Economic Analysis of the Multi-Tenant Residential Retrofit Market Untapped Reservoir of Energy and Economic Potential

Source: Union SF by Palisades

Concept Paper

Jake H. WiseNovember 23, 2009

UPDATE

This paper was written in late 2009. Since then the landscape has changed.

One, the Energy Savings and Industrial Competitiveness Act (S.1000) was approved. This bill boots private-sectro investments in building efficiency upgrades by expanding the DOE’s Loan Guranteee Program and use of Energy Savings Performance Contracts (ESPCs).See: http://ase.org/resources/energy-savings-and-industrial-competitiveness-act-2011-section-section-summary

And two, the OpenADR2 standard has been developed. This standard will further enable ESCOs or Alternative Energy Suppliers (AES) to engage customers and participate in the demand response market.See: http://www.openadr.org/resources

FOREWARD

There is no such thing as green building. Any building is an unnatural act that requires

resource extraction and production of waste. However, since buildings account for 30–

40% of CO2 emissions in the U.S.1 and the Center for Neighborhood Technology has

predicted that 80% of the existing housing stock will still exist in 2020, our approach to

improving the efficiency of the built environment is critical to curbing climate change. The

U.S. Green Building Council asserts that in the U.S. alone, buildings account for 72% of

electricity consumption, 40% of raw material use, 30% of waste output, and 14% of

potable water consumption.2

Findings from the McGraw Hill Construction, Green Building Smart Market Report of 2006

show that green buildings decrease operating costs by 8-9%, increase building values by

7.5%, improve return on investment by 6.6%, and increase rent ratios by 3%. Green

building currently accounts for 5-9% of the retrofit and renovation market activity by

value, which equates to a $2 billion to $4 billion marketplace for major projects.3 By 2014,

this share is projected to grow to 20-30%, making it a $10 billion to $15 billion market for

major retrofit projects. The Department of Energy also announced $454 million under the

American Recovery and Reinvestment Act (ARRA) for energy efficiency efforts nationwide

and is now accepting applications for a new $390 million "Retrofit Ramp-Up" program that

will deploy innovative approaches to energy efficiency building retrofits. Retrofitting

existing homes has the potential to cut home energy bills by $21 billion annually.

The green building retrofit market has many distinct segments. These include, single-

tenant residential (2-4 units), multi-tenant residential (MTR) (5+ units), small

commercial/industrial, and large commercial/industrial. This paper will focus on the

1 United Nations Environment Programme (UNEP) Sustainable Construction and Building Initiative (SCBI). (2007). Buildings and

Climate Change: Status, Challenges and Opportunities 2

U.S. Green Building Council. (2009). Green Building Research, Retrieved from http://www.usgbc.org/DisplayPage.aspx?CMSPageID=17183

McGraw Hill Construction. (2009). Green Outlook 2009: Trends Driving Change.

under-addressed multi-tenant residential segment of the green building market with the

expectation that key learnings in this area may eventually translate to commercial retrofits.

Specifically, this paper will consider the structure, opportunities, and potential threats that

exist in this relatively nascent market.

The venture proposes providing customized energy and water efficiency solutions, via an

energy service company (ESCO) turnkey structure and financed through an energy

performance contract (EPC). These are time-tested tools that can be applied in a new

context. However, in order to achieve sufficient scale as well as maximum energy savings,

projects need to embrace a much more integrated approach. 4

For this analysis I researched business journals, industry white papers, industry

associations, and private sector studies. Given that this subset represents the nexus

between the green building and energy service markets, and given that it is a rather

dynamic niche segment, my sources do not include much federal economic data.

OVERVIEW

It is fairly well known that smaller opportunities, such as MTR retrofits, have remained

under addressed due to dispersed decision making in the split-incentive facing property

owners and tenants, and intolerance on the part of property owners to pay high upfront

costs per unit of energy saved and revenue generated. In addition, technology is a dynamic

component and therefore a driver of change in this industry. Building property owners

may feel it ‘pays to wait’, for fear of obsolescence or better and cheaper products.

However, it is not the myriad of technological solutions that pose a hindrance to the

venture, but rather the appropriate incentive mechanism. A cost minimization strategy

that utilizes an integrated ESCO model will overcome these hurdles.

