Building a Business Case

By ReNew Canada 10:02AM August 28, 2012



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Algoma Orchards Ltd., which is the largest independently owned apple grower and packer in Canada, is now hosting a 543-kilowatt solar power system on the roof of its processing facility. The system will generate approximately 575 megawatt hours of electricity per year.

A complete retrofit of that processing facility, including water and energy efficiency, could also likely save Algoma a significant amount of electricity per year. If the company hasn’t done that, it may be in part because it’s easier to sell a solar project, for example, that has a built-in revenue model in the Ontario Feed-in-Tariff (FIT) program. A retrofit with high upfront costs—and high risk to the developer—seems less attractive. In reality, however, it may be the smarter choice for the long term.

Of course, the energy generated on Algoma’s roof will be fed into Ontario’s power grid for a profit, not consumed by the facility. It’s not quite the same as saving energy through efficiencies. But Ledcor Renew’s Bryce Conacher says, “If you took that holistic approach to upgrading the facility, you could you use the revenue from selling that solar power to fund green retrofits to the building.”

Participants in this session – pictured here L-R: Tim Stoate (TAF), Mark Salerno (CMHC), Jonathan Westeinde (Ledcor Renew). Not pictured – Mark Holden (Morguard), Eleanor McAteer (City of Toronto), Bryce Conacher (Ledcor Renew)              

Ledcor recently sponsored a roundtable, held in Toronto, on how to build a business case for green building retrofits. The consensus among all participants was that these types of activities don’t need to be done as independent one-offs. In fact, taking a whole-building approach actually strengthens the business case. The caveat: developers and landlords need to take the long view to see that business case.

Right now, early stage funding has dried up in Canada, not just for green building. “It was always spare to begin with but it’s now become even more difficult,” said Conacher. “There’s a need for investors to have that performance guaranteed structure that would be government backed—a specific fund that would target existing buildings.”

Is it just energy?

When making a case for building retrofits, energy savings are often a key part of any business model. It can often seem like it’s the only factor when upgrading an existing building.

But according to Ledcor Renew’s Jonathan Westeinde, “If you really go deep and do a whole repurposing of that asset, energy is really only 50 per cent of the equation.”

Eleanor McAteer agreed: “Energy is a very critical piece, but it’s just a starting point.” McAteer is director of the City of Toronto’s Tower Renewal program. She said, “It’s the icebreaker for us. It leads to other things. When we do benchmarking of the apartment buildings [in the Tower Renewal program], we do the three utilities: energy, water, and waste. They all have savings involved.”

From there, McAteer said, it doesn’t take too long to get into how well the overall building is operated, maintained, and used.  “At that point, you start to look at the engagement of the building’s users. In my experience, residents, superintendants, and property managers are involved, too.”

As corporate representative, Greater Toronto Area, for the Canada Mortgage and Housing Corporation (CMHC), part of Mark Salerno’s job is building relationships with housing industry stakeholders in an effort to create more sustainable and affordable housing. He said energy was CMHC’s first focus when trying to incent upgrades in multi-unit residential buildings through its mortgage loan insurance product. “Initially, we just considered heating and electricity costs,” said Salerno. “In our latest product update, however, we consider water savings. It’s an incremental step.”

The whole building retrofit

The problem with incremental steps is that it can mean missed opportunities to address upgrades to an aging building holistically. “Cherry picking is our biggest enemy,” said Toronto Atmospheric Fund’s (TAF) VP of impact investing, Tim Stoate.

The prevailing attitude regarding green building or retrofits is that Canada is slowly moving in the right direction. Landlords are installing LED lights in their buildings, choosing energy-efficient windows and low-flow toilets. But, according to Stoate this action is based on “the myth of the low-hanging fruit.”

“[At TAF], we have a diagram of a fruit tree surrounded by an electrical fence with an anvil hanging over it,” said Stoate. “Because there’s no such thing as a low-hanging fruit. There are all kinds of reasons for people to say no to an energy retrofit, and it starts with the cost and competing need for capital.”

The sense that a complete overhaul of an old, inefficient building is unaffordable leads to a piecemeal approach that everyone agreed is short-sighted. “When someone is looking into an energy retrofit, they see a lot of barriers, and they also put up their own barriers,” said Stoate.

Conacher said Ledcor is trying to “disrupt the incremental retrofit trend that’s happening in the market.”

This happens, in part, because most landlords attach an annual capital spend to each property. Each year, the property manager is dealt a few dollars to improve some part of the building. It might be a lighting retrofit one year, a new HVAC system, mechanical upgrades, or a new building envelope. “Each of these things seems to be incrementally approached by the landlords,” said Conacher, who believes there’s a missed opportunity to increase savings by looking at the whole building.

Removing barriers

“A structured finance program is one of the key answers,” said Stoate.

To get beyond these ad hoc approaches to building improvements, there needs to be a program that borrows, in some ways, the straightforward math of Ontario’s FIT incentive: money out equals money in.

