Jamie Mandel–Managing Director, Rocky Mountain Institute–and Phil Keuhn–Principal, RMI–discuss energy project portfolio optimization and the value of green leases for real estate owners and investors.
Gridium: Hello everyone, and welcome to this conversation with Jamie Mandel and Phil Keuhn of Rocky Mountain Institute. It’s fun to have two guests on the podcast today—double the expertise! Phil has over a decade of industry experience in energy auditing, retro-commissioning, energy modeling, and HVAC design. Jamie’s experience includes working closely with Fort Collins Utilities to develop and pass a plan to reduce 80% of its emissions by 2030, and he leads RMI’s analysis of the value of distributed storage and flexible demand resources in reducing grid costs.
My name is Millen, and I’m with Gridium. Buildings use our technology to develop energy project revenues that boost building value and sustainability.
Jamie, Phil, and I will be discussing energy project portfolio optimization and the value of green leases for real estate owners and investors. Specific examples we will cover include their work at REI’s portfolio of 134 stores, spanning 3.8 million square feet, and the green lease at Boulder Commons, a 100,000 sf building in Colorado.
Phil: Great, thanks for having us on the show Millen.
Jamie: Yeah, hi Millen. Thank you for the invitation. I’m really looking forward to the conversation.
Gridium: Wonderful, same here. So, let’s jump in at a little bit of an angle… Phil, you worked on energy efficiency in Chicago’s Merchandise Mart, which was the world’s largest building when it opened in 1930, and still features heavily in the by-boat architecture tours of that lovely city (which I can speak of from experience there this past summer). What was that like?
Phil: Yeah, as you mention, the building is enormous at around 4.2 million square feet—I get lost in there after spending months studying it. I believe it used to have its own zip code. What I remember most was the strong facilities team; it was a real pleasure working with them.
Gridium: Jamie, when we chatted a few weeks ago, you had just returned from India on an energy efficiency assignment. It’s stunning to see some of the serious effects of pollution there, such as the closing of airports for lack of visibility—quite sad. Of course, it’s also encouraging to see that building owners and others there are taking steps in the right direction. What did you learn from that trip?
Jamie: Thanks Millen. Yeah, I was there for another of our efforts called the Global Cooling Prize, which is an international prize competition to identify a 5x more efficient room air conditioning for India and for the developing world. I would agree: the visibility, the air quality in general is something that was really surprising to me. I had been there before and I was ready for it. I think it’s elevated the opportunity for buildings to contribute to clean and healthy air and environment. They talk a lot about the right to thermal comfort as something that’s somewhat of an equity issue, and so it’s definitely a focus. India’s going to double the amount of cities they have between now and 2030, which is not very far.
Gridium: Wow, yeah.
Jamie: Yeah, a huge opportunity and I think a huge risk. It’s a space to get right.
Gridium: I wanted to ask about this experience because I think it’s just this exact type of experience that unlocks a unique dimension to the work done by RMI—Jamie, can you tell us a little more generally about RMI, and then more specifically about the Portfolio Energy Optimization report that we’ll be discussing? I’ll be sure to link to it in the show notes.
Jamie: Great. Yeah, Rocky Mountain Institute’s a 37-year-old non-profit. At this point we’re about 220 people, globally; about half of our work is international and half is focused on the US. It’s exclusively focused on energy and in particular, the energy transition.
Phil and I work in our buildings program, which is focused on how to accelerate buildings in the energy transition, which has focused on energy efficiency for a long time. It’s been, I think, one of the most successful areas of the energy transition and now we’re starting to face new opportunities in that space with things like grid-interactive buildings, with the grid becoming much more renewable.
I would say that at RMI, generally we focus on market-based and business-led solutions. So, we do work in the policy sphere, but we’re really focused on unlocking private capital to do things that are in their economic best interests.
Gridium: There are quite a few highlights from that work that I want to discuss, which I’m happy to say are also quite clearly laid out in the report, so small thanks for that.
We don’t have time to cover all of them, but I do want to explore a few and also the REI case study. Why should a building owner, let’s say a REIT, evaluate all potential projects with a common, single methodology?
Jamie: I think a portfolio approach as opposed to a building approach can have a lot of value to a portfolio owner.
