Property Values in the Age of Renewable Energy

Once the market begins to grasp that renewable energy, any form of clean energy, means free energy and therefore no energy bills, and therefore permanently lower O&M (Operating & Maintenance) costs compared to a fossil fuel infrastructure, property values will forever be affected by that information. Property values will become directly related to energy prices for the one and only reason that now there is an alternative--there is a benchmark. It is only a matter of time until net-zero is that benchmark, because it is so simple and easy.

As economists would tell you, the action always happens on the margins, and in this case what's happening on the margin is that net-zero construction flourished all through the recent real-estate downturn. That is important information for property valuation. Currently, we are at the dawn of a more public awareness of that net-zero homes and buildings, as the financial industry is grappling with the related underwriting issues, and beginning to formulate green financing methods for renewable energy retrofits, which they somehow stubbornly continue to misunderstand as energy efficiency retrofits.

The sceptics will argue that the incremental cost of renewable energy is sometimes greater than the incremental value added, but that is a short-sighted argument. This may have seemed true at times during the recent low energy prices... Just wait until energy prices start rising again! the point being that whoever was able to find renewable solutions will see the value of their property go up in tandem with the energy prices. The mission is simple: find such renewable energy solutions as make sense today, and be prepared to add-on in the future. For existing buildings, net-zero is a direction, and what matters is getting closer to it.

The secondary issue affecting property values will become resiliency: to what extent is your property able to continue functioning if the grid comes down. This implies that net-zero is not the be all and end all, must have objective, after all net-zero is easier to do in new construction than in old construction. Even approximating net-zero can only be achieved with renewable energy options, however - no amount of 'energy efficiency' will get you there. Independence from the grid is more important than achieving net-zero status, even if it is only partial. Just ask the people who were without utility service for weeks and months after hurricane Sandy. They would have given their hen's teeth for hot water, if nothing else. Valuing resiliency is trickier, and will depend in part on how many power outages we had in the last year.

Case one: property values for Net-zero or not-zero (but close)

Green Looks are not enough

If you can start from scratch, with new construction, net-zero is now a broadly feasible thing, and it is in high demand. Given that this was the only area where construction flourished during the downturn, it is clear that the market values the notion of net-zero, and developers would not be building it if it wasn't financially worthwhile. So all the theoretical arguments that the costs exceed the benefits are out the window. Like with everything else, some designs will be better than others, and no doubt there are solutions that are uneconomical in the short-term. Thus it is up to property owners to figure out the winning formula for their properties that will get them partial independence from the grid. The central strategy is renewable energy in whatever form.

We might notice that in the data center industry it has been the rule for a long time now that the most reliable designs are to use the grid only for a backup, not as a primary source of power. This is another fringe phenomenon that holds a lot of information value. With respect to property values, any property that is practically independent from subscription energy sources and therefore the grid, will go up in value with every energy price hike and with every major power outage - all else being equal. These will be the premium properties. The benchmark will be the energy usage for comparable homes. And remember again, you can only get there with forms of renewable energy--energy production, not energy savings (although they help).

CASE TWO: ENERGY EFFICIENCY WAS ALL WE COULD DO

There is almost no case where you can't do at least some renewable energy, and but in the worst case you make your home as efficient as possible, and provide a generator to get you through the storms. Broadly speaking, these will be the mediocre homes, and for a long time they will be the majority, in part because people invested foolishly in energy efficiency even if they could have done renewable energy. Energy efficiency alone is a lousy strategy because of diminishing returns. Usually, 30% "energy savings" is very good from an energy efficiency standpoint, but with renewable energy 70-90% reductions in energy are usually within reach.

The underwriting industry for the most part is focused on energy efficiency as a priority and a requirement for certain financing, mostly referred to as green mortgages, etc. This is a trap for the financial industry as a whole and for building owners as well. There seems to be a general energy efficiency mania going on, which will have us miss the boat in terms of what could be done with renewable energy. Pity the poor property owners who get trapped in all these misguided incentives. Investments in energy efficiency will be wiped out if same/similar buildings implement successful renewable energy strategies.

Financially, the funniest part of the market will be those buildings that went along with the energy efficiency mania, but will come to trade at a discount, because investment-wise the efficiency strategy is a dead-end, and the resale value of these buildings will suffer as a result, if they had evident potential for renewable energy infrastructure, but followed the pied piper of energy efficiency.

case three: property values without potential - scrap it or fix it up?

The next class down is the lowest, and here increasingly tradeoffs between energy retrofits and demolition will take place. If the building is in bad shape, and doesn't have the potential for a serious renewable energy overhaul, the value will come under increasing pressure, again, simply because net-zero will emerge from the fringe and become increasingly main-stream. Entire classes of buildings will see property values decline because of it. Sometimes whole streets.

