SF Apartment : April 2016

FEATURE

Eco Logical

by Stephen Bjorgan

Two-thirds of San Francisco’s housing stock is multifamily buildings, the vast majority of which predate the first energy efficiency codes of the 1970s. Retrofitting older apartment buildings to use less water and energy is a significant step toward improving the sustainability of San Francisco. While new green building codes are important, changing the carbon footprint of existing buildings has an immediate environmental impact. But can greening your apartments also boost your building’s value?

Nowhere But Up
It’s well established that sustainability in real estate management can result in substantial cost savings. Sustainability and energy efficiency provide a hedge against the inevitable spikes in energy and water prices—and against the risk of market obsolescence. A green investment property gives an owner the ability to demand a higher base rent in trade for a comfortable and healthy tenant environment—not to mention lowered vacancy rates.

Making the Case
Quantifying the value enhancement opportunity of going green—through better tenant demand, higher rents and higher sales prices—has become clearer. Net operating income (NOI) and asset value (AV) are compelling financial motivators for any building owner considering green improvements.

In a recent overview of the commercial real estate market, ENERGY STAR® calculated that a 10% decrease in energy consumption leads to a 1.5% increase in NOI (Source: “Commercial Real Estate: An Overview of Energy Use and Energy Efficiency Opportunities,” ENERGY STAR®).

Given our low capitalization rates in San Francisco combined with a larger NOI after a green upgrade, it’s easy to see how the value of a property can be substantially increased with just a few green improvements.

Let me explain. NOI is a simple pre-tax figure that subtracts all operational expenses from operational income. In a green building, utility bills are lower and operational expenses and maintenance costs decrease. Operational income may also increase due to a higher base rent and higher occupancy rates in greener buildings.

Assuming a stable capitalization rate, incremental NOI can increase the AV of a property significantly. Using the “income approach” to appraising, income-producing property defines AV as AV = NOI/Capitalization Rate

An increase in AV of a property may justify an owner’s greening project investment, regardless if the owner or tenants pay the utility bills. A high AV is particularly important to a building owner when a property is sold or refinanced.

Turning Theory Into Results
As part of my apartment brokerage business, I help clients calculate the AV of their buildings. In today’s market, it’s always a nice surprise for an owner to hear how well their building is performing. And with a few suggestions, I’m able to help owners improve their building’s value beyond the status quo.

For one of my clients, whom I’ll call “Grace,” I performed a recent valuation of her 1890s Victorian in the Haight. Using real numbers, I was able to increase her AV by $120,000 by making some simple recommendations that cost her less than $3,000 after rebates to implement. Now that’s a great return. Here are the numbers:

Initial AV based on status quo NOI:
$4,000,000 - Capitalization Rate: 3%

- NOI improvement after a few green upgrades: 2%

- AV based on improved NOI: $4,120,000
Net increase in AV 
($4,120,000 - $4,000,000):

+$120,000
Initial AV based on status quo NOI: $4,000,000

 - Capitalization Rate: 3%

- NOI improvement after a few green upgrades: 2%

- AV based on improved NOI: $4,120,000

Net increase in AV 
($4,120,000 - $4,000,000):
+$120,000

Regardless if Grace decides to sell her building today or next year, just a few changes helped increase the value of her investment by $120,000. The recommended upgrades—installation of some simple lighting controls, switching out incandescent bulbs for LED lighting in the common areas and an HVAC retrofit—also allow Grace to save $3,600 annually. This money goes directly into her pocket.

I also recommended a few other changes, like upgrading some older in-unit appliances, installing insulation and weather-stripping and converting an unused storage area into a ZipCar parking space. Grace decided to schedule these additional improvements to coincide with her more capital-intensive seismic retrofit work planned for the summer.

With respect to AV, it doesn’t really matter in what order these improvements are done, just that they get done at some point—preferably prior to sale. In Grace’s case, the plan is to bundle the larger green improvements together with her seismic retrofit capital expenses, resulting in a single passthrough of costs to her tenants.

