When you approach a landlord with an efficiency project, one of the most common objections you may hear is, “My tenant’s leases are all ‘net’ – why should I care about efficiency improvements?” The next time you’re presenting an expense-reducing capital improvement to a landlord whose tenants might be the beneficiary of the resulting savings, be sure to mention one or more of the following points. They will help inoculate your presentation against the objection “My tenants stand to get all the savings.”
Energy efficiency supports higher base rents. Why? Because when a tenant looks at a space, he or she generally considers total occupancy cost, which is base rent plus the tenant’s share of Operating Expenses. To the extent that you can compress the tenant’s share of Operating Expenses by sensibly applying energy efficiency measures, you’re giving yourself headroom to increase the base rent. The occupancy cost that the tenant sees doesn’t change – the landlord simply captures more base rent, which supports higher Net Operating Income, which is the mother’s milk of real estate investors.
You can use other people’s money (famously known in the industry as “OPM”) to pay for the improvement. Real estate developers live by the OPM model. They will take a construction loan from a bank or take-out financing from an insurance company or a pension plan. It’s all about leveraging other people’s money to make a healthier return on the equity they invest. How does the OPM concept apply to expense-reducing capital projects? Let’s assume the landlord’s model lease includes language that allows him to repurpose dollars his tenants are now spending on unnecessarily high utility bills. By exercising the lease’s Cap Ex Cost Recovery clause, the landlord could invest in energy-saving improvements that would lower the tenant’s share of the operating expenses, and then recover some or all of that savings in the form of additional rent until the capital improvement is fully paid for (plus interest in some cases). And what happens if the landlord doesn’t play the Cap Ex Cost Recovery card? He’ll likely spend his own Cap Ex Reserve dollars to replace the equipment when it finally fails. Moreover, at that point, he’s lost not only the opportunity to frame the equipment replacement as an expense-reducing capital improvement eligible for Cap Ex Cost Recovery, but also any possibility of collecting a rebate or incentive since the existing equipment is no longer operational.
Stay tuned for more on this topic tomorrow…
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