One of the things we find is that the financially-optimal set of decisions varies quite substantially across a portfolio. And you can achieve better financial outcomes by taking a portfolio-focused approach as opposed to a single-building approach.
New tools are making that much more possible today than it ever has been before, and we wanted to see what was possible both for financial return, emissions reduction and energy reduction when we took a portfolio approach. We outline an approach at RMI and the tools we’ve developed in the report, but we wanted to recognize that this is something that can be done in a variety of ways.
The important thing is to look holistically at the portfolio to see where you can find the better answer.
Phil: I would add a few things as well. To me, the obvious answer is it allows us to approach the portfolio systematically and be able to compare projects in each building apples-to-apples to improve investment decisions.
But I think taking that a step further, RMI is very focused on scaled solutions, and that’s really led us to focus on mass customized and industrialized processes that would allow building retrofits to be faster each year, and cheaper.
One example of that would be a program that we’re working on called “REALIZE”, that’s similar to the Energy Sprawl program that originated in the Netherlands that uses factory-built exterior panels and HVAC systems that, in that case, is more focused on residential sector, but homes can be retrofitted in a matter of days; we’re trying to adapt that to multi-family residential at the moment.
For the REI project, we used a different approach, which would be the portfolio optimization tool, which is a mass customized analytics tool. And the intent is to more quickly and in a more standardized way, allow portfolio owners to know the ROI and emissions reductions for a whole host of solutions and bundles of solutions for each building in their portfolio.
Having that in one strategic document allows you to make better decisions of where to put money across that portfolio and to optimize the whole in a way that we think would be better than, you know, typically going bottom-up, building by building.
Gridium: One of the things I noticed in the report is that it is focused on energy and recommends projects based on their economics rather than simply efficiency. Can you talk a little bit more about that?
Phil: Yeah, if you don’t mind, I’ll rephrase that slightly in the fact that I think improving the performance of buildings is critical for climate change.
And it’s something that we push partners to set aggressive goals on. But, you know, ultimately, the tool that we’re working on is a market-based solution, and so once we worked with the partner’s and investment criteria have been established, we then look for the deepest emissions reductions we can while meeting those investment criteria to ensure high likelihood that building owners are going to be willing to act on that recommendation.
Gridium: Got it.
Phil: Commonly, this results in more money being funneled towards certain buildings in the portfolio, but the overall portfolio-level performance increases significantly.
Gridium: Even better. Some of the things we think about here is project timelines—your team in the report points to cash flows and the timing of cash flows as being important. How so?
Phil: Yeah, you know I’m glad you ask these questions, and I think it points towards one of the core tenets of the initiative, which is ensuring that we’re speaking the language of the investor.
And you know, I think we’ve talked about kind of energy vs. ROI, but I think when you are thinking about the building owner, a lot of the things they’re considering in addition to just the ROI of a specific project are the leasing in the building, the hold period of that property, and similar attributes; they can have a major impact on the results of… whatever the financial results are of that project.
So for instance, do leases allow the capital investments to be passed through to tenants? Or is there a split incentive involved there? Do the project costs increase the rent of the tenants or are the energy cost savings able to compensate for that capital cost? Are they intending to hold that building for a few years? Can PACE be used? Or can the valuation of property be increased to the point where it’s okay to have a short hold period? Those are the types of things that folding into the analysis and prioritizing investments with those included can have a huge impact on the recommendations.
Phil: And you know, I think commonly it’s believed that these considerations are folded into the results by the building owner once the energy portion of the study is complete; but I would challenge that to a certain extent to the fact that typically you would be putting together a recommendation or a strategy that would be incomplete without that information.
And especially… like, in our case we ended up creating bundles of solutions per building. We use an energy simulation with EnergyPlus on the energy analytics side and take into account interactive effects. Then without knowing the things like the lease and the hold period, you really don’t know what to bundle together.
Gridium: That’s very interesting, Phil. The REI stores project was also interesting and it was great to see the level of detail in the report. Can you all summarize that for us—the REI project?
Phil: REI, or Recreational Equipment Inc., which is an outdoor equipment retailer or cooperative… we worked with them a couple of years ago.