Location, location, location, and four more times

Assessment of property values will never be the same again, and NYC will never be the same when these lessons sink in. Manhattan will tend to be a permanent energy sink, and a future energy slum, although there are interesting options such as triple glazing with capabilities for shedding and harvesting heat as needed, which are a renewable energy option. The recent 90by50 report from the Urban Green Council put a lot of emphasis on this option, but for Manhattan, this is just about the only viable renewable energy option. All other options are overwhelmed by the scale of buildings. Most will never even get close to net-zero.

The outer boroughs by and large are in far superior position to exploit renewable energy quickly. Of course, the opportunity is rapidly being squandered with the current gas conversion tsunami, with the NYC Clean Heat program as cheerleader for the lemmings going off the cliff. Be that as it may, eventually property owners will get it, and there will be a tremendous shift in the NYC real estate landscape as a result. Besides the insights offered above, about the three broad classifications of buildings along the lines of their energy independence, any property must be evaluated on the basis of its suitability for all types of renewable energy: geothermal, wind, and solar, and in some cases hydro-electric power. Along with it the options for passive solar etc. need to be considered. And how close a property gets to net-zero status will become the benchmark for success.

Conclusion

Valuation of properties will never be the same as the impact of renewable energy is being felt. Besides the old location, location, and location, there will be 3 or 4 more: suitability for solar-, geothermal-, wind- and hydro-power. Net-zero buildings are becoming the gold standard in renewable energy implementation, and property values will reflect how close a building comes.

Compound Returns from Renewable Energy

There are many ways to look at our energy conundrum, and to understand why we're so dysfunctional, and not getting the job done with renewable energy. As argued here repeatedly, one of the primary obstacles is putting the cart before the horse with honorable sounding secondary objectives, which obfuscate sound financial decisions. Energy efficiency, energy savings and clean air standards are examples that cause such distortions, and lead to policy failure. They are secondary objectives, not primary ones. The worst policy failures are resulting from confusing energy efficiency with renewable energy, and treating them as if they were interchangeable, or worse yet, additive, when they are often mutually exclusive in practice.

The effect of majoring in a minor by putting these secondary objectives first, is to postpone the switch to renewable energy indefinitely, and to subsidize the fossil fuel industry at the expense of property appreciation. Therefore it produces the opposite of energy independence and undermines any attempts to ever meet Clean Air standards, such as New York City pretends to want to do. Energy Star, NYSERDA MPP, NYC Clean Heat, PlaNYC, various tax incentives, are all examples where false priorities foul up sound financial decision-making about renewable energy. Collectively they have more to do with why we are not making the progress that we claim to want than anything else. They are examples of policy failures. Their ally is the fallacious financial practice of property owners making energy decisions based on payback of equipment, instead of net present value add to property values.

In short, government incentives have assisted property owners in making more bad decisions about energy faster, by rewarding them to ensure they keep making the wrong decisions, and the beneficiaries are the fossil fuel industry primarily, and to a lesser degree the manufacturers of energy efficiency equipment. It all comes at the expense of property values, so owners of real estate are destroying their capital asset base, to the extent that there are renewable alternatives that make economic sense, and in many, if not most cases, there are. False priorities supported with government incentives amount to government sponsored capital destruction in our economy, and serve to prevent the switch to sustainability. In NY State there is even an Energize New York Finance Handbook, and an exam to make sure you learn how to destroy your property values even quicker, using other people's money (but you're still liable). There is even an entire not for profit industry to help you manage your property into the toilet, such as "Energize New York, comfort and savings for your home."

Sustainability is only sustainable if it is also profitable

Adam Smith's invisible hand arguably does not always work, but sometimes it does. And here we have a capitalist society, embracing soviet style 20-year plans to make sure we prevent the invisible hand from working... But the good news is, there is a way to sort it out on an individual level, though eventually the whole structure of false incentives will have to be revised.

Every property owner can, with a simple spreadsheet make a 30 year energy plan for their property. And if you are lazy, you can make it a thesis project for your kid. It does not matter if you're going to sell it sooner than that or not, for if you invest wisely, it will come back to you when you sell it. After all, real estate simply has a long economic life, but if your analysis shows that your property is a wreck, and incapable of being made somewhat energy independent, sell it quickly while the going is good. The energy companies and the government will keep you in the poor house by confusing your decision-making and keeping you a slave to the energy companies longer than you have to be. Proper financial modeling is the way out, he process is a simple 30-year NPV analysis of all energy decisions about your property. Do not ever give in to the energy efficiency argument, it will keep you in bonds to carbon energy forever. Salesmen of energy efficiency and Solar PPAs are stealing appreciation of your property from you.

