Survival of the Retro-Fittest

A growing list of financing options is making it easier to turn existing apartment properties green. Fannie Mae upgraded its Green Rewards program last fall, and Freddie Mac launched its own Green Advantage program to compete. Then there is the Federal Housing Administration’s PowerSaver Energy Rehab loan and Property Assessed Clean Energy (PACE) financing options across the country. Clearly, the real estate financing market is embracing energy-saving property retrofits.

“The recent opportunities granted by the big lending agencies have demonstrated that our industry has finally recognized the benefit of energy efficiency in our nation’s housing stock,” noted Gemma Geldmacher, senior director of Berkadia’s Boston office.

“We really do want to encourage borrowers to make these enhancements to their property … to make it more efficient, because it’s better for us; it’s better for the sustainability of the property; it’s ultimately better for the tenants,” Hilary Provinse, senior vice president of customer engagement at Fannie Mae, told MHN.

Greenbacks for green enhancement

In a report from the Urban Land Institute, Iain Campbell, vice president of global energy solutions for Johnson Controls, estimated that whole-building energy retrofits can cost anywhere from $2 to $7 per square foot and can take two to 15 years to achieve a full return on investment, depending on the property’s age, design and targeted savings. But the savings can be significant, to say nothing of the improved property value and competitive standing against new properties, which increasingly feature energy-saving appliances and systems.

A study conducted by the U.S. Department of Energy found that an estimated $16 billion in possible energy cost savings go unclaimed nationwide. Yet in a sample of 13 multifamily properties in Chicago with a median age of 95 years and an average of 30 units, the study found that, post-retrofit, buildings saw an average decrease of almost $200 per square foot in natural gas expenditures and an average 2.95 percent increase in net operating income. While taken from a small sample in one area of the country, the study’s findings are promising, as the natural-gas savings resulted in the equivalent of almost two months of additional rental income and the increase in net operating income amounted to an average of $55.96 per unit per year.

Such savings benefited Park Terrace Apartments, a 92-unit property in Yuba City, Calif., according to the Department of Housing and Urban Development.  Built in 1974, the property had inefficient boilers and an outdated design that were resulting in excessive energy costs. Following a facility energy audit, owner Mercy Properties Inc. installed a new solar hot water system, modern efficient windows and room air conditioners. The project cost some $6.8 million, but it saved $9,000 worth of energy annually. The property realized its return on the original investment in six years; it has since maintained a 50 percent reduction in energy costs for hot water and is exceeding California energy standards by 15 percent.

The RADCO Cos. has seen similar energy savings. “We have found that if we change the HVAC system, the appliances and the windows, that you can see up to a 50 percent savings in utility costs,” noted CEO Norman Radow, adding that for residents who make $50,000 per year or less, this can result in significant savings.

And on resale, according to a report released by the Northeast Energy Efficiency Partnerships Inc., ENERGY STAR certified buildings sell for an average of $61 more per square foot, and LEED buildings sell for an average of $171 more per square foot compared to similar properties.

Critical criteria

The financing provides a big step forward, Geldmacher observed. “(ROI) can vary extensively based on the property specifics, but in the most successful scenarios, the upfront costs are often mitigated partially or entirely by the particular lender’s pricing benefit, with the ongoing savings going directly back into the property,” she said. However, “these opportunities are not without challenges.”

“The age of the building can play a big part in its energy-efficiency opportunities, and the way it was constructed can play a big role,” said Holly Charlesworth, a manager of government affairs with the National Apartment Association. “Multifamily are not all alike, and you can’t expect them all to reach a certain level in the benchmarking score.”

Age is a critical consideration. While the word “retrofit” indicates the enhancement of an older property, Freddie Mac Senior Vice President of Production & Sales John Cannon advised that the best returns are achieved in properties that are more than a decade old. “We’re not targeting a property that was just built 10 years ago, because you’re probably not going to … see the dramatic decreases in utility expenses.”

Accordingly, Freddie Mac is targeting 20-year-old properties. And that, according to Cannon, means the best financing candidates are limited to certain parts of the country. The Sunbelt region, for example, tends toward newer housing stock. “A lot of the older housing stock is not in the Sunbelt. Not to say that there aren’t any there, but we’re seeing a lot of demand in the Mid-Atlantic, the Northeast, the Midwest, where there tends to be a little bit older housing stock,” he explained.

In addition, “there are very few properties that haven’t been traded or worked on in the last five years, so very often you’re getting a second-generation bite at the value-add apple,” Radow noted.

The degree of retrofit has also changed. “Some things we did to value-adds three or four years ago now are obsolete because the market has gotten more sophisticated,” said Radow. RADCO’s current priorities include such system upgrades as replacing incandescent with LED lighting or installing water-saving plumbing.

Financing for such projects has gotten more sophisticated, as well, as Brendan Coleman, managing director with Walker & Dunlop, pointed out. “It’s important to note that both agencies, and even HUD, through their regulator, have really focused on providing financing solutions for properties across a spectrum—for apartment buildings that hit improvements of energy usage or to encourage development of new, ‘certified green’ so to speak buildings, and it’s really become a hot-button issue for all of them.”

Energy-saving edification

While each financing source has its own special focus, varying in costs and benefits, according to Geldmacher, elements of both of the GSEs’ programs cover the cost of the required energy audit in exchange for specified energy and water reductions. “Fannie Mae really has taken the lead because they are specifically reaching out to their participating banks and offering the (Green Rewards) program, which includes an energy audit funded by Fannie Mae,” explained Nicole Upano, a manager of government affairs for the National Apartment Association.

Such audits can be very beneficial for older systems. While they are almost always in need of a little upgrading, an energy audit can identify exactly where a property is wasting energy and money.

Geldmacher recommended conducting an ASHRAE II energy audit, “since it identifies all the potential energy upgrades and shows the Savings-to-Investments Ratio (SIR) so that the owner can decide which items will provide the biggest bang for the buck.” The independent organization’s level II audit includes a primary analysis of utility bills and operating data and a detailed financial analysis of each prospective upgrade based on building-specific initial costs and expected savings. If supplementing financing, she said, “the agencies and HUD will either refund the costs of these reports or include it in the cost of the mortgage.”

Since gathering energy data takes more time than a traditional deal, Geldmacher advised, “the only way to combat the clock is to get started early, have a good data collection plan and educate the residents on how this will benefit them so that they can be partners in the process.”

Achieving energy reductions will only become more important, and not only for the cost savings. Municipalities increasingly are ensuring that commercial and multifamily buildings monitor energy use by implementing benchmarking ordinances. “Across the United States, the benchmarking ordinances, which started in New York City, have moved to a lot of the larger cities already, and they’re moving now to the midsize cities,” Charlesworth said. “I expect a lot of the larger municipalities will revisit their benchmarking ordinances as the program keeps moving forward.”

Ultimately, though, the higher-quality living experience associated with an energy-efficient building is what makes the initial costs worth it for RADCO. “I hear from residents all the time, and it just makes me feel so good, how the quality of their life is better, not just that they save money,” Radow attested.

Originally appearing in the April 2017 issue of MHN.