We evaluated the majority of their storage across the United States. I think 134 to be exact. The sum of the stores was about 3.8 million square feet. We evaluated 34 different project types, which included energy efficiency solutions, renewable energy, energy storage and water efficiency. And by looking at… so we would create a unique model for each of those stores and evaluate each of these solutions for each unique situation.
And when aggregated back together, it suggested that REI could cut their energy use by around 39% while meeting their economic goals, which were to have a 10-year simple payback in an NPV-positive at the individual investment level.
Phil: …at each individual investment level. I think one other interesting note is that the REI stores have an average ENERGY STAR score of above 75, so that type of savings is kind of above what would be considered a pretty high-performing building already.
Phil: I think one thing also that… because of the fact that 10-year simple payback and NPV-positive, when you’re thinking about the commercial building sector is a little bit longer than I think a lot of people would consider. But we did look at that at the individual solution-level, and when you pull it all together, the overall portfolio return is much shorter when projecting a 4-year simple payback there.
Gridium: Wow, that’s great.
Jamie: I might add a couple of additional details to this case study, because I think it’s a really powerful one.
You know, why was REI interested in a portfolio-scale analysis in the first place? One of the things they were very clear about was that they were interested in investing with their own money and for the reason that they believe that this was a high return, lower-risk opportunity for that than they could put elsewhere, and it was inline with what their members wanted as a member of the co-op.
I think what they lacked was an ability to look across the portfolio and put capital to work at the scale that would make sense for a CFO, and I think, you know, one of the things that we were able to do is identify over 600 individual projects across the portfolio—different sort of project/store combinations. A layout or rollout plan and come back to that with both a substantial ask and detail kind of risk/return analysis on that ask that they could use to underwrite a pretty substantial program.
Gridium: That’s great.
Phil: One other thing to note, before we move onto the next topic would be I also wanted to mention that our initiative has continued to progress since the REI project.
Most recently, we’ve been working on a similar analysis for a portfolio of over 60 million square feet. It’s for a zero-carbon plan for Canadian federal buildings in the Ottawa national capital region.
Gridium: Wow, that sounds really interesting, too Phil. Briefly circling back to the REI project, can you walk us through the stack ranking of the NPV projects? I think there were around 45 and the distribution really caught my eye.
Phil: We did create a graph where we were comparing the NPV of pretty much the investment potential of each store across the portfolio.
And we made the graph because the results were actually quite a bit broader than we were expecting them to be. There are definitely variations between the stores, but in reality, the vast majority of the stores are big-box retail configuration.
But by combining the different climates, the different existing conditions, the different lease structures, the different utility rates… when all of those things collided, we ended up with some very unique investment recommendations for each location.
And you know, I think the longer we work on the problem the more apparent I think it’s become that when all of these unique attributes collide, the investment potential is quite variable building by building. And I think the good news is, the solutions themselves are not that unique. So for instance, an LED fixture or high-performance rooftop unit are very standard building to building—or they can be. Like, if you choose something that would fit into that solution, you can define that in a very standard way.
Phil: And by having a mass customized platform, you can then apply that very standard solution to a very kind of diverse set of situations that you come across in a portfolio like this.
Gridium: Yeah, that’s really good stuff. Allow me to shift gears slightly now before I let you both go. I should want to talk about your work on the net-zero energy buildings and green leases.
Of course I’ll link to some of this in the show notes. Jamie, in our first conversation you touched on some of the most compelling results from RMI’s study of green leases spanning occupancy rates to rental rates and building value. What were those?
Jamie: Yeah, I’m glad you raise this topic Millen.
There’s been a lot of, I would say research and projects and communication around the benefits of net-zero energy buildings in terms of improved productivity, comfort, health and overall increased value in a building.
What’s been challenging to date is that most net-zero buildings are owner occupied or owner-built, and they don’t turn over very often. So, what we were really excited to see is the increasing number of net-zero energy leased buildings. So, you know, commercial buildings that are built for future tenants.
We’re able to measure things like operating cash flow, sale value premium, overall profits as these buildings have different lease turnovers. What we found was pretty surprising. We reviewed I think 4 buildings in depth, but tried to get a sense of kind of all the net-zero commercial leased buildings that were in existence at the time of writing, and we found some pretty impressive results.