If you do that 30-year CAPM model, you will not easily make wrong energy decisions again. Never allow yourself to be seduced by the sellers of energy efficiency, and any government incentives, or subsidized finance from your energy company (talk about the fox watching the chicken coop). Remember always: Good financing or incentives can NEVER make a bad project good, it can ONLY make a good project better.  Hang that on your kitchen wall before you start talking about anything to do with energy in your property. Now for the good news: Renewable energy pays, because of compound returns.

Compound Returns from Renewable Energy Make Sustainability So

Payback of a piece of equipment may be useful as a quick and dirty calculation to see if it could have promise, but you need to have a coherent, holistic energy plan first, or else you will be cheated out of your money, and squandering it. The obvious mistake is if you start using equipment payback for your actual energy plan, such as models from NYSERDA and similar organizations elsewhere tend to do. Incentives are then added to the mix to make other objectives more attractive to property owners, either from a societal standpoint (and most often indirectly benefiting the energy companies and/or the manufacturers), or for the energy companies directly, and then if you add up all these wrong decisions and you score enough points in their system, you are rewarded with subsidized finance to help you destroy the value of your property faster. The shareholders of the energy companies thank you.

But now you know. And armed with your 30-year energy plan for your property, here is what you do: You do your model first. You focus on selecting the technologies that make the most long-term sense for your property. And next you figure it out with the NYSERDA MPP model, or your Energize New York application, or whatever is appropriate in your case, and you now figure out backwards how to maximize your use of incentives, and how to exceed their standards so that you do qualify for the subsidized financing, including PACE bonds. But never follow the methodology of these institutions, for it will destroy your property value. Your own economic energy plan must be king, meeting their objectives is a secondary criterion that gets you the financing you want, but you must take ownership of the plan.

Here's the payoff: on your list of potential things to do you might have a geothermal heat pump and a wind turbine, with paybacks of 8 and 7 years respectively, and they are kind of at the bottom of your list. But then you find out, when you integrate it in your model, that the heat pump allows you to store output from your wind energy in the form of pre-heated hot water. By doing so, you no longer have to sell excess energy back to the grid at wholesale rates, so you are now improving the payback on your wind turbine. Put together, they might have a 6 year payback, but again, the 30-year projection tells all.

Or, you were evaluating a tankless hot water heater with a 3-year payback and a solar thermal system with an 8 year payback, but your thirty year model reveals that the solar thermal system works out better in the long run, in part because with solar thermal you can harvest process heat, and if you take that effect into consideration, it may turn out that it's a better investment than tankless hot water heaters. Thirty years of no energy bills beats 30% energy 'savings' hands down. And of course solar thermal beats out solar PV because it produces 5x more energy per square foot, and on top of that allows storing process heat. All of which you would never see in a payback analysis, but you will see it in your 30-year model.

Or, you were evaluating a geothermal hot water against solar thermal hot water, and it turns out that on a payback basis solar thermal won, but then you started to look at your integrated model, and you could put your geothermal heat pump on a time of use meter, and integrated it with self dimming LEDs (100% dimmable!) for premises/common area lighting, and suddenly the geothermal hot water system won, and now you could look if you could drive your HVAC from geothermal also.

Sustainability through compound returns

Examples abound where the thirty year model shows you synergies of two (or more) technologies that you would not otherwise figure out, but most importantly it is the time value of money that allows you to see that 30 years of no energy bills beats 30% reduction in energy consumption most of the time, and a bigger capital outlay is warranted, and feasible if you can access subsidized financing. Such compound returns through synergy are worth gold.

Conclusion:

Renewable Energy done right produces compound returns through integrating several Clean Energy technologies at once. Energy Efficiency of a fossil fuel system produces strongly diminishing returns after you hit about 30% 'savings,' which is literally fool's gold. Only energy-efficient renewable energy gives you financial sustainability.

Of PACE Bonds, Freddie Mac, Fannie Mae and Property Values

There are some fascinating developments around PACE bonds, and apparent obstructionism on the part of Freddie Mac and Fannie Mae, as reported in the New York Times on June 30th, 2010, "Loan Giants Threaten Energy-Efficiency Programs."

Based on some of the issues discussed in recent posts on this site, Freddie Mac and Fannie Mae arguably are actually right to threaten these energy efficiency programs, for to the extent that PACE bonds can be used to extend the fossil fuel franchise, they are suboptimal, and therefore destructive of real estate values.

The smart thing to do would be to have maybe the energy department provide simple criteria to ensure that the energy enhancements are viable renewable energy investments which would in fact enhance property values and therefore provide increased security for any mortgages, so that the technicality of the priority lien becomes irrelevant. After all an investment with a thirty year useful life, and a five year payback, in fact offers twenty-five years of free cash flows from energy "savings," which means a tremendous increase in value of the underlying asset.

