Energy Comes to the Forefront, Again
California's attempt at energy deregulation is a perfect example of Murphy's law at work. Anything that could go wrong did go wrong. The questions savvy owners and managers of real estate in other regions should be asking are: Can it happen here and if so, what should we be doing about it?
The first step is to understand your local markets and the state of energy deregulation. The metropolitan Washington region, for example, is in the second year of a four-year deregulation plan. During this time, public utility commissions have required power suppliers and utility companies to offer comparable rates or in effect levy price ceilings on how much power can cost. Certainly there are examples of companies buying commodity at prices lower than the top price ceiling, but a true deregulated market is still two years away. Are you prepared to deal with a totally open market that could lead to a similar California-like experience? Managers should let owners know that they need to account for potentially much higher utility costs when determining and negotiating pass through costs to tenants. Managers must carefully look at base year costs when providing data to owners for new leases and renewals. How would your property's bottom line be impacted if energy costs climbed from $1.70 per square foot to $5.20 per square foot like they did in California?
The uncertainty of energy costs, particularly in the future, is causing some managers and owners to rethink traditional lease terms. Instead of providing full-service rent contracts, some owners now are shifting the utility cost burden and risk directly to tenants. That can be a double-edge sword, however. Tenants are much less sophisticated energy buyers than are property managers and owners. As such, managers and owners need to determine the efficacy of throwing innocent tenant lambs to the hungry wolves that prey in the deregulated marketplace. When tenants have to spend more on utilities, they have less in the pot to pay for rent increases.
Clearly, the uncertainty of energy costs and the reliability of new providers entering the marketplace are focusing senior level attention on the issue. Some firms are looking at alternative energy sources such as co-generation as a way to help reduce peak demand, better control systems that help to regulate start up and shut down of mechanical equipment, and aggregating power purchasing across portfolios and buying from nontraditional providers.
The onset of deregulation focused most management attention on commodity. However, given the recent fluctuation in commodity pricing, determining how much gas and electricity are likely to cost in the future has about the same amount of certainty as predicting the weather. Controlling utility costs will be a primary factor in managers' ability to continue to produce gains in net operating income.
The most recent Building Owners and Managers Association (BOMA) Experience Exchange Report found that utility costs increased $0.05 per square foot from 1999 to 2000 and BOMA expects a similar increase in 2001. Effective energy management should come as no surprise that it will play an increasingly important role especially as the ability to increase rents decreases in a softening real estate market.
Energy deregulation strategies need to be constantly evaluated and revised in light of changing market conditions. Tenant education is one avenue that should be considered. Tenants will look to management for guidance on choices they have and how to best react to a deregulated environment. If energy costs are passed through and deregulation has increased operating costs by percentages that cause tenants sticker shock, management will have to be in a position to explain the actions they have taken to reduce those pass throughs in the future. Explain to tenants what you have done and what you plan to do in the future to help offset the escalating cost of utilities. An effective communications strategy will help to prepare tenants for higher bills and soften the impact. Energy management does not have to be management's responsibility alone. Whether you communicate with tenants through memos, newsletters, websites or a a combination thereof, offering suggestions to reduce consumption can help recruit support for energy management efforts. Tenants may benefit from knowing that raising the thermostat by 2 degrees during air conditioning season can lower energy costs by as much as 5%.
Many companies have assigned energy management to engineering departments or outside contractors. This outsourcing does not mean energy management disappears from the property manager's or portfolio manager's radar screen because the effect of energy policies will reflect on your properties' balance sheets.
Managers and owners need to evaluate the operating efficiency of control systems, control programs, lighting, air conditioning, electrical distribution, metering, emergency back up generators, annd preventive maintenance programs. Analysis of a property's utility bills, electrical power usage, equipment age, maintenance histories, and operating performance are needed to develop an effective energy strategy.
There is almost universal agreement among facility experts that the expansion of deregulated energy markets means higher energy costs. Managers need to work with owners to determine areas where retrofits of older equipment and systems make sense and provide the economic return needed to justify the cost. A common standard to justify cost is return on investment. However, the formula used needs to be based on past consumption patterns and not necessarily the amount of your bill. Recent history indicates that the past is not a harbinger of things to come.
HVAC and lighting systems typically are prime targets for savings. They account for approximately 60% of a building's energy usage. Upgrading these systems can cut lighting costs by as much as 50% without compromising lighting quality. An HVAC system upgrade has the potential to reduce costs by as much as 20%. Return on investment can be accelerated if you lease terms permit you to pass through these costs as capital improvements.
Property managers that take proactive steps to respond to the current energy crisis will create value for their owners, their tenants and their companies. The opportunity exists. It's time to capitalize.
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