Investing in Multifamily Energy Upgrades

The Top Three Financial Benefits of Energy Efficiency for Multifamily Housing

October 31, 2014
November/December 2014
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.

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Built in 1976, Sorrento Tower is a 198-unit, high-rise community for seniors in San Diego, California. (RAHD Group)

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Built in 1959, the Puerto Villa Apartments complex consists of 93 units in Rancho Cordova, California. (TRC Energy Services)

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Figure 1. Energy-efficient buildings save owners money in maintenance as well as gas and utilities—not to mention the reduction in carbon emissions.

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Figure 2. Investing money for energy retrofits in a multifamily building has big payoffs.

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.

Energy Efficiency Upgrades in Action

The following case studies describe projects that have completed significant energy efficiency upgrades to increase NOI and improve resident satisfaction.

Puerta Villa Case Study

Project Name: Puerta Villa Apartments
Location: Rancho Cordova, California
Buildings/Units/Stories: 1 building / 93 units / 2–3 stories
Year Built: 1959
Energy Upgrade Program: SMUD Home Performance Program
Owner/Developer: Acclaim Companies
Project Team: E3/NorCal (Energy Rater)

Project Description
As a general contractor and multifamily developer, the Acclaim Companies identified an opportunity to revitalize a blighted community, while providing its investors with a positive investment opportunity. Puerta Villa was a blighted apartment project with an extensive list of code violations. The company purchased the property in December 2010, at 40% occupancy and began construction in February 2011. The remodeling was completed in January 2012. At that time, the Acclaim Companies had leased Puerta Villa at market rents and had already reached an occupancy rate of 70%.

Energy Upgrade Description
At the time of acquisition, Puerta Villa had no roof or wall insulation. The Acclaim Companies replaced the roof and insulated the exterior walls to increase the building’s thermal performance. The developer replaced single-pane metal windows with new, energy-efficient, double-pane vinyl windows. The building received new, higher-efficiency A/C systems to replace the window units. Each of the interior units also received a comprehensive remodeling.

Benefits of Energy Upgrades
The comprehensive energy improvements significantly reduced energy usage. These upgrades also achieved significant cost savings in the project’s operations, which went straight to the bottom line. Occupancy levels and rental revenue increased significantly, resulting in increased property value.

Savings Snapshot
Total Project Cost: $459,500
Program Incentive: $269,700
Owner’s Copay: $189,800
Percent Improvement: 30%

“The rebates provided the incentive our firm needed to take on high-end energy retrofits. These retrofits have helped us raise our rents from $.65 per square foot when we purchased the building, to $1.00 per square foot currently.” (Gary Johnson, the Acclaim Companies).

Sorrento Tower Case Study

Project Name: Sorrento Tower
Location: San Diego, California
Buildings/Units/Stories: 1 building / 198 units / 14 stories
Year Built: 1976
Energy Upgrade Program: Energy Upgrade California in San Diego County
Owner/Developer: RAHD Group
Project Team: ICON Builders, Phase 3 Construction, Jeanne Fricot

Project Description
Sorrento Tower is a 198-unit, high-rise community, dedicated entirely to providing housing to low-income seniors. Built in 1976, the building sits atop a hill, providing breathtaking views of San Diego and the Pacific Ocean. Although the previous owner maintained the building well, at nearly 30 years old, Sorrento Tower was in need of capital infusion to replace or repair all major components. RAHD Group, a firm specializing in the development and preservation of affordable housing and founded by Case Haeling and Colin Rice, purchased the property. Upon acquisition, RAHD Group immediately began a large-scale renovation.

Energy Upgrade Description
RAHD Group upgraded a wide variety of items to increase the building’s energy efficiency. The group replaced all windows with dual-pane, low-e units, and replaced light fixtures in the apartments and in the first-floor common area, including the lobby, office, and meeting rooms. RAHD Group also replaced the building’s central boiler with two new high-efficiency domestic hot water heaters, and new 0.25 horsepower DHW circulation pumps with demand control. Each apartment received an Energy Star refrigerator.

Benefits of Energy Upgrades
The project reduced overall energy use by an estimated 10.4%, leading to major cost savings. New lighting and windows brightened the dwelling units and common areas, creating a more pleasant and comfortable living environment. New boilers ensure that residents receive faster water delivery while also reducing gas consumption, in turn benefiting both the residents and building owner.

Savings Snapshot
Total Project Cost: $5,975,961 (includes all building renovation costs)
Program Incentive: $233,640
Percent Improvement: 10.4%

“It’s rare in construction and development when improvements can be cost-effective, be good for the environment, enhance the property’s value, and benefit the residents’ lives all at once. The Energy Upgrade California program allowed us to do just that!” (Colin Rice, RAHD Group).

Hear Colin Rice speak about the value that energy efficiency upgrades brought to the Sorrento Tower renovation.

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.

Resources

These sources provide insight into the state of energy-efficiency initiatives and programs in the multifamily market.

Enterprise Green Pass Program
In Northern California, the Enterprise Community Partners Green Portfolio Analysis, Sustainability and Support program (Green PASS) directly confronts market barriers to greening older properties.

Scaling Up Multifamily Energy Efficiency Programs: ACEEE Report #E135.
Scaling Up Multifamily Energy Efficiency Programs: A Metropolitan Area Assessment.American Council for an Energy-Efficient Economy. Johnson, Kate and Eric Mackres. Washington, D.C.: American Council for an Energy-Efficient Economy, March 2013.

LISC Retrofit Tool Kit
Tohn, Ellen, Elizabeth Glynn, and Kristin Blum. Green & Healthy Property Management: A Guide for Multifamily Buildings. Boston, Massachusetts: Boston LISC, February 2013.

Apartment Hunters: ACEEE Report #E13N
Apartment Hunters: Programs Searching for Energy Savings in Multifamily Buildings. Kate Johnson. Washington, D.C.: American Council for an Energy-Efficient Economy, December 2013.

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.

learn more

U.S. Multifamily Energy Efficiency Potential by 2020, Benningfield Group, 2009.

Multitenant Buildings: The Energy Opportunity, Nicole Sturdevant, Energy Cost Savings Council 1999.

Partnering for Success: An Action Guide for Advancing Utility Energy Efficiency Funding for Multifamily Rental Housing, National Housing Trust, 2013.

“The Impact of Energy Costs on Multi-Family Residential Building Value: Case Study Pine Harbor Apartments,” Cliff Majersik, Institute for Market Transformation.

Energy Star Success Story: TIAA-CREF Multifamily Housing, www.energystar.gov.

“The Impact of Energy Costs on Multi-Family Residential Building Value: Case Study Morrison Manor Apartments,” Cliff Majersik, Institute for Market Transformation.

Mcllwain, John. “The Rental Boost from Green Design.”

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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