This issue goes to the heart of the matter and is very suggestive of a constructive solution. The nation certainly needs some support for real estate values, and the unfortunate fact is that the current confusion of energy efficiency and energy independence based on renewable energy in the rules and incentives, by Energy Star as much as by the ARRA incentives, which in turn depend on the Energy Star programs, is to blame for this confusion. Energy Efficiency only makes sense within the context of a viable renewable energy program, when it comes in the context of a direct trade off against installed capacity, and an improvement of the economics of the project.

Energy Efficiency as applied to extending the franchise of fossil-fuel based energy solutions does not deserve tax credits, or other incentives, it is an operational savings. To emphasize again an issue that I've raised in other posts on this site: Energy Star rated High Efficiency Tankless Hot Water Heaters are perhaps the poster child of federal subsidies for increasing our dependence on fossil fuels, and preventing a switch to renewable energy at a time when numerous viable renewable DHW solutions exist in the market place. They should be outlawed, not subsidized. There are many other examples along these lines, but this one has perhaps more visibility than anything.

If you think of these issues over the typical thirty year life of a mortgage then you'll quickly see that a 30-40% gain in efficiency in water heating with fossil fuels will be eventually offset by energy prices, and perhaps forms of carbon taxation, while solar or geothermal hot water are available and reduce dependence on subscription energy by 80-99%. Energy Efficiency of fossil fuel based systems only possibly makes sense if there is no economically viable renewable alternative. Thus the issue here is "free energy" versus a temporary reduction in energy bills, and the permanently free energy will win the day in most cases if the value of that free energy over the next 30 years is taken into account, and that is a direct enhancement to property values.

The whole issue goes back to focus on payback periods of the investments as if they were independent of the buildings. They should instead be viewed as intra-marginal investments in the building, to ensure that they enhance property values. For society as a whole this will lead to the optimal result.

Freddie Mac did the right thing for the wrong reasons, and the solution lies in a test along the lines suggested here to ensure that such energy investments are constructive and supportive of property values, not a mere green washing that undermines long term real estate values for the appearance of being green.

The Lessons of Lamborghini Applied To Energy in Buildings

Lamborghini underwent an interesting paradigm shift with their latest new model, the limited edition Gallardo LP 570-4 Superleggera  and the lessons of their design considerations are relevant to what is going on around energy usage in buildings. The "Eureka" came when they finally understood that investment in more horse power was running smack into the wall of diminishing returns as it was becoming exponentially more expensive as it became less and less effective, while reducing weight was so much more effective that at that level of performance carbon fiber became a totally affordable option by comparison in seeking to raise performance.

In buildings the reverse paradigm shift needs to happen. We have been overemphasizing energy efficiency, without looking into energy production sufficiently. Often because energy efficiency investments tend to be smaller, and more easily justified, and no one seems to realize that in the process we cheat ourselves out of the investment decision to produce energy in the first place and become at least somewhat energy independent. Simply put, since money tends to have some resource constraints (costs and availability), by nickel and diming ourselves into a stupor with more and more energy efficiency, we will ensure that we will never invest in energy production and energy independence because the more efficient we become at burning fossil fuel, the lower are the returns on investing in renewable production. So energy efficiency is the lullaby which will make us once again the perfect little victims for the next energy price spike. Still the energy efficient buildings which do not invest in renewable production will eventually be worth less than the equivalent buildings which do because of the rising value of eliminating recurrent subscription costs of energy.

Seen in this light, energy efficiency is not a worthwhile goal unless it is truly the only option, and the basic make or buy decision of renewable energy production versus the alternatives should be considered first, lest we cheat ourselves out of ever making it. The way current policy and incentives reward energy savings on a par with renewable energy causes a metastatic cancer in our energy posture as a country, in which we continue to tinker with becoming simply more efficient addicts to fossil fuel consumption without ever making the switch to energy independence through renewable energy production. The way out of this delusion is to ask which building is worth more, this energy efficient building, which shaved 25% off their energy bills or the equivalent building next door which is e.g. 50, 60 or 70%% energy independent. Now it all comes down to a real estate decision, not an energy saving decision, and if you think you are in the real estate business, that is likely to be your better investment posture. And again, decision made, you can improve on it with energy efficiency.

Or, to put it differently, energy independence produces a higher property values than energy efficiency, and the order in which we consider these options matters a lot. As soon as some of the market adopts an energy production posture building values of those that don't will be depressed. Every investment in energy production is a direct price hedge, while energy efficiency for fossil fuels only attenuates the price risks. Politically the upshot is that the national interest in energy security coincides with a maximal use of renewable energy at the building level, and current incentives produce wildly suboptimal results. For real estate owners it is hard work to make the right energy decisions in spite of incentive systems which are very seductive, and make the wrong investment decisions seem plausible.