Multifamily REITs Acquire New ENERGY STAR Benchmarking Opportunities

The apartment REIT sector is receiving welcome and long overdue news – the ENERGY STAR program is releasing a new multifamily energy benchmarking and scoring tool in Fall 2014. Owners and operators of existing multifamily housing properties with 20+ units will be able to use this capability to assess their property’s energy performance relative to a national peer group.

ENERGY STAR’s Portfolio Manager can now produce a 1-100 percentile ranking for multifamily properties normalized for climate, weather and occupant activity that serves as an objective assessment of building energy performance. The Fannie Mae Multifamily Energy and Water Market Research Survey provides the underlying data used as the basis of comparison for a multifamily building’s ENERGY STAR score.

Energy Measurement and Management

Rising utility rates bring financial risk, reducing the profitability of multifamily investments while digging into the limited disposable income of renters. Owners of energy efficient properties are well positioned to attract and retain tenants while also saving operating expenses on common area utility costs. Fannie Mae, the leading lender to the multifamily sector, performed in-depth analysis to inform a series of findings published in their 2014 white paper, “Transforming Multifamily Housing”. Three key findings jump out:

A spread of $165,000 in annual utility costs between the least and most efficient properties of similar size and scale
The most vs. least efficient properties exhibited a 3x spread differential in energy consumption and 6x differential in water consumption.
The average 100,000 SF property spends $1.25/SF on energy and $0.33/SF on water; reducing these costs by 15% leads to an asset value increase of approximately $400,000 at a 6% cap rate.

For apartment REITs and their private equity firm counterparts, the ENERGY STAR multifamily benchmark tool allows executives to better understand a property’s absolute energy use with the additional benefit of comparative context and ranking. This information on an asset’s relative standing can inform building upgrade investment decisions, or when tracked over time can factor into ownership’s buy / hold / sell equation. At minimum, any purchaser of a multifamily asset should request the property’s ENERGY STAR score as part of the investment due diligence process.

The ability to assess relative energy performance also offers on-site management personnel new tenant engagement opportunities aimed at reducing energy consumption and related OpEx costs. Implementation typically includes community-wide tenant communication campaigns, common area lighting and HVAC upgrades, and new lease clauses requiring tenants to provide energy data access to the landlord for benchmarking purposes.

Market Signaling

An ENERGY STAR score provides REITs with market signaling opportunities at key financial moments of truth:

1) attracting debt/equity capital investment

2) leasing and keeping residents

3) at time of property sale

When seeking investment capital, institutional investors and debt and equity capital providers pay close attention to indicators of management skill, and asset value. Investor confidence in management’s competence is essential to maintaining share price and access to capital markets, both of which are critical components to a company’s overall cost of capital and competitive position.

Transparency on energy performance is highly beneficial when communicating with investor stakeholders, particularly through the GRESB and GRI reporting frameworks. Also, portfolio owners who achieve an ENERGY STAR rating of 75 or higher will find these assets recognized in the Green Building Information Gateway showcasing their market leadership.

Competition for high-quality tenants has strengthened significantly and owners who can demonstrate superior value are best positioned to outperform. Harvard University’s Joint Center for Housing Studies December 2013 report America’s Rental Housing: Reducing Energy Costs reveals US averages on energy costs as a percentage of total rent (14.9%) and disposable income (4.8%). The accompanying Harvard JCHS research brief breaks out these energy cost factors by state, while showcasing how energy guides like the City of Austin’s can be used as a leasing communication tool. Given the National Apartment Association forecasts 2014 apartment supply growth exceeding 4% in many major markets coupled with a 50 basis point drop in occupancy rates, apartment owners who offer the greatest value proposition to their tenant customers are best positioned to succeed.

At time of sale, investors will be sure to note the market precedent being set by the 788-unit Gerding Edlen Green Cities Fund I portfolio. This 100% LEED Gold/Platinum portfolio of seven urban core apartment assets is currently offered to the market with final bids due 4Q14. Owners and investors will be keen to dissect this transaction to understand: 1) total price paid, 2) time on market, and 3) bid velocity among other value drivers [CBRE listing overview here].

It will be interesting to see how REIT management teams respond to these new multifamily ENERGY STAR tools. Industry leaders that engage with sustainability tools like ENERGY STAR and LEED signal to the capital markets that their assets are well-managed, operating expenses are monitored, and best practices are in place to help mitigate unforeseen risk factors. All things equal, investors prefer companies with these characteristics and price their capital accordingly.

Learn more about the implications for achieving LEED Existing Building certification from my USGBC colleague Bryan Howard.

UPDATE: For more on ENERGY STAR’s release of the multifamily rating tool, please see Part II of this series titled “Energy STAR for Multifamily: Implementation and Management Strategy“.