ESCOs typically provide a range of services including energy audits, design and installation,

financing, maintenance, and property management. ESCOs offer the convenience and

efficiencies of an integrated, whole-building approach with a single point of accountability 4

and full range of retrofit options. Given that retrofit projects have a time horizon of 24-72

months, the ESCO is entering into a long-term relationship (i.e. the length of the retrofit

project) with the property owner, which affords the ESCO the opportunity to address

future savings or benefits.

The Clinton Climate Initiative, Energy Efficiency Building Retrofit Program (EEBRP) sets

out the framework for ESCO energy performance contracting. The ESCO contractually

guarantees a pre-specified amount of energy savings at a pre-specified maximum cost. If

the ESCO falls short of the savings target or the project exceeds the maximum cost, the

ESCO is financially responsible for reconciling the difference. Thus, risk is transferred

from the property owner to the ESCO via an EPC. However, in a 2005 paper that examined

the markets for ESCO services, 72% of projects reported greater savings than guaranteed.5

See Tables 1, 2 and Appendix A1 for an illustration of this arrangement.

Some may argue that entering into an EPC in a smaller, fragmented market creates

transaction costs that are an obstacle to scalability. However, the operating cost reductions

from energy savings more than outweigh these frictional expenses. According to Clinton

Foundation calculations, for residential retrofit projects in metropolitan areas, the

following is a fair estimate based on three different scopes of work.6

Level of Retrofit Cost Range Energy Savings Efficiency Improvements

Low Cost $2,000 - $10,000 5-20% Duct sealing air infiltration, Attic

insulation, Compact fluorescents

Tailored $10,000 - $20,000 20-40% Add: HVAC Equipment upgrade, Water

heater upgrade, New windows

Comprehensive $30,000 - $40,000 40%+ Add: Comprehensive envelope

improvements, New appliances, On-site

solar thermal, On-site solar PV

5 Hopper, N., C. Goldman, J. McWilliams, D. Birr, K. McMordie Stoughton. Public and Institutional Markets for ESCO Services: Comparing

Programs, Practices and Performance. Ernest Orlando Lawrence National Laboratory, University of California Berkeley, 2005. p. xviii.6

Clinton Foundation. Clinton Climate Initiative. (May 2008). CCI Residential Energy Efficiency Program Draft Proposal.

Post-retrofit there exists an increasingly divergent wedge between the projected property

appreciation and projected property energy cost saving vectors. This wedge represents the

project’s gross margin.7 Also, energy cost savings could be reinvested into projects from

which the property owner might derive future value in ‘micro-grid’ applications, such as,

net metering, distributed generation, compressed air or fuel cell storage and/or electric

vehicle charging stations.

INDUSTRY ANALYSIS

BARRIERS TO ENTRY

Given the comprehensive and integrated ESCO approach, accreditation criteria can present

an obstacle. National Association of Energy Service Companies (NAESCO) accreditation

requires a showing of technical competence in retrofit engineering, energy auditing,

financing and knowledge of EPCs. To gain accreditation, ESCOs must demonstrate the

technical and managerial competence to design and implement projects involving multiple

technologies and must demonstrate the ability to provide the full range of services

required for a comprehensive energy efficiency project.8 These obstacles may be overcome

by partnering with an existing ESCO.

The ESCO industry is characterized by diverse companies with different corporate and

property ownership structures. Many are subsidiaries of large building equipment and

control manufacturers, oil/gas companies, non-regulated energy suppliers, or engineering

firms. Others are owned by regulated electric and gas utilities. Some are independent

companies that sell no products; just resource performance improvement services.

FORESEEABLE THREATS FROM SUBSTITUTE PRODUCTS AND SERVICES

There exist a large and diverse number of energy efficient technologies available at a

different price points; therefore, payback periods are highly variable. The ESCO integrated

model mitigates the threat from substitutes by utilizing a blended payback approach.