A 9% operating cash flow premium, a 17% sale value premium. If you assume a 10-year hold period, a 19% increase in profits. All of that set against what was an average of a 7% construction cost premium, which is—I would say—both an average and a number that appears to be declining as energy buildings become more common.
Jamie: Yeah, so overall, I think a very good investment and one that we’re starting to be able to quantify in ways we couldn’t before.
Gridium: Yeah, that’s really encouraging. I think also as I understand it, there are even further ancillary benefits about permitting timelines—is that right?
Jamie: There can be. I mean, I think one of the things that’s exciting about these projects is they line up a lot of different interests. So, not only are tenants excited but often cities want to see more net-zero energy buildings. They want to see walkable developments. A lot of times those things are correlated, and so there can be benefits in terms of incentives, in terms of permit time and things like that.
Gridium: You’ve touched on it already and you might think of it as the difference between a new-construction or an existing building, and clearly one of the big differences there is the lease. This report and the work that you’ve done, points to 4 crucial components in a green lease, and you’ve been so kind as to share some example lease language as well. What would those lease components look like?
Jamie: Yeah, so a net-zero lease I think is one of the really powerful tools for tenants as opposed to building owners to engage high-performance buildings and the energy transition.
I’ll say that an increasing number of tenants we notice seek out high-performance buildings and want to write-in energy performance language into their lease—and that’s something that is another exciting trend.
In this case, where we’re looking at a net-zero energy commercial building and we’ve got tenants coming in, I’d say there’s sort of 4 things that are really critical to make the arrangement work.
1 is, probably most crucial, is setting an energy budget. And we’re, I will say in kind of one of the main buildings here, we’re also the anchor tenant for the building, so we can… I can speak with experience that the energy budget has not been a significant constraint for us in occupying the building. So this is often common sense guidelines around the lighting density, plug load controls and things like that. And simply put, when a tenant exceeds their energy budget, they would settle up with the owner in the same way that if you had your own utility bill, you would pay more if you used more energy.
The second is submetering and disclosure—so, a really critical component is making energy use very transparent to the tenants. So, making sure they get reports on energy use and making sure major loads are submetered so that they have the tools to monitor their energy use. And again, this is maybe not as onerous as it sounds—it’s a pretty straightforward thing to periodically check energy use, see if there are ghost levels and address them.
Commissioning and recommissioning the building is really critical. So, a responsibility for both the building owner and the tenants to make sure that the building and the building controls are effectively the energy needs of the building.
And finally, cost recovery. So, often these leases are supported by an energy model that anticipates what a co-building’s energy costs would be, what the costs associated with the net-zero energy measures are, and making sure that costs are split equitably and savings are split equitably. And again, in most cases, the tenant is paying lower than they would if they were paying the energy bill in a co-built building; and there is opportunity for the owner to benefit on that side, in addition to we talked about the higher lease sub-rates and the sale value premium.
Gridium: Let’s say that I am an existing building and let’s say that I am owning it and operating an existing building and I want to get that building to zero. What would your recommendations be? And I think there might be 4 steps, if I’m not mistaken.
Phil: Yeah, there are. So a net-zero energy lease is kind of an extreme example of a green lease, in the case of an existing building.
Step 1 is just gathering past energy data on the building use and sharing it with tenants, so everyone’s got the same fact base to go off of. The second is setting aggressive yet achievable energy goals for the tenants. So, working through a process with them to identify where energy can be saved. As you can imagine, getting the existing buildings to net-zero or close to it, requires a lot of buy-in and cooperation from the tenants; a lot of the energy use is driven by tenants as opposed to common spaces. And so that dialogue and that buy-in with the tenants is really critical.
Step 3 then, once you’ve kind of worked with the tenants or started that process is recommissioning the building, so it’s operating as efficiently as possible overall. And then step 4, kind of once you’ve done those things, it then becomes time to implement energy efficiency and solar PV upgrades, ideally using financing mechanisms that can be passed through the tenant.
