Why Energy Savings Matter Now More than Ever for the Buildings Sector

As we look ahead to the new year, the buildings sector faces many unprecedented challenges, including rising interest rates, increased regulation, and the changing nature of work. 

Chief among them is the soaring worldwide cost of energy, which peaked in 2022 at the height of the COVID-19 pandemic and has emerged as a critical concern for businesses and consumers alike. With energy demand expected to accelerate in 2024, high prices are a top concern for real estate owners and operators grappling with a variety of economic headwinds. 

In this article, we’ll explore the many reasons why energy savings now stand to make a greater impact than ever before for the buildings sector. There’s no time to waste, so let’s jump in. 

Reducing Energy = More Bang For Your Buck 

As mentioned above, a top challenge for global real estate is that energy costs have been on the rise since the beginning of 2021. The dynamics driving the increase in prices are multifaceted. Supply and demand fluctuations, geopolitical influences (including the war in Ukraine), and the pressing need for more investment in global energy infrastructure all contribute to the higher utility bills that many are experiencing. 

From a practical standpoint, however, this can present a perhaps unexpected opportunity for savvy building operators and real estate sustainability teams; namely, when electricity prices surge, each kWh saved has a greater impact on the bottom line. Energy saving activities across the spectrum – from operational changes and basic efficiency measures to capital improvements – now offer greater ROI potential than they may have previously. 

Understanding the cost-benefit calculus of potential efficiency measures requires historical performance data to generate an accurate baseline, as well as the ability to forecast and reliably measure energy usage on an ongoing basis. But when utility bills start breaking the bank, there’s no better time to make energy savings a focus and priority. Avenues to explore include shoring up building operations, empowering engineering teams with the data and tools needed to make low-cost efficiency improvements, and weighing the potential energy and carbon savings from larger capital projects – which, depending on your region and market energy rates, may now deliver a higher financial return than in years past. 

Increasing Asset Value through NOI and the Cap Rate 

Energy savings can have both an outsize bottom- and top-line impact when rates are higher – thanks to the twin concepts of NOI and cap rates. 

Let’s start with net operating income, or NOI, which is a crucial factor in determining the valuation of a building and evaluating its profitability. NOI as a metric refers to the total income generated by a property minus its total operating expenses, excluding financing costs such as mortgage interest and loan repayments. The formula for calculating NOI is thus: 

NOI = Total Income − Total Operating Expenses

Here's a breakdown of those two components:

• Total Income: This includes all revenue generated by the property. It typically comprises rental income from tenants, parking fees, income from on-site services, and any other sources of revenue directly related to the property.

• Total Operating Expenses: These are the costs associated with operating and maintaining the property. Operating expenses may include property management fees, maintenance and repairs, property taxes, insurance, utilities, and other day-to-day operational costs. Financing costs such as mortgage interest and loan repayments are excluded from this calculation.

It's important to note that while increasing rental income is one clear way to boost NOI, controlling and reducing operating expenses is equally crucial – with energy usage often comprising the single largest operating expense in a commercial building (sometimes as much as one-third of a typical building operating budget). And when utility bills increase, that percentage can of course creep upward. Finding ways to reduce energy can therefore be an effective vehicle for positively impacting NOI. 

But the financial benefits don’t stop at NOI. Thanks to a related metric (the capitalization rate, or “cap” rate), reducing energy can also deliver material gains in property valuations. 

The cap rate is used to evaluate the potential return on a real estate investment. It is expressed as a percentage and is calculated by dividing the property’s NOI by its current market value or acquisition cost. The formula for calculating cap rate is thus: 

Cap Rate = (Current Market Value / NOI) × 100

Using this equation, it’s easy to see how operational and energy savings that impact NOI can lead to huge swings in asset values – and how greater energy savings can yield greater gains in valuation. 

For example, let’s take a 100,000 square foot office building located in the the heart of a major urban center. The building generates $1M in NOI at a 7% cap rate. Per the equation above, this property would have a valuation of $14.2M. 

Now let’s imagine that the same building has cut its energy usage by optimizing equipment startup times and identifying and fixing an HVAC controls issue, saving $100,000 in annual costs. At $1.1MM NOI (thanks to the energy savings), that building now has a valuation of $15.7M. 

In this scenario, every dollar on energy saved yields a 15X return in property value.  

At a time of great uncertainty for many CRE asset classes, finding ways to shore up (and even measurably increase) property values has never been urgent for owners and investors. Reducing energy can be a powerful avenue to do just that. 

Need to Differentiate 

In the current competitive real estate market, it is imperative for owners and operators to find an edge. It’s a truism at this point that energy efficient, sustainable buildings can attract both cost- and eco-conscious tenants – and even command higher rents. The increasing awareness of environmental issues (and an overall drive to reduce costs) has led many businesses to prioritize sustainability as a triple-bottom line activity. Tenants, especially those with strong environmental commitments, are demonstrably inclined to choose buildings that actively engage in energy-saving and carbon-mitigating practices.

Implementing energy-efficient measures is thus not just a short-term fix that provides relief when bills are high: these strategic investments can drive long-term cost mitigation, enhance resilience, and improve building marketability. 

One potent example of this theory in action? Onsite solar installations. Not only do onsite solar projects increase cash flows by reducing utility bills by anywhere from 20-40%, but they have also been shown to contribute to higher rents and occupancy rates.  

Energy Requirements and Regulations Galore 

Another compelling reason to prioritize energy savings is that governments and regulatory bodies around the world are increasingly focusing on energy efficiency as a means to address long-term climate concerns. Building owners and operators must assess their organizational readiness for upcoming regulatory requirements and deadlines and begin making measurable, reportable progress – or in many instances, face the threat of significant fines. 

In the US, states and cities have largely taken the lead on climate regulations, with measures like New York’s Local Law 97, Boston’s BERDO, and Washington, D.C.’s BEPS setting forth specific energy and carbon emissions thresholds for commercial buildings that grow increasingly stringent over time. Unlike traditional local benchmarking ordinances, which require commercial buildings above a certain size to publicly disclose (but not necessarily improve) their utility performance each year, these policies require buildings to comply with a defined level of energy and/or emissions performance, even if getting into compliance entails that building owners must undertake costly retrofits as the thresholds progressively contract down the road. Overall, the trend for major municipalities to adopt building performance standards, or mandatory green building codes, like California’s CALGreen standards, presents significant implications for building owners and investors around the nation, many of whom operate at least in part in these top markets. 

In Europe, the EU has set forth a variety of measures that drive towards achieving full carbon neutrality by 2050, including the Energy Efficiency Directive (EED), which now stipulates that member countries must reduce overall energy usage by an additional 11.7% by 2030 relative to 2020 projections, and the Energy Performance of Buildings Directive (EPBD), which includes provisions that require countries to promote renovation to ensure the long-term decarbonization of the EU’s building stock. As of December 2023, the European Environmental Agency (EEA) reported that it is likely but uncertain that the EU will achieve its stated interim target to cut emissions by 55% by 2030 relative to 1990 levels.

Overall, taking a forward-looking and proactive approach to energy efficiency will help organizations stay in compliance with current regulations while ensuring readiness for future requirements. 

Final Thoughts 

Against a backdrop of rising energy costs, contracting property valuations, competition for top tenants due to the onset of hybrid working, and increasing regulation worldwide, there is considerable urgency for the buildings sector to prioritize energy savings. Beyond the immediate financial impacts, adopting energy-efficient measures enhances competitiveness, attracts environmentally conscious tenants, contributes to sustainability goals, and positions buildings and their owners for long-term financial resilience in a rapidly evolving market.