Environmental
Protection Agency’s Energy
Star Portfolio Manager energy management tool, the score is an assessment of
individual systems, an estimate of the total amount of energy used and consumed
by end use, and efficiency upgrade opportunities.
generation of a simple energy efficiency rating score enables Asset Score users
to compare their buildings against others and determine what measures will
improve performance and add value to holdings. The Asset Score can guide energy
improvements for building owners and third-party management companies. It
enables energy service companies to enhance existing services and tools, allows
for state and local governments to identify energy cost-saving opportunities
within their own portfolios, and assists utilities in identifying customers
eligible for energy efficiency rebates.
Kanojia is a communications consultant for the U.S. Department of Energy.
Contact her at Monica.Kanojia@ee.doe.gov.
Department of Energy’s Asset
Score complements the Energy Star Portfolio Manager tool developed by the
Environmental Protection Agency. A Portfolio Manager score enables the
comparison of buildings based on their energy consumption, as indicated by
actual energy bills. The Portfolio Manager score reflects the energy efficiency
of a building’s
physical structure and its systems, as well as how efficiently it is operated
The Asset Score reflects the energy efficiency
of a building based solely on its design, construction, and energy systems. It
normalizes for operational and occupancy factors, enabling users to identify
specific opportunities to invest in energy upgrades. Using both tools gives
users powerful information that can inform both energy upgrades and
improvements in building operations.