Two of the most prominent of these programs in Ontario were represented at our roundtable. Both programs, in some way, remove the bulk of the financial risk for building owners, which goes a long way in convincing landlords to act.

TAF’s program reallocates the risk away from the building owner, putting it on the engineer, the finance group, and the insurance company. Toronto’s Tower Renewal program involves a similar re-allocation of risk. TAF launched its new program last spring. “Now that we have a non-debt financial instrument, the phone doesn’t stop ringing.”(For details about this program, visit www.www.renewcanada.net and search “TAF.”)

The demand is there, but money is limited. “We’re now in the market looking for additional financial help in order to be able to expand our program,” said Stoate.

While TAF is looking for financial backing, McAteer said the City is looking to the provincial government for policy support. “Tower renewal financing really is a concept that requires a few regulatory changes at the provincial level,” she said. “What the TAF financing product does is very similar to what the tower renewal financing would be, but tower renewal financing is just on a bigger scale.”

What makes it work, said McAteer, is being able to finance very competitively so that that one barrier on the cost of capital is addressed. This would be done by mitigating risk for the providers of the financing. “What is needed is the ability to collect any defaulted project payments as property tax.”

The City is looking to create a Tower Renewal Corporation that would have the ability to raise funds to invest in apartment building retrofits, manage the program commercially, and ensure that the program remains financially self-sustaining. Tower Renewal is asking the Province to amend Ontario Regulation 504/6 (which permits the City to add the amount of certain unpaid fees, such as water, sewage and waste collection, to the property tax bill) to allow this new corporation to collect fees in that same way.

McAteer said this should really be a provincial initiative, to achieve any significant penetration in the market. “In the City of Toronto, we have about 1,200 of the really big apartment buildings,” said McAteer. “But there are 2,000 of them across the province. So, it’s not a Toronto issue, it’s a provincial issue.”

Beyond residential high-rises, the Province owns other types of buildings. McAteer said, “It would be excellent to have some sort of umbrella organization to support retrofits across the province.”
Right now, bigger cities such as Vancouver and Toronto have their own approaches to financing retrofits, but smaller cities don’t have programs in place. Landlords with multiple properties across the board need that support in order to navigate this complicated process.

The Provinces have yet to engage on that level, but Ontario is at least supporting Toronto’s Tower Renewal program. It recently posted its intention to bring forward a regulation that would allow municipalities to offer local improvement charge approaches to financing capital improvements such as energy retrofits on private property.

The tower renewal financing option is a bit of a variation of the TAF  offering. “In our approach, the municipality would not directly finance the work. It would just be a conduit between the capital market and the private sector,” said McAteer. The financing would never appear on the city’s books—”that is critical, at least to City of Toronto, in moving forward with the project,” said McAteer. “As it stands, it is something that city council would have to decide, but certainly the indications we have is that there is not any significant likelihood that the city council would go forward and support a large scale financing commitment.  With the requested regulation changes, there would be no need for it.”

Westeinde argued that while cities, and the public sector in general, are extremely risk averse in this scenario, they also stand to gain the most from these projects. “The public arguably benefits more than private on the individual retrofits, yet the private sector is currently taking all the risk,” he said.

“The void is not so much capital as it is security, because it’s always a question,” said Westeinde. “There also needs to be some way to verify the results that engineers and engineering models are promising.”

Creating value 

“Nobody gets excited about the equipment room,” said Stoate, and that is the crux of the problem. Solar and other more visible green elements have a cache that the less exciting upgrades can never match.

There are, however, ways to create that same cache through labelling systems. Without a swath of solar panels to tell people your building is green, you need a plaque or some other designation.

Mark Holden, VP of office industrial asset management at Morguard, said, “With our office towers, we created that intrinsic value by deciding to go with a LEED-certified project. That puts a label on it that the general market understands. We are going to be doing a little bit of exterior architecture work as well to announce that the building is little bit different than it was prior to the retrofit. You have to be strategic in how you manage the overall program and dispense some funds on non-LEED or non-energy components of the model.”

Morguard isn’t the only major landlord taking this approach. Cadillac Fairview is upgrading all of its TD Centre buildings to meet LEED standards by July 2013.

Westeinde said, “Partly, the success of green buildings and new builds is what’s creating the momentum. When you see LEED-Gold buildings going up in downtown Toronto, it just makes puts that much more pressure on the older buildings to upgrade. You have to decide if you’re going to stay in a low market or upgrade.”

Despite this, the only results that truly count involve money. Stoate said, “If you as an owner got a cheque every month for your savings, you’d feel a lot differently about your retrofits. What we’ve tried to do with our product is create the vision of the cheque. So you’re making money off my money, and you’re getting a cheque in your hands that says, ‘I did something really smart here, I invested in a retrofit.’”

Stoate said there are case studies showing a 45 to 55 per cent reduction in operating costs—and that’s what will convince landlords to make these changes. “It’s all about that bottom line—it’s very simple, it’s not very difficult. And if I can deliver you a product that’s going to make you money, then guess what? You’ll start paying more attention.”