Cheap low hanging fruit (i.e. lighting) can be aggregated with more expensive building

7 See Appendix A2

8 National Association of Energy Service Companies. Retrieved from http://www.naesco.org/accreditation/categories.htm

envelope or large appliance costs. However, there is also the question of not ‘what’ but

‘when.’ Given the rapidly evolving field of energy efficient technologies, a property owner

may conclude that it ‘pays to wait.’ If the current savings in energy costs are greater than

the annual annuity of adoption costs, it can pay to wait if those adoption costs are expected

to fall over time at a sufficiently rapid rate.9

FORESEEABLE THREATS FROM PROPERTY OWNER BARGAINING POWER

Again, the blended payback approach mitigates this risk. Perhaps property owners of

multiple properties may have leverage over the ESCO’s goods or service but currently this

market is diffused, so it appears reasonable, especially considering the advantages

provided by Clinton Climate Initiative (CCI) affiliation, which will be further elaborated on

below, that the property owner’s bargaining power is very limited.

FORESEEABLE THREATS FROM SUPPLIER’S BARGAINING POWER

The CCI, established in August 2006, affords participating ESCOs discounted pricing

arrangements that the CCI has pre-negotiated with leading manufacturers and suppliers of

energy efficient products.10 ESCOs participating in the CCI program are afforded access to

the Purchasing Alliance (PA) which provides discounts from 17-50% on envelope products,

5-35% on cooling products, and 5-70% on lighting products. The PA negotiates reductions

in the cost of energy saving technologies by leveraging the incremental sales opportunity

participating ESCOs represent.

COMPETITIVE RIVALRY

ESCO accreditation is achieved through membership with the NAESCO. As shown below, of

the thirty ESCOs that are NAESCO members, only four are involved in the residential

market and only two are involved specifically in the MTR market. Only one accredited

ESCO is both involved in the MTR market and afforded the advantages of CCI affiliation.

9 Resource and Energy Economics. (May 1994) The Energy Paradox and the Diffusion of Conservation Technology, A. Jaffe, R. Stavins,

p.10810

Clinton Foundation. Clinton Climate Initiative. Building Retrofit. Retrieved from http://clintonfoundation.org/what-we-do/clinton-climate-initiative/our-approach/cities/building-retrofit

NAESCO Member StateCCI-

AffiliatedMarket

CapitalizationType of Market

AECOM Energy CA $3.1B Commercial/MunicipalAMERESCO MA X private Multi-Family Residential (partnered w/ Oakland Housing Authority)Atlantic Energy Solutions NY private MunicipalBurns & McDonnell MO private Industrial/MunicipalChevron Energy Solutions KS X $260B CommercialClark Energy Group LLC VA private Data Centers/ HospitalsCM3 Building Solutions Inc. PA private Industrial/Commercial/MunicipalComfort Systems USA Energy Services CT private IndustrialConEdision Solutions (Edison) NY subsidiary Industrial/Commercial/Municipal/ResidentialConstellation Energy Products & Services Group (Berkshire) PA X subsidiary Industrial/Commercial/MunicipalControl Technology and Solutions (CTS) MO private MunicipalEnergy Focus Inc. WI $17.4MM CommercialEnergy Systems Group IN private MunicipalFPL Energy Services FL $21.5B MunicipalHoneywell International Inc. MA X $30.4B Industrial/Commercial/MunicipalJohnson Controls Inc. WI X $18.7B Industrial/CommercialLockheed Martin MD $29.3B Federal GovernmentMcClure Company (PPL) PA subsidiary Commercial/MunicipalNORESCO MA X private Industrial/Commercial/MunicipalOnsite Energy Corporation CA $1MM Industrial/Commercial/MunicipalPepCo Energy Services Inc. VA private Industrial/Commercial/MunicipalTAC (Schneider Electric) PA X subsidiary Industrial/Commercial (foreign based)Science Applications International Corporation (SAIC) MI private Federal Government/CommercialSiemens Building Technologies IL X private Commercial/MunicipalSynergy Companies UT private Multi-Family Residential/Industrial/Commercial/MunicipalThe EnergySolve Companies NJ private Industrial/CommercialTrane (Ingersoll Rand) MN X subsidiary Residential/CommercialUCONS, LLC WA private Utilities/Property Management FirmsWendel Energy Services NY private MunicipalWestern States Goods Movement Alliance CA private Commercial

http://www.aceee.org/conf/mt08/3a_Baczko.pdf

As evidenced above, there are limited multi-product, multi-service ESCOs, in the residential

market. A Lawrence Berkeley National Laboratory11 2007 study revealed that the tax-

exempt municipal market accounted for more than 80% of total ESCO investment activity;

only 3% was attributed to the residential market.

