Rising energy costs and a heightened environmental awareness have forced owners of office buildings to scrutinize their energy consumption like never before. By implementing operational changes, building owners can achieve annual energy savings of 40 cents per sq. ft., industry experts say. Capital improvements can boost the total savings to as much as $1 per sq. ft. In a 100,000 sq. ft. building, for example, the investment can shave $40,000 to $100,000 off annual costs.

Arden Realty, a Los Angeles-based REIT, is keenly aware of the savings potential. Over the last six years the publicly traded firm, which owns 19 million sq. ft. of office buildings in Southern California, has spent $25 million to increase energy efficiency across its portfolio.

It generally takes five years to recoup the cost of the investment, says Scott Lyle, president of next>edge, a Los Angeles-based energy management company and Arden subsidiary. Depending on the extent of a particular building upgrade, Lyle adds that the internal rate of return on energy-saving investments can range between 20% and 40% annually.

At 8383 Wilshire Blvd. in Los Angeles, Arden's payback took less than two years. The REIT spent $1.8 million to revamp the 417,463 sq. ft. office building built in 1971. Improvements included an energy management system — software that controls all electronic devices — the replacement of low-efficiency bulbs and ballasts with more efficient ones, and new chillers. When completed in 2001, the retrofit helped reduce Arden's electrical costs by nearly $1 per sq. ft.

Such dramatic cost savings are not unusual for buildings 25 years or older that undergo a building systems overhaul, Lyle says. Lower operating costs equal higher net operating income, and thus higher net asset value. Building owners can pocket the savings going forward, then pocket more when they sell. Or, when the markets are soft, owners who have invested in efficiency can undercut competitors on rent. “However you look at it,” Lyle says, “you have a positive impact that is coming out as increased cash flow.”

Growing Awareness

While Arden and other large office building owners such as Houston-based Hines led the office sector's efforts to become energy efficient, the sharp rise in prices and shocks such as the California energy crisis of 2001 have made energy awareness a more prominent issue throughout the commercial real estate industry, Lyle says. But the vast majority of office building owners lack energy-saving strategies, he is quick to point out.

Stuart Brodsky, national manager of commercial property markets for the Environmental Protection Agency's Energy Star building label program, says the industry collectively is just beginning to understand the potential for savings. “For a long time, the industry didn't have a standard way of measuring what is, and what isn't, efficient,” says Brodsky.

In late 1999, the EPA introduced the Energy Star building label program, an initiative to make commercial buildings more energy efficient. The program centers on Energy Star's “Portfolio Manager” tool, which enables owners to assess building efficiency.

Portfolio Manager assesses a building's energy use, occupancy, space use and other information and then ranks the building on a scale of 1 to 100 on how it performs compared with similar structures. Variables such as weather and location are taken into account to standardize the comparisons. For example, a ranking of 40 means that 60% of similar buildings are more energy efficient. A ranking of 75, which puts a structure in the top 25% of efficient buildings, earns a building the Energy Star label.

REITs were the first to embrace the Energy Star's building program, but recently pension funds and advisors have become active — as a way to enhance their returns. Late last year, the EPA and Energy Star recognized Lend Lease Real Estate Investments and TIAA-CREF for their involvement in the building label program. The EPA estimates that strategies implemented by the two investing giants have reduced energy costs by about $14 million on 35 million sq. ft. of property annually.

Since 1999, the Energy Star program has grown from 1 billion sq. ft. of office space to more than to more than 4 billion sq. ft., according to Brodsky. He anticipates about 250 million sq. ft. annually will be added to the program over the next few years.

Incentives

Still, only about one quarter of all office structures in the U.S. will be able to achieve a ranking of 75 or higher, Brodsky says. That, he adds, should not deter office building owners from pursuing power-saving programs.

