NYC LL87 – Shifting the Focal Point for Commercial Office Real Estate

By Randy Mead, Certified Energy Manager, Certified Building Commissioning Professional

On December 9, 2009, the New York City Council and the Mayor’s office passed  Local Law 87 as part of a set of four bills known as the “Greener, Greater Buildings Plan” that aim to reduce the energy consumption and carbon footprint of New York City’s existing buildings. Law 87 affects buildings larger than 50,000 gross square feet and requires building owners to perform an ASHRAE Level II Energy Audit and Retro-Commissioning on the base building systems and submit an Energy Efficiency Report that documents both processes.

Some building owners have responded to this as yet another bureaucratic intrusion into their business operations and are seeking to perform the least amount of work at the lowest cost possible to meet the minimum requirements of Law 87.  There should be no mistaking that there will be a significant cost to performing the work and that many business owners are operating on small margins with the realities of today’s economy.  Though there is some improvement, some building owners are still struggling to fill space.  According to Commercial Observer reporting on April 3, 2012, “lease activity has hit a lull in the first quarter, down 24 percent from the first quarter of 2011. 5.8 million square feet was leased in the first quarter of this year, compared to 7.6 million square feet leased in 2011. The overall vacancy rate for the Manhattan commercial real estate market was at 9.1 percent”.  So why would anyone expect commercial real estate owners be welcoming of this type of mandated expense?

If commercial real estate owners will look at Local Law 87 not through the lens of legal requirements and compliance, but rather through their normal financial business investment lens, I believe they will find an answer that may surprise them.

Net operating income (NOI) is the lifeblood of the commercial office real estate business.  The building is the business!  You improve your asset value by increasing NOI or by a lower capitalization rate or both. You increase NOI by reducing vacancy, increasing rent price, or decreasing expenses or a combination of the three.

Energy is expensive and represents the largest controllable expense in commercial office space. Reducing consumption directly improves profitability and reduces risk against rising energy costs.  Experience shows that retro-commissioning, as required by NYC Local Law 87 can typically reduce energy consumption by at least 10 percent and potentially as much as 30 percent. Additional monetary savings result from the retro-commissioning process by improving operations and maintenance of the facility and systems.

You may be thinking “That is fine for my house energy but my tenants pay their own bills and/or I pass through the cost of energy, so why should I care?”  Did you know that excess energy spending by tenants equals abandoned wealth and is a source of Other People’s Money?  Let’s say a tenant occupies 100,000 square feet and spends $2.25/square foot for energy resulting in an annual energy expense of $225,000.  Retro-commissioning is applied and saves 10% or $22,500 the first year and becomes worth more over time as the cost of energy increases.  Your tenant is now paying $202,500 in the next year for energy.  Why not strike a deal with your tenant to increase their rent by an amount equivalent to the energy savings for a period of three years.  The net cost to the tenant is the same as today; they are just paying you the money they would have sent to the utility company.  Retro-commissioning costs vary depending on building type and building systems type and can range from $0.30 to $1.00 per square foot.  Let’s take a look at this example with a retro-commissioning price of $0.60/square foot.  If 100,000 square feet are retro-commissioned, the project price would be $60,000.00.  At a modest 10% savings with an energy price increase of 2% per year, the return on investment in a 5 year analysis would be 42.5% with a savings-to investment ratio of 1.7.  This is before utility or other financial incentives for which the project would most likely qualify.  Sure, working out the details of leases is some work and it seems like a good idea to review them anyway since several people I have talked to don’t seem to know if their leases allow for cap-ex cost recovery or other ways to work out the financial aspects of something like this, of which there are several.

Better performing buildings can help attract or retain tenants that might look elsewhere if their energy expense is too high or the building performs poorly in terms of comfort.  If you are a commercial real estate owner and have been at it for any length of time, you know how expensive the loss of a tenant can be.

Performing retro-commissioning can be a great investment which mitigates some of the impact of future energy price increases, saves money on maintenance expense, makes happier tenants, and increases NOI and the asset value of the property.   So, when you think of New York City’s Local Law 87 compliance, use your financial brain and not your legal brain to maximize your return.