KEY PLAYERS

Apart from ESCOs the residential retrofit market is comprised of utilities, energy service

providers (ESP), cities, and counties. Utility energy efficient expenditures are typically one-

off, technology-specific rebates and not integrated or comprehensive measures. ESPs are

suppliers of electricity. They are differentiated in that they are more short-term and risk

averse and therefore do not enter into EPCs. As a result, some ESPs subcontract thru

ESCOs. There are also municipal organizations such as the San Francisco Energy Watch

(SFEW), which offers free energy assessments and financial incentives for energy efficient

upgrades. These entities do not enter into EPCs, either. Far from being competitive

programs, these rebates can be utilized by the ESCO’s client to further reduce total project

costs. These programs are complements not substitutes.

11 Lawrence Berkeley National Lab. (May 2007). Survey of the U.S. ESCO Industry: Market Growth and Development from 2000 to 2006.

Energy auditors, building material and mechanical system equipment suppliers, utilities,

financial institutions and others all play important roles in providing energy and financial

services in the real estate market but do not currently have a well-defined role or

consistent involvement in the retrofit market. Although real estate brokers and appraisers

are not directly involved, they are important stakeholders that establish value for building

improvements in the real estate market.

MARKET ANALYSIS

Energy policy in the State of California is an additional driver. The 2008 California Energy

Efficiency Potential Study12 differentiates between the residential market potential and

economic potential of energy savings for California investor owned utilities. Market

potential is defined as, savings achievable under current market conditions, and therefore

is consistent with the State of California planning standards. Economic potential is defined

as, the theoretical total savings. From 2007-2016, estimated market savings are

6,000GWh/year and economic potential savings exceed 15,000GWh/year. The difference

represents 9.7% of total annual residential electricity consumption. The existence of the

large gap is due in part to the long established focus of ESCOs on municipal sector facilities.

As a result opportunities in the residential market have, for the most part, been forfeited as

many utility sponsored programs provide one-off rebates rather than integrated solutions.

According to Senate Bill 542, introduced in February 2009 by Senators Wiggins and

Strickland and currently held in committee, 43% of California’s residential housing units

are rentals and the residential sector makes up 32% of California overall energy demand.

Therefore, 43% of 32%, or 14% of California’s overall energy demand is attributed to

residential rental units. In order to meet California’s aggressive solar and energy efficiency

goals the multi-tenant sector cannot be ignored.

Aside from being at the top of California’s loading order of preferred energy resources,

according to the McKinsey Global Institute13, energy efficiency has been singled out as the

lowest-cost measure for achieving large-scale national greenhouse gas (GHG) reductions.

12 Itron. (September 2008) California Energy Efficiency Potential Study.

13 McKinsey & Co. (May 2007). Curbing Global Energy Demand Growth: The Energy Productivity Opportunity.

As such, U.S. ESCO revenues are largely derived from energy efficiency (73%), followed by,

renewable technology (10%), consulting/master planning (8%), and distributed

generation (6%).14

PRINCIPAL-AGENT DILEMMA

Another reason the MTR market is under-addressed is due to the split incentive that exists

between property owner and tenant. The incentive for either party to invest in energy

efficient or renewable technology depends entirely on the metering of the property. In

most multi-tenant buildings, the building property owner does not pay the utility bill, this

arrangement is known as a net lease. If the tenant pays his/her own bill then the property

is sub-metered. If rent is utility inclusive this arrangement is known as a gross lease. In

this case the property is master-metered. In either case, the meter is not visible within the

unit and subject to monthly billing so there exists an information lag with respect to energy

consumption. Effectively the property owner sees no reason to make an investment that

results in lowering tenants’ costs, and tenants see no reason to make an investment in a

property in which they have no ownership.

