Are We At a Pivotal Point in Energy Efficiency Financing?

Philip Henderson is a senior financial policy specialist at the Natural Resources Defense Council. As part of the Hanley Wood Sustainability Council for 2014, he will lead the Vision 2020 initiative in Economics + Financing.

Last year, our Economics + Finance chair Bob Sahadi said we’re at a very pivotal time regarding how we look at financing energy efficiency. Do you agree?

We’re at a pivotal time in how we finance single-family homes. Fannie Mae, Freddie Mac, the [Federal Housing Administration], and commercial banks—the traditional lenders—are at a pivotal time, period. How that plays out in part will inform how energy usage fits into that framework.

Energy usage in a property is one of the operating expenses, so it is Financing 101 to account for those expenses in the value of the property and in the borrower’s ability to pay for the property. At the same time, that’s hard to do in a house so there is a lot of work underway to test different methods of doing that and to see how it plays out.

I think there are definite signs that are very encouraging in the single-family market. One of them is that many home builders are marketing their houses to people with messages that include efficiency and energy use. I think they’re doing it because it works, it’s effective, it’s on people’s minds, it’s a material interest of value. That is a very encouraging sign.

In the commercial space, I think we are clearly through a pivotal time. If you talk to the leading building owners such as Vornado, Jones Lang LaSalle, Boston Properties, and CBRE, they are attuned to the importance of energy use in their buildings as it relates to value, tenant appeal, rents, and maintenance expenses. If you look at commercial buildings, it is a longstanding practice for the owner and lender to factor in operating expenses when determining how to value and pay for a building. Operating income is a centerpiece of valuation in commercial office buildings as energy use and expense are substantial costs. But then you think about multifamily apartment buildings and you have to ask if the usage is separately metered and are there inhibitors to aggregating the expenses into a single number.

Multifamily is a question mark right now. Many market-rate, multifamily building owner-developers are using efficiency to market spaces, but affordable housing has been ignored. We have an obligation to collect data and direct time and resources to those properties because whether they are affordable depends on energy expenses, not just the nominal rent.

Is it more complicated because energy use in a home is so behavior dependent?

I think it’s people’s intuition to think along those lines. It would be interesting to look at energy use before and after home sales across a large pool to see to what extent it has changed. Did it change 10 percent or 50 percent? We ought to make decisions with those kinds of facts, but we need more facts and a better understanding.

So, going back to your first question, are we at a pivotal time? We are in the financing structure of single-family homes, and for understanding the national interest in energy efficiency. In the second case, it’s pivotal that we have a better sense of whether our energy is sustainable. Just because power plants are away from town and not visible does not mean we don’t have to think about them.

Looking at all three market sectors without pitting them one against another, what are some of the most innovative things you think are being done today?

In the commercial market, it’s accepted and conventional to be very attuned to energy use in your building. Look at how Energy Star labels and LEED certifications have proliferated. Large tenants think about how long they will be in a building and ask, what can we do with the owner of the building to manage expenses in a smart way? A lot of large tenants look for Energy Star-labeled buildings and value them higher.

Do you think that the emergence of the energy benchmarking legislation will have a dramatic effect?

I think it’s very important. When it comes to buying, Energy Star is something of a yes/no indicator for expected energy use. Benchmarking gives you a much better sense of where a building stands. It’s compelling for cities to do this and we’ve seen how better information can change consumer behavior, as well as the behavior of market participants, lenders, insurers, tenants, and appraisers. The more information, the better.

It’s a little hazardous to predict exactly what everybody’s going to do with this data. I think we’ll have to let it unfold a little bit, but it will have powerful effects. One of the effects is simply to inform this conversation about what’s going on in buildings around the country.

In the single-family market, what would you identify as a few important things to do to help address the valuation challenges?

Let me reframe your question slightly to ask: assuming people in an institution are acting rationally, is the market working or is there a problem? Some people argue that it is working fine and expenses are low, so people are not irrational in ignoring it. I don’t think that’s right. What tells us that the market is not working well? Number one: Is the information ok? When a person goes to value a house—whether it’s the prospective home buyer, Realtor, seller, lender, appraiser, or insurer—it’s usually a few steps to get the actual energy expenses. How do they compare to other houses of a similar size and occupancy? In order to understand whether the market’s working, I think you have to have that information to look at how it relates to value and affordability.

Is one of the next steps taking benchmarking legislation to smaller-scale buildings and single-family?

I don’t want to take the leap of going from problem to solution.

Number one: You have to improve the information and the access to information. What we’re seeing at the leading edge of the market is really fantastic innovation in design, architecture, and building materials. Giving prospective homeowners information about how the house compares to others can be a very powerful tool. When you talk to lenders and insurers, the level of information they have about home energy use and valuation is shockingly low. We have a long way to go to get them the information they need to make good decisions.

Number two: Education in this market has a long way to go.

I think it points out an opportunity for professionals who specialize in this realm to become the providers of that education. How can they help bridge the divide and ensure that people know what information to ask for?

Most Realtors will say that’s not right because they have the bills and will give them to you if you ask. The problem is that it happens very late in the real estate transaction and is not readily incorporated into the shopping. Also, education takes time. Something has to happen as homeowners are thinking about moving or renovating their house.

Since 2012, Hanley Wood has conferred with building industry experts to establish a timeline of critical goals and metrics that building professionals must establish and meet by the year 2020 in order to preserve our environment and meet large-scale goals such as those of the 2030 Challenge. Scroll over points in our on-going timeline to learn more about the path ahead in green building. Track our progress all year as the Hanley Wood Sustainability Council shares their perspectives on initiating, tracking, and ensuring progress toward these sustainable priorities and goals. This year's program will culminate in an exclusive Vision 2020 Sustainability Summit in conjunction with Greenbuild in New Orleans, and with a special Fall edition of ECOBUILDING REVIEW.