Unlocking Hidden Value in Class B/C Office Buildings

| January 27, 2020

The following is an excerpt from a report issued recently by the Urban Land Institute. The authors are Joey Cathcart and Greg Hopkins of Rocky Mountain Institute, and Monika Henn and Marta Schantz of Urban Land Institute.

The report is intended to simplify and streamline energy efficiency and green leasing opportunities for Class B/C office owners and provide strategies that are appropriately tailored to the reality of the market, anchored around overcoming core barriers for Class B/C building owners.

It’s time that Class B and C office owners recognize the largely untapped business opportunity to improve the energy performance of their properties. Beyond the more obvious financial benefits of energy cost savings, additional market factors also play into the timing to move on energy efficiency sooner rather than later.

Local benchmarking ordinances and building performance improvement regulations, initially targeting larger commercial properties, are now phasing in compliance for smaller properties, which include many Class B and C assets. And although Class B/C office tenants may not pay higher rental rates, owners are likely to lease more quickly than competitors and retain those tenants during lease renewals, when a space is more sustainable and energy efficient (increasing occupancy while avoiding turnover, vacancy, and new tenant improvement costs).

Furthermore, for the ambitious owner looking to reposition a Class B or C office asset into an A property, incorporating energy efficiency measures into renovations provides an opportunity to add longterm value via new building systems and improved operational efficiency.

Even with all these benefits, there’s a reason that the Class B/C office market hasn’t yet wholeheartedly adopted energy efficiency and green leasing into its general business practices: It’s at a disadvantage compared to the Class A market. These properties are information-constrained: stakeholders operating Class B/C buildings are often so consumed with day-to-day activities that they do not have the time to learn about best practices for energy efficiency, green leasing, or new technologies to improve operations, and they need quick, low- or no-cost options to choose from.

These properties are resource constrained: Staff working at Class B/C buildings wear multiple hats; rarely do they have dedicated third-party management and/or building engineering staff with time to focus on identifying, championing, and implementing energy efficiency efforts. And these properties are funding-constrained: Class B/C buildings typically do not have large budgets/capital planning funds to invest for large energy retrofits with high up-front costs.

A survey of stakeholders with expertise in the Class B/C office market, who were involved in developing this report, identified the top barriers to energy efficiency in this sector as limited working capital to pay for project costs (60%), limited staff capacity to implement (47%), and low priority versus other business activities (40%).

Nevertheless, the business case is strong to unlock hidden value in Class B/C office buildings and portfolios through energy efficiency and green leasing. The time is now for owners to take advantage. Compared to business-as-usual operations, Class B/C properties could save roughly 15% of their energy costs with a bundle of low-to-no-cost measures, and 35% or more with larger investments that still reap a three year payback period. That can reduce a property’s operating expenses by $0.26 to $0.61 psf (i.e., $20,000 to $46,000 for a 75,000sf building), increase net operating income (NOI) by 1.9% to 4.3%, and boost property value by approximately $4 to $8 psf (i.e., adding $269,000 to $627,000 in value to that same 75,000sf building).

With green leases in place, an owner can recoup its investment with even better financial outcomes for the property: NOI increases of 2.4% to 5.6%, property value increases of $5 to $11 psf (i.e., $343,000 to $800,000), and 0.5% to 1.0% higher internal rates of return (IRRs) over a five-year period.

Class B/C buildings are not making as much progress as Class A assets on capturing financial and other benefits of energy efficiency and green leasing, but they also have the most to gain, by focusing on low-cost, high-impact strategies. In a changing market with evolving tenant preferences, new energy efficiency technologies, and continued policy action to reduce building emissions, buildings implementing energy efficiency can stay ahead of the market.

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