Any building can benefit from the Portfolio Manager program. It is free and can be found on Energy Star's Web site (www.energystar.gov). To use it, users don't have to become Energy Star partners. The idea is to persuade building owners to make simple operational changes to improve efficiency, such as making sure the cleaning crew turns off the lights, says Jim D'Orazio, senior vice president of the facilities resource group for Grubb & Ellis in Chicago. “We're not necessarily looking for (Energy Star) certification,” he says, “but this is a no-cost thing, so we're saying enter your data and see where you stand.”

So, what are the obstacles to greater energy efficiency? While owners will gladly make operational changes to improve energy efficiency, short-term investors generally won't invest capital in new lights, chillers or other building systems, say industrial professionals.

That's especially true in markets where low utility costs mean that any payback on the investment won't be realized for five years, says Roy Cook, vice president of engineering and construction for Transwestern Commercial Services, a full-service real estate firm that manages more than 100 million sq. ft. On the other hand, Cook says that building owners in California — home of sticker-shocked energy buyers — may recoup the same investment in two years.

Do It Your Way

Chicago-based Equity Office Properties hasn't been shy about spending money to make its portfolio more efficient. The REIT saves some $30 million per year in operating costs thanks to programs that began in the 1990s, according to Frank Frankini, senior vice president of development and energy operations.

Now, Equity Office has taken a more aggressive tack. The REIT has an effort under way to generate its own electricity at its buildings. Known as “distributed generation,” the strategy has been practiced for years by large manufacturers and owners of campus settings. But deregulation has made it attractive to smaller users as well, and today distributed generation is touted as a way to create cleaner, more efficient electricity.

It also reduces grid demand and provides buildings with backup power. Those advantages have convinced office owners to pursue the cost-saving technology, especially in California where high electricity costs and blackout worries persist.

Equity Office has committed $15 million for natural gas-fueled co-generation power plants powering nine buildings. A reciprocating internal combustion engine, essentially an automobile motor, already is producing about one-third of the power for 30 North LaSalle, a 926,000 sq. ft. office building in Chicago. In addition, plants that power buildings in Boston, San Diego, New York, San Francisco and Los Angeles will be operational this summer.

The amount of electricity the plants provide to each building will vary between 15% and 35% of total consumption. The heat created by the power generation will be used in other building systems.

An Equity Office subsidiary will own and operate the systems, offering tenants power at 99.5% of the local utility rate. That doesn't seem like much of a price break for tenants. But the systems will reduce the amount of electricity buildings buy from utilities during peak usage times. Those are periods of high demand, such as in the middle of a hot afternoon when air conditioners in homes and businesses are all running at full-throttle.

Peak times also are when electricity costs the most, and less demand for a utility's electricity during those periods will allow Equity Office to negotiate for lower rates from utilities. That will save tenants money in the future, Frankini says.

Frankini estimates that energy savings in the nine buildings will pay off the initial investment in about five years and provide an average annual cash-on-cash return of about 20%. Equity Office intends to expand distributed generation to as many as 100 buildings.

Starting from Scratch

While Equity Office chose to own and operate its systems, other options are available. RealEnergy of Woodland Hills, Calif., for example, builds generation plants at office buildings, typically providing the structures with half of their power.

Since starting up about four years ago, RealEnergy has built some 20 systems in California and has contracts to double the number of plants there. The company also has penetrated the Northeast, and late last year agreed to provide half the electricity for Transwestern's Park 80 West, two buildings totaling 488,000 sq. ft. in Saddlebrook, N.J.

Signing with RealEnergy is part of a two-pronged strategy to reduce costs and beef up efficiency, says Randy Bessolo, managing director of Transwestern Investment, which has acquired more than $3 billion in real estate assets in the United States, including 10 million sq. ft. of office space. He anticipates saving $50,000 a year in energy costs with the RealEnergy system.

“Everything being equal,” Bessolo says, “tenants would prefer to be in a building that has been given a stamp of approval for operating cleanly and efficiently.”

Joe Gose is a Kansas City-based writer.