The principal-agent (P-A) problem is a function of incentives, information asymmetry and

enforcement capacity. 15 The ‘principal’ represents the whole set of possible renters and

the ‘agent’ represents the property owner. The problem exists because one party chooses

the technology, one party pays the energy cost associated with that technology and one

party is the actual end-user. A study conducted in 2006 segmented a set of 2003 U.S.

housing data16 by tenant status, inclusion of energy costs in rent and housing unit type. The

study then cross-referenced this set by average energy consumption17 for each end-use,

specifically, refrigerators, water heating, space heating and lighting. The study shows that

an estimated 35% of all residential site energy is associated with households affected by P-

A, and estimates, based on 2003 sales, that this represents annual energy savings of

14 Clinton Climate Initiative. (April 2009) An Introduction to EPC: EPC Toolkit.

15 Ernest Orlando Lawrence Berkeley National Laboratory, Environmental Energy Technologies Division. (August 2006). Quantifying the

Effect of the Principal-Agent Problem on U.S. Residential Energy Use, S. Murtishaw, J. Sathaye, p. i16

Census Bureau. (2005). American Housing Survey of the U.S. Census and U.S. Census Construction Statistics: Census Bureau 2005a, 2005b , 2005c.17

U.S. Energy Information Administration. (2001). Residential Energy Consumption Survey.

6.37TBtu. This is the equivalent of 1.87Tkwh. To put this in context, 1.87 trillion kilowatt

hours is the equivalent of running 214 baseline generators, each with a capacity of

1000MW on a twenty-four hour basis for one year. This represents the annual unrealized

residential energy savings from just refrigerators, space heating and lighting, from the P-A

problem alone.

However, without in-unit meters (not sub-meters, but price signals in-unit) there is

currently no practical or legal, way to monitor or enforce energy consumption behavior.

Heterogeneity and turnover among tenants adds to the complexity of engagement.

Therefore, this paper proposes a gross lease, coupled with tenant education and outreach

efforts, as the most efficient means by which to enable MTR retrofits. Gross leases

generally allow annual rent adjustments based on fluctuations in operating costs.18 There

may be impediments to this approach (i.e. rent control) but those may be handled by

providing 30 days notice and an addendum to the original lease.19

Ultimately the total project costs should target upgrades over which the property owner

has control. The length of tenant showers, use of washer and dryer, and use of the heater

or air conditioning are all variable factors over which the property owner has essentially

no leverage. Instead the property owner should concentrate on upgrading the water

heater, making better use of natural daylight, installing an energy efficient furnace, double

pain windows, common area timers, lo-flow showers and restrictors, or higher rated

insulation. LEED for Existing Buildings (LEED-EB) presents an entire menu of core and

shell projects that aim to limit tenant consumption. The P-A failure is so immense that

even a small reduction in tenant consumption can drastically improve total project cost

savings.

There is of course a cost associated with learning and technology adoption. Just because a

building has been retrofit does not mean it is being used efficiently. This misuse can be

mitigated through outreach and education and the cost can be capitalized in the total

18 D. Schneider, D. Probst, June/July 09. Making Energy Retrofits Work for Tenants and Property Owners: Tenant Engagement is Key to

Acheiving Energy Efficiency and Reducing the Carbon Footprint of Multi-Tenant Buildings.19

See Appendix B. Retrieved from http://www.ci.berkeley.ca.us/ContentDisplay.aspx?id=10450

project cost. Current and prospective tenants will need to be provided a detailed

breakdown of the equipment costs and projected energy savings to accept higher rents. In

addition, monthly rent should be itemized for existing and prospective tenants alike, in

order to illustrate the ‘rent to utility expense ratio’ relative to comparables.

PROJECT FINANCING

The success of MTR retrofits rests on the ability to finance the project in such a way as to

align debt service costs with projected energy reduction benefits. This paper recommends

a gross lease structure because this approach circumvents foreseeable problems with

respect to tenant turnover and on-bill financing constraints. As such, the property owner

could utilize a number of debt and equity options.

First, unlike a shared appreciation loan, EARN equity certificates (EARNs)20 represent a

pure equity investment in a fraction of the property value. The property owner contracts

with an investor, rather than a lender, entitling the investor to a fixed percentage of the

property when the EARN matures. There are no monthly payments in this scenario.

