August 2018 — No-cost or low-cost improvements that generate economic, social, and environmental benefits are easily funded as they require little to no capital investment. High-performance improvements, however, generally require some level of capital investment, which means that additional cash must be obtained.
To successfully source the best funding solutions, managers must be aware and be able to identify potential challenges that may be associated with obtaining financing and the various financial mechanisms. Typical investment barriers that may prevent an owner from obtaining financing for a high-performance project include:
- Property size
- Investment details
- Accurate investment assessment
- Credit ratings
- Investment limits
Once these investment barriers are identified, owners or property managers can address and mitigate these potential issues in order to obtain the best financing solution for their high-performance focus.
Strategies for Mitigating Investment Barriers
Owners and property managers constantly face barriers in the daily operations of a property. Whether related to market competition, demanding tenants, extreme weather events, or financial stress, barriers must be overcome in order to generate returns on the property investment. Similarly, with high-performance investments, it would be highly unusual for everything to be neatly laid out and easily accomplished. The following will help identify strategies to help high-performance investments overcome barriers.
Property Size
Notwithstanding potential returns achievable by a high-performance investment, the size of the property frequently influences the availability of external financing options. Utility programs seek to generate maximum impact from rebates and incentives. So they often have a minimum energy reduction threshold for eligibility. A smaller property may not be able to achieve the required minimums and thus would not be able to access the incentives offered. The HVAC equipment in a smaller property might be decentralized and difficult to replace without significant disruptions to the tenants.
In other situations, the administrative and technical support required for a particular project may exceed that which is available at the property. Larger properties tend to employ more staff, who in turn have a wider scope of capabilities and skill sets. As a result, the property team is able to deal with the demands of a high-performance investment. Even if using a power purchase agreement (PPA) where the energy service company (ESCO) undertakes all of the technical and administrative chores, the ESCO may reduce the savings offered because the required overhead is not properly supported by the returns available on a small property.
Aggregating multiple properties for a particular program can often help overcome the size issue for individual property funding. This may be easier for a single ownership with multiple assets, but would require coordination if multiple owners are involved. A common property management firm may be able to offer the coordination required. But concerns over potential conflicts of interest must be closely monitored and controlled to avoid the aggregation from falling apart.
Investment Details
An owner seeking to fund a high-performance investment through cash flow from property operations may be willing to proceed with less than complete information. Perhaps the owner has experience with a previous project, or is curious enough to risk testing new technology, or is even willing to accept a lower return simply to make a statement about its commitment to sustainable operations.
When expecting to use other people’s money, there is a more stringent duty as a fiduciary owed to the party advancing the funds needed to implement the desired project. The direct and indirect impacts of a project must be thoroughly vetted. Issues such as local zoning restrictions, physical suitability of the property to accommodate the equipment and systems needed for a project, neighborhood opposition, tenant expectations and possible disruptions to their operations during the installation, and even future maintenance requirements for the project after installation must all be identified and taken into consideration.
Accurate Investment Assessment
Few things are more embarrassing to a property owner or the property team than using an incorrect financial analysis to support a high-performance investment. What assumptions are being made on first costs, ongoing maintenance costs, interest rates, and anticipated life spans? Were the calculations executed correctly? Double-checking calculations will help expose simple mistakes. An in-depth review and validation of the assumptions by an experienced working group or subject matter experts brought in especially for this purpose will catch obvious errors. It is important that valuation is aligned with key stakeholder preferences. More details on these topics are available in other chapters of this course.
Credit Ratings
If a property owner has maintained a good credit rating, it should be easier to obtain third-party financing for loans to fund high-performance investments. Even ESCOs will review the property owner’s credit history before moving forward with a project.
Investment Limits
The owner’s specific plans for a property are separate from any external issues related to accessing financing options for high-performance investments, as are the internal governance and controls in place at the entity level. Two examples of internal governance are a limit on the total capital to be invested in a property, or a limit on the loan-to-value ratio permitted for a property.
If the property is slated for disposition, this may mitigate against entering into any long-term commitment or obligation to a third party. The ability to transfer any commitments to a purchaser will reduce this exposure. But recognize that the introduction of another variable may make a negative impression on a prospective purchaser. Even if the high-performance investment meets the current owner’s return objectives, the prospective purchaser may have different objectives.
Some owners may have organizational limits on the amount of debt allowed. For instance, investment funds will have specific ratios established that cannot be exceeded without violating the fund covenants, even if the investment offers an accretive return to the property.
It is impossible to address every possible contingency related to challenges in obtaining financing. Financing for high-performance investments will have an additional hurdle to overcome beyond that experienced by regular financing, because social and environmental values are not yet recognized by every potential lender. Success in the high-performance arena relies on the ability to find the right lending partners focused on all aspects of the triple bottom line.
This article is adapted from BOMI International’s High-Performance Sustainable Building Investments, part of the new High-Performance Sustainable Buildings credential (BOMI-HP™). More information regarding this course or the BOMI-HP™ credential is available by calling 1-800-235-2664. Visit BOMI International’s website, www.bomi.org.