Investing in Multifamily Energy Upgrades

A version of this article appears in the November/December 2014 issue of Home Energy Magazine.

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Apartment owners typically do not see energy efficiency as a worthwhile investment. When residents pay their own energy bills, owners often assume that they will reap the savings only from common-area upgrades. However, what property owners often don’t realize is that investment in energy efficiency can do more than lower resident utility bills. It can increase a property’s net operating income (NOI), return on investment (ROI), and property value. Here’s how.

Financial Benefits of Energy Efficiency

Investment in energy efficiency offers apartment owners three important financial benefits. It can achieve market differentiation. It can decrease vacancy and turnover rates. These in turn increase NOI and ROI. Investment in energy efficiency can also directly increase ROI and property value.

Achieving Market Differentiation

Today, market rate properties with energy efficiency improvements can gain a competitive edge in the marketplace by taking advantage of the appeal of green. As Urban Land Institute’s John Mcllwain puts it, energy efficiency is “the new granite countertop.” More and more residents are expecting energy efficiency and green amenities as part of the rental home package. By incorporating these amenities into their properties, owners can set themselves apart.

Improved apartments must compete for the same potential renters as new-construction properties. TIAA-CREF, one of the largest institutional real estate investors in the nation, implemented a set of energy management initiatives across its portfolio of multifamily properties in 2008. “The green building movement was gaining momentum, and we wanted to position our portfolio ahead of the curve,” says Scott Anderson, director of asset management. Anderson understands the need to offer the same efficiency and green amenities as new-construction developments. Adding energy-efficient products, energy-efficient equipment, and certification of existing properties will give these properties a competitive edge in the marketplace.

Decreasing Vacancy and Turnover Rates

These same amenities will help to ensure low vacancy rates and high demand. Growing evidence suggests that energy-efficient apartments lease faster and experience less turnover than more traditional units. This lower vacancy is attributable to resident comfort and health. A report by the National Center for Health Housing found that specific medical conditions, including ear infections, bronchitis, asthma, and respiratory allergies, decreased as much as 15% in a 60-unit, mixed-income apartment building retrofitted with new insulation and new heating and ventilation systems. Residents who are comfortable and healthy are more likely to stay put, reducing vacancy rates.

In a case study conducted by the Institute for Market Transformation, Pine Harbor Apartments, a 208-unit property in Buffalo, New York, had a 15.7% vacancy rate. The property invested in energy efficiency upgrades and reduced its vacancy rate to a steady 3%. The owner attributes 90% of this reduction to the heating retrofits. Energy efficiency upgrades equip owners with additional means to meet resident demand and keep vacancy levels low. This in turn increases revenue and benefits the bottom line.

Increasing Property Value and ROI

According to a report by the Energy Cost Savings Council, every $1 invested in retrofit measures can increase a property’s value by $3. For a real-world example of the ROI, consider Morrison Manor Apartments, an 83-unit retrofitted apartment complex in Troy, New York. The property was purchased for $750,000 in 2000 and sold for $1.79 million in June 2005, less than two years after the retrofits were completed. This appreciation in value far exceeded that of comparable properties in the area. The increase in NOI attributable to the retrofits was a staggering $65,300, using a capitalization rate of 9.5%. The property value growth attributable to the retrofits was $687,000! The ROI for the retrofit at a cost of $320,000 was 215%.

In a study on the nonenergy benefits of multifamily efficiency improvements, Bikerdike Redevelopment Corporation quantified the energy and nonenergy benefits of upgrading a 70-unit apartment building in Chicago. The upgrades consisted of air sealing, insulation in the roof cavity, and replacing the furnace. These upgrades resulted in a 10% utility cost savings of $12,624, which equates to 17 months’ rent for one unit, or annual maintenance costs for 15 units, or a 27% decrease in vacancy loss as a percentage of potential receipts. Figure 1 shows the nonenergy benefits that resulted from the upgrades.

Similarly, Massachusetts developer Chris Yule’s goal was to improve the energy efficiency in a 188-unit property. Yule invested $6 million in an exterior update, site work, and an energy rehab. The rehab budget consisted of $1.6 million and supported air-sealing, door and window replacement, roof and attic trim upgrades, and siding and insulation improvements.

Why bother with such upgrades when the tenants pay their own utilities? In theory, investment in energy efficiency should attract higher-quality tenants and higher rents. Because of the renovations, Yule increased rent by $100 per unit; however, this did not affect the residents’ housing budget as the utility savings made up for the increase in rent. This change in rent increased Yule’s operating income by $225,600 per year ($100 x 12 months x 188 apartments). Using a 10% capitalization rate, Yule considers the capitalized value of a $2.2 million return on a $1.6 million energy upgrade to be a worthwhile investment. (See Figure 2.)

Energy-efficient retrofits increase a property’s revenue through green leases. These leases allow property owners to negotiate higher rents with their tenants to offset the utility cost savings from the retrofit. Green leases provide transparency to tenants on planned expenditures that will benefit them personally. According to the Green Real Estate Journal, green leases are in the pilot phase, but so far they have provided a creative solution to revenue generation.

Marketing green properties increases revenue by attracting the 80 million Millennials expected to flood the rental market over the coming decade, as the next section explains below. Finally, energy-efficient properties can generate additional revenue when they are sold. Multifamily properties with Energy Star or LEED certification can sell for more than comparable noncertified properties. And a recent study conducted by the University of California, Berkeley and the University of California, Los Angeles found that Energy Star and LEED-certified homes sold for about 9% more than comparable, noncertified homes.

Why Energy Efficiency Matters Right Now

Energy efficiency matters for a lot of reasons but here are two important ones for multifamily buildings.

Reduced Risk

Investing in energy efficiency can position property owners ahead of the curve on rising energy costs, new building performance disclosure laws, and tighter building codes. As of 2013, four cities—Austin, Texas; New York City; Seattle, Washington; and Washington, D.C.—required owners of multifamily properties to conduct energy benchmarking and disclose building performance at time of sale. Building codes are also becoming more stringent. The city and county of Goleta (near Santa Barbara, California) has already adopted a more stringent building code, and counties throughout the San Diego area are also poised to adopt more stringent codes.

The Next Generation of Renters

We have seen how energy efficiency can help properties achieve market differentiation, decrease vacancy and turnover rates, and increase property value and ROI. We must also understand the factors that drive the apartment rental market. In particular, the Millennials—young professionals between the ages of 26 and 35—are deferring home purchasing into their late 30s, and they account for nearly one-quarter of the U.S. population. According to the National Association of Home Builders, Millennials want to live in a green building. Sustainability, energy efficiency, and environmental awareness are among this generation’s core values. With a green-focused mind-set representing nearly one-quarter of the population, Millennials will have a significant impact on the demand for, and the supply of, multifamily housing, and especially on the market for energy-efficient and green apartments.

Leveraging the Trend

Multifamily property owners can leverage these trends by investing in energy efficiency. Energy efficiency not only differentiates a property, but also reduces vacancy rates and tenant turnover and increases property values. Energy costs will probably continue to rise over the coming decade, and local, state, and national jurisdictions are adopting stringent building codes to satisfy energy reduction goals. Residents of the Millennial generation demand green products, services, and housing. Properties that take advantage of limited rebate resources now can profit from these trends.

Julieann Summerford is an associate vice president for TRC Energy Services.

Michael Maroney and Melissa Buckley also contributed to this article. Maroney is an associate project manager for TRC Energy Services. Buckley is a program associate for TRC Energy Services.

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