Secondly, if the property owner does not wish to give up a portion of her property

ownership she may refinance the property as an energy efficiency mortgage (EEM), energy

improvement mortgage (EIM), conventional energy efficiency mortgage (CEEM), or soon to

be made available, Energy Star mortgage (ESM). An energy efficient mortgage credits a

property’s energy efficiency in the mortgage itself. An energy improvement mortgage,

sponsored by federally insured FHA, allows the borrower to use money saved in utility bills

to finance energy improvements. Conventional energy efficiency mortgages allow the

lender to increase the borrower’s income by a dollar amount equal to the estimated energy

savings. Energy Star mortgages will allow the borrower to pay for improvements over the

life of the loan which increases the amount deductible in interest. CCI is experimenting

with a combo triple-net lease and energy performance contract (EPC) in the commercial

office space context.21

20 See Appendix C.

21 See Appendix D.

CONCLUSION: OUTLOOK AND FUTURE

According to a survey conducted by the New York State Energy Research and Development

Authority (NYSERDA), done in conjunction with the National Association of Energy Service

Companies (NAESCO), the most persuasive benefit in motivating a property owner to

implement an energy performance contract is ‘building maintenance and operation cost

savings.’22 Non-energy benefits, such as, reduced tenant turnover, or reduced tenant

complaints, were essentially ignored. But what can not be ignored are the societal benefits

from avoided electricity generation, transmission and distribution costs. The MTR market

represents a largely untapped reservoir of energy and economic potential. ESCOs, or

affiliated entities, can offer scalable, value adds, through an integrated approach. With

mortgage rates at multi-decade lows and high product inventories, now is the time for

property owners to capitalize and prepare for future opportunities.

22 National Association of Energy Service Companies. (December 2008). Analysis of Non-Energy Benefits of Efficiency Retrofits for

ESCOs and ESCO Customers. D. Birr, T.E. Singer, p.7

ADDITIONAL INFORMATION

The following serves as an illustration of how an annual true-up, between the ESCO and property owner, might be performed. Notice the annual financing costs are exceeded by the energy cost savings. This affords the property owner a cash flow positive project.

Table 1

Year 1

Annual Aggregate (12 units)

Natural Gas

(Therms)

Electrcity (kWh)

Natural Gas ($)

Electricity ($)

Total Annual Energy Costs

($)

Pre-Retrofit 7,800 117,000 $11,700 $29,250 $40,950Post-Retrofit 7,020 105,300 $10,530 $26,325 $36,855

Energy Savings 780 11,700 $1,170 $2,925 $4,095

Normalized Usage Utility Costs

Table 2

Year 1 Pre- Post-

Revenues:Gross Rent (~3%) $72,000 $74,160

Expenses:Net Energy Costs (~10%) $40,950 $36,855Project Financing Costs (15yrs. @ 6%) $0 $12,518

→ Maximum Project Cost of $30,000

Net Operating Income $18,532 $37,305

Capitalization Rate 9% 9%Derived Property Value (Income Approach) $205,912 $414,500Incremental Value from Retrofit $0 $208,588Retrofit-Specific ROI 0% 834%

The above assumes that the improvement is reflected in the market value of the property. A well-functioning, well-informed market should reflect the upgrade in the value of the property. The positive correlation between energy efficiency and higher home values is well documented, thus providing an incentive for both property owners and realtors alike.23

Additionally, treatment of energy efficient assets, classified as ‘general building’ items by the IRS can be depreciated on a 39 year straight line basis.

23 California Clean Energy Fund. CalCEF Innovations White Paper. (2009) New Business Models for Energy Efficiency. B. Hinkle, S.

Schiller, p.19

As an integrated solution provider, an ESCO can improve upon its performance metrics by tracking and analyzing operating data from multiple properties.An ESCO could perform an analysis as referenced in The Energy Paradox and Diffusion of Conservation Technology (A. Jaffe, R. Stavins, May 1994) which discounts the projected energy savings by a principal-agent slack factor, accounts for the different characteristics of the property (i.e. size, type) and compares that to the projected total cost of installation which is adjusted for engineering complexity, developer history, amount of new construction in the area, and tax credits.