What can government do?

According to Westeinde, building retrofits can deliver that bottom line. “Once you get into the opportunities for retrofit, often returns are greater than the FIT.”

Beyond the visual appeal, FIT projects also have something retrofits may not: a provincial program with revenue attached to it. “The key difference between FIT and retrofit is a structured finance program that is better and financeable and easy to move forward,” said Westeinde.

“You almost need that kind of infrastructure to deliver a program provincially or internationally,” he continued. These retrofits involve a multitude of small transactions based around what Westeinde calls a “black art” of energy modelling. “The banks don’t have the wherewithal to fully understand it,” he said. “Something like the FIT program acts as a sort of central clearing house for a whole bunch of transactions.”

Without a structure like Ontario’s FIT program, retrofits either attract a very high cost of capital or it seems too much trouble to bother with, which leaves owners back at that low-hanging fruit approach, taking small steps like lighting retrofits.

Salerno said CMHC can help, but it can only support certain elements of these projects. “CMHC’s incentive is directly tied to the loan and associated mortgage loan insurance premium. There’s a reduction in that premium where energy efficiency upgrades are undertaken, and we’ll also consider the anticipated lower energy costs when calculating the net operating income to determine property lending value.”

“Admittedly, this incentive is but one piece of the puzzle,” continued Salerno. “But when coupled with other incentives through the utilities and municipalities, we start to get a more robust incentive which we hope will begin to motivate investment in energy efficiency.”

Long-term thinking

Westeinde said the projects they’ve recently done with Morguard only worked because, since Morguard represents a lot of pension funds, they consider their assets to be long-term investments. “The project wasn’t restricted by the client’s desire to spend x amount of money or accomplish x amount of upgrades—it was a matter of getting the right return to justify spending money on retrofits. And as long as we can justify this return we can push it as far as we can. And I guess the third part of that is it was around a 10-year life cycle versus often these discussions were around two- or three-year paybacks and so by having both the extended timeframe, the notion of unlimited capital, (as long as the return is there) that’s when you can really dig deep and turn over the revenue stones.”

“If you can’t see past three years, getting a project done becomes a real challenge,” Stoate agreed. “With a paper program or an (ESPA) energy savings performance agreement you can go up to 10 years. As long as the funds are paid back within 10 years under the ESPA, there’s no challenge in terms of paper.”

Again, Stoate and Westeinde are talking about a whole-building approach, something McAteer reminded us it is hard to accomplish. “Apartment building owners don’t have experience doing a complete package, and there aren’t a lot of people in the marketplace that offer that, so they’re left to project-manage the multi-faceted retrofit, which really isn’t what property owners or property managers regularly do.”

Stoate said TAF’s program does corral the engineer into being the project manager. “We play the contract manager role and the engineer plays the project manager role and takes the energy retrofit from beginning to end,” he said. TAF usually recommends that building owners look at the engineers that are being qualified by the insurance company.

Stoate expects that, with this approach, TAF will have about 20 qualified projects in the pipeline by the end of December.

But, as McAteer pointed out earlier, there are thousands of buildings waiting to be retrofitted in Ontario alone. Stoate said, “The Ledcors, they’ll move the market themselves, they’ll take advantage of the opportunities, they’ll get a return on their capital, and it’ll all work properly for them, but it’s the other 50 per cent which will be the ultimate stick, or the government will come along and say ‘you’ve got to do this. We’ve been working with you for 15 years, and now we’re going to legislate, because you obviously don’t get it.’”

“There’s also a carrot,” countered McAteer. “Once the projects are paid off, your net operating dramatically increases and the prime rate dramatically increases, so the early adopters stands have to have a tremendous advantage in the marketplace.”

“Ten years from now, early adopters are going to be in a position where they can make the market, because our energy bills will be half of the energy bills of the building across the street,” said McAteer.

“So we can set the rent, we can make the market. But you have to have a very long-term view to see that carrot. “

Related: Companies Now Sell Financing for Energy Retrofits of Buildings

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Alex Aylett
5 years ago
Excellent piece - "Nobody gets excited about the equipment room,” and in the same way nobody really gets excited about financing! But finding ways for retrofitts to pencil out is a crucial part of the project to reinvent our cities. Montreal (where I'm based) has a uniquly high percentage of rental residential property. Much of it centenial brick triplexes each under different ownership. Creating incentives to address that type of built stock is tricky, but not impossible. Portland's Clean Energy Works program (now Clean Energy Works Oregon) is another excellent example of how to spark large-scale residential retrofits. https://www.cleanenergyworksoregon.org/ I think it's important to point out the economic benefits in terms of job creation. If we are going to tackle retrofitting seriously that will mean creating thousands of jobs in each of our cities. Jobs in trades where there is already expertise and training programs in place. There are very few areas where you can find such a good relationship between investment in and local job creation.