We talk about solar power purchase agreements and commercial property assessed clean energy, or CPACE as financing mechanisms that can be really efficient in achieving that outcome. And those 4, that should allow both lower costs to tenants as well as a more desirable building and allows the owner to achieve much higher energy performance and ideally, net-zero, while passing costs through to the tenants in the same way that those tenants were paying utility bills in the past.
Gridium: I want to point out, because you and the RMI team should be proud of the fact that this is not just theoretical, but there are multiple case studies here, Boulder Commons being one of them. Can you tell us a little bit about what happened at the Boulder Commons and how that project developed?
Jamie: Yeah, Boulder Commons is a really personal one for us.
We started in dialogue with the developer. The developer has a history of building high-performing, high-quality developments; wanted to build a net-zero, transit-friendly development in Boulder.
We worked with them on the design of the building, specifically focusing on the energy performance of the building. We then worked with them on the lease structure and the lease language, to help work through that not only can they build this but also it can be leased. And finally, we signed ourselves up as being their tenant in that building and have been pretty happy occupants, for I think close to 3 years now.
Gridium: That’s great. And tell me a little bit about the solar investment in this building, and I think there might be certain elements of the physical structure itself, which are solar integrated.
Jamie: Yeah. You know, the solar generation on site is a really key part of achieving net-zero energy. Boulder’s blessed with 300-days of sunshine, so it becomes a really good place to do solar.
On this building, it abuts a rail line, and so actually has a south-facing wall that has clear view lines for the sun. And so what we have is solar on the roof, but also a solar facade on the south wall. And I think one of the really interesting things—because the solar panels themselves act as the facade, as opposed to being bolted on, on top of the facade. And that became a cost savings in the development of the building itself. And it looks nice.
Gridium: Cool, I’d like to see it one day. I didn’t warn either of you, but you know we’re recording this after the media company Bloomberg launched it’s Bloomberg Green and we got a letter from the editor on climate change.
This follows a very compelling message from Larry Fink, CEO at BlackRock, followed by CEO of Fidelity International talking about the role that active management can play in climate change.
What do you both think about the role of sustainability in the marketplace? And am I imagining this or does it seem like there’s some real traction now in a way that there hasn’t been in quite a few years?
Jamie: I would agree with that. I think climate change is becoming a pretty top issue everywhere, it seems like. Right? Policy, international discussions… and I would agree with you.
One of the most exciting things to see is the activation of the corporate sector and now the finance sector in a big way. We worked in 2014 with corporates who wanted to procure renewable energy offsite and founded something called Business Renewable Center, which recently spun out to become the Renewable Energy Buyers’ Alliance partnership with a few other organizations.
But at the time, we set a goal of 60 GW of procurement as something that felt very aspirational, but we just wanted to put something aggressive down there. And what we’ve seen is above 6 GW per year of procurement of off-site renewable energy by that sector. And it’s kind of blown our mind that not only was that not super aggressive, but it’s going to be achieved and probably achieved ahead of target.
And I think the industry’s just continued to go from there. And so, as an organization that focuses on business-led change, it’s one of the most exciting things we see. And I’d say this work, you know, we’re really focused on making sure that when businesses and financial institutions want to take that step, that it’s not only the right thing to do, but it’s in their best financial interests as well.
And we can demonstrate that. I think that’s just increasingly become the case.
Gridium: Yeah, it’s very good stuff.
Phil: Yeah, and I guess to chime in with a few additional thoughts, I would agree with everything Jamie said. I think, you know, you see policies and new solutions and technologies all coming into place and just overall, it seems like the market is more focused and willing to do these things.
With that said, I think—you know, I mentioned early on—some of these solutions are very mass-customized and industrialized. And the reason for that is we still do not see the scale of retrofits that are needed to really deal with the challenges we have ahead of us over the next couple of decades. So, I think our focus is really to continue on that radical scale and see a lot more projects come to fruition.
Gridium: Yes, you’re right to point that out Phil. It is encouraging to see some of this activity. Nevertheless, there is quite a bit of work to do.
Let me say, thank you Phil. Thank you Jamie. This conversation has been fun. It’s been good to have a chance to talk about some of the hard data on the value of the work, and see it applied and as measured in the cases that you walked us through. So, please keep it up!
Jamie: Thank you! And thanks for and giving us a chance to speak to you and your listeners.