APPENDIX A1

The means by which energy savings are quantified begins with establishing an energy baseline, against which all future energy savings will be measured. Typically the ESCO requests 24-36 months of consumption history. This data is then adjusted or smoothed to account for fluctuations out of the ESCO’s control (i.e. weather, number of tenants) as it is exceedingly difficult to quantify energy savings if the ESCO is held accountable for factors beyond its control. In that same vein, this baseline is separate and apart from the utility rate assessed in the service territory in which the building property owner resides. As utility rates account for transmission, distribution and public purpose charges in addition to the costs of generation, the utility rate could increase even if energy use decreases, so a dollar value of energy cost savings ($/sqft.) needs to be established and expressed annually over the life of the project. As shown in the figure below, the baseline is compared to each subsequent year’s consumption and the difference is the energy saved. It is incumbent upon the ESCO to clearly define all formulae and account for all non-routine adjustments (i.e. sale of the property) in the measurement and verification (M&V) of project savings within the EPC. Each contract can be catered to the property owner, and may include some flexibility, such as, if excess savings are realized one year, they can be used to offset shortfalls in subsequent years, or vice versa. The financing for the project can be structured such that the monthly payment is less than the expected monthly energy savings to achieve positive cash flow during the entire payment period. As such, the project can improve the facility’s bottom line from day one. In exchange for assuming the project’s performance risk and providing the property owner with the cash flow certainty there is also the possibility of gain sharing, whereby any reduction of project cost below the guaranteed maximum cost is shared between the ESCO and the property owner in a pre-negotiated percentage split.

Source: Clinton Climate Initiative, An Introduction to CCI, American Council for an Energy Efficient Economy (ACEE),

April 2008

APPENDIX A2 – ESCO BUSINESS MODEL

In short, the ESCO benefits from two revenue streams. It charges a flat management fee for services rendered, which can be capitalized into the total project cost, and splits the energy cost savings with the property owner. The percentage split depends upon how the property owner finances the project, the size of the retrofit (shallow vs. deep), the means by which the energy savings are quantified, and may be front-loaded, accelerated, lumpy or fixed throughout the life of the project.

The property owner benefits from three revenue streams. The owner receives a percentage of the annual energy cost savings, thereby decreasing building operation and maintenance costs (costs = income), realizes a premium in future rents, and an appreciation in the value of the property.

APPENDIX B – TENANTS RIGHTS

The following is an excerpt from the City of Berkeley (a rent controlled area) Rent Stabilization Board website:

FAQ: Our landlords plan to raise our rent (a fixed amount with utilities included) because they say our utility expenses are higher than the amount allotted in the rent payment. We'd like to know what we're actually paying for, but they ignore our repeated requests to see the utility bills. Can they suddenly raise our rent without proof that it's necessary?

A: Assuming this house is subject to the Rent Ordinance, your landlord cannot raise your rent without first petitioning the Rent Board and receiving authorization to do so. Should

the landlord file such a petition, you would have the right to review any documentation the landlords might submit is support of their claim for the rent adjustment. If you objected to the evidence or had any questions about the documents submitted, the matter would be set for hearing.

APPENDIX C- EARN SCENARIO

For example, if the fair market value of the property is appraised at $600,000, the investor may offer you an EARN equal to 20% of the current property value or $120,000. The property owner would then receive the $120,000 and at some future date when he/she decides to sell the property, the investor will receive a portion of the sales price as repayment for the EARN. The investor may give the property owner 20% of the current property value in return for 24% of the future value.

APPENDIX D – HYBRID LEASE

The lessee covers pro-rata expenses such as insurance, taxes, and maintenance with a standardized EPC. As part of Governor Schwarzenegger’s Green Building Initiative, CCI, the Building Property owners and Managers Association (BOMA) and California Business Properties Association (CBPA) have been directed to combine key features of triple-net leases, EPCs and Title 24 operating guidelines for existing buildings.24 This may have applications in the MTR sector, though it would require sub-metering.

24 Sustainable Industries. (April 2008) BOMA ‘Greens’ Lease Guidelines. Penafiel, Karen.