Money Well Spent
As an owner, you have many choices to consider when greening your building. But which ones create the most bang for the buck?

Here are ten strategic choices to make your building sustainable, as well as increase asset value:

Water Heating. Water heating offers the single largest opportunity to save energy in an apartment building. Strategies include increasing the thermal efficiency of the water heater, installing solar hot water systems, and improving distribution systems with circulation pumps or by simply insulating hot water pipes.
Heating, Ventilation and Air Conditioning. Substantial energy savings can be achieved by replacing outdated boiler and furnace systems.

Appliances. Cooking and refrigeration make up a larger portion of energy use in apartments than in a single family home. Efficient dishwashers and washing machines save both water and energy.

Common Area Lighting creates a significant energy load that is unique to multifamily housing. This load can be reduced through timers or photocells (for exterior lights) and occupancy sensors (for garages, hallways, and laundry areas).

Water Fixtures. Simple aerators and high efficiency faucets and showerheads are some of the easiest ways to conserve water. Free audits from SF’s Department of the Environment can help prioritize improvements.

Toilets. In most households, toilets use more water than any other fixture. Toilets installed before 1994 use twice as much water as the standard toilet available today. And don’t forget leaking toilets can be easily repaired through a simple valve adjustment or float replacement.

Weatherization. A multifamily building’s shared walls mean that less heating and cooling is lost to the exterior. However, older buildings can still benefit from new windows, cool roofs and insulation at strategic locations.

Small Fixtures within individual units—such as programmable thermostats, LED lighting and efficient ceiling fans can save both electricity and gas.

Water-Wise Landscaping can greatly reduce your water bill. And if your building’s backyard resembles a concrete jungle, consider replacing as much of it as possible with porous surfacing. This allows water to drop back into the ground instead of running out into the sewer.

Convert Unused Space to Side Income by renting space to ZipCar or Scoot. Not only will you increase your NOI, but your tenants will also love having direct access to this amenity.

When to Go Green
According to the April 11, 2011 Final Report of the Multifamily Subcommittee of the Home Energy Retrofit Coordinating Committee, there are natural times in your building’s lifecycle to “go green.” The trigger points listed below are opportunities for different types of green upgrades. The scope of upgrades will depend on factors such as the age and condition of the building, and whether the building is rent controlled or market rate.

Tune-up/Spruce-up: This is a time for ongoing mechanical equipment maintenance, and/or for lower-cost, easier-to-implement measures such as servicing mechanical equipment, repainting common areas or making landscape improvements. Assess how you might make your systems greener; take small steps here towards efficiency.

Replacement: An opportunity to go green exists when a replacement is needed for specific central or individual-unit equipment that is aged or broken—including water heaters, boilers, furnaces, air conditioners, appliances, lighting and irrigation systems.

Unit Turnover: When occupants vacate, it’s common practice to paint units, replace carpets, address moisture intrusion, make minor repairs and replace fixtures and appliances. Consider the eco-options available as you get ready for the next tenant.

Retrofit: More limited in scope than a whole-building rehab, retrofits typically consist of a package of coordinated improvements designed to achieve a specific goal, such as seismic safety or energy efficiency. 
Rehab: Building-wide overhaul may include remodeling common areas; upgrading structural elements; installing new electrical, plumbing and mechanical equipment. It’s a great time to consider implementing fully green systems.

Reap the Rewards
Greening actions are available to just about anyone. Any building can benefit from these practices. By taking a long-term outlook, you can reap the rewards today. Owners not only benefit from direct utility cost savings, but from the lifetime impact that these investments have on their income-generating property and the environment.

By adopting a few sustainable real estate management practices, you can truly “do well by doing good.”

Stephen Bjorgan is a broker associate with Marcus & Millichap and has specialized in creating and protecting wealth through the purchase, repositioning and sale of San Francisco apartments for over 20 years. He can be reached at 415- 625-2198 or stephen.bjorgan@marcusmillichap.com.