Financing Focus

Carbon Credits

Offsetting CO2 emissions may provide a competitive edge for properties.

Energy and carbon credits can help to reduce variable operating expenses, increase net operating incomes, lower capitalization rates, increase internal rates of return, and mitigate risk. These dynamics reflect the changing characteristics of socially responsible investment models and create a sustainable competitive edge. Property owners and investors who set independent, verifiable audit baselines first can generate added income and value from emission reductions via conservation and renewable energy efforts.

The commercial real estate industry is already moving toward a socially responsible investment model. ASTM’s recently adopted “Standard Practice for Building Energy Performance Assessment” is expected to have a significant impact on the commercial real estate industry, similar to the effect of ASTM’s Phase I environmental site assessment standard.

As BEPA assessments standardize energy due diligence, investment grade audits are standardizing the generation of carbon credits. These credits are becoming an essential tool for businesses, investors, and polluters. They can be used to comply with reduction requirements and create added value by monetizing carbon and mitigating risk.

What Is a Carbon Credit?

Carbon dioxide makes up about 85 percent of the seven damaging greenhouse gases, and all other emissions are expressed in carbon dioxide equivalents, or CO2e. Carbon credits are created by offsetting carbon dioxide emissions with conservation; solar, wind, and waste conversion to energy; and other technologies. The credits are then traded on both voluntary and compliance carbon markets.

Throughout the world, markets are set up for trading carbon credits. For example, California now has a compliant carbon market using four methods for generating carbon credits. Many new models are emerging, from harvesting emission reductions from energy conservation in buildings, to providing energy management as a value-added service with pay-forward savings.

What Does It Mean?

An investment grade audit sets a building’s energy audit baseline and balances bills, equipment, and use to within 5 percent. This audit identifies opportunities in lighting and electrical outlet controls, behavior modification, and upgraded mechanical systems that can reduce the fixed overhead by 30 to 40 percent. In addition to saving this power, carbon credits in the form of voluntary emission reductions, or VERs, are generated every year for the 10- to 25-year life of the investment. Today VERs are trading around $6 per credit and are expected to go up in value 10 to 20 percent a year, according to Bloomberg. VERs can be generated in the U.S. and sold internationally. VERs are about 3 percent of conservation income and 20 percent of renewable energy upgrade income.

This income stream is significant and is part of a building’s financial stack. For example, a recent project provided a $900,000-a-year reduction in operating expenses and increased the NOI. Using a 6 percent overall capitalization rate on this savings creates $15 million in added value. For portfolio owners, significant gains in operating efficiency using conservation and renewable energy strategies can create an edge in real estate transactions. New technologies include insurance wraps, independent auditing/reporting software, and remote and automated building management technologies. This can turn real estate operators into energy service companies that sell power to their tenants.

For building portfolios there is a two-phase investment grade audit. Phase I involves an audit of the buildings and billings that identifies inefficient equipment, lighting, controls, and business practices that can be adjusted to typically achieve 10 percent savings at no cost by changing behavior and time of day activities.

Phase II of the audit identifies and develops a capital expenditure program of equipment upgrades to achieve energy savings and possible co-generation or renewable energy additions. National and state energy conservation programs, along with the non-cash benefits of ownership, such as component depreciation, contribute to the after-tax IRR. For qualified clients, full project funding from audits to improvements to carbon reporting make monetization viable.

Building owners who develop and put into place a carbon-based energy management strategy create a sustainable competitive edge. Along with managing risk to meet socially responsible investment models, those who set audit baselines first can generate added income and value. The future is now.

Greg Watkins is president of Carbon Consultants and Kurt Goeppner, CCIM, is a principal with Carbon Consultants, based in San Juan Capistrano, Calif. Contact them at greg@carbconsultinc.com and kurt@carbconsultinc.com.

Greg Watkins and Kurt Goeppner, CCIM

Monetizing Carbon Carbon credits are generated by: setting a baseline measurement of a property’s existing “business as usual” greenhouse gas situation;using an approved methodology standard to reduce CO2 emissions;filing a “project identification note” and “project design document” with the appropriate credit approval body;using third-party independent verification, validation, auditing, and reporting to measure project successmanaging carbon credits in registries; andusing standardized emission reduction contracts to transact carbon credits.

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