When asked to envision the source of carbon emissions, many would conjure images of smokestacks, exhaust pipes and chimneys, belching out puffs of dark smoke. Most carbon emissions, however, boast a far more urbane and polished origin: commercial buildings. In fact, buildings account for 39 percent of the United States’ carbon dioxide emissions from fossil fuels each year — more than the emissions from the industrial and transportation sectors. Specifically, electricity is the most common source of such carbon dioxide emissions. Because buildings consume 70 percent of the electricity load in the United States, even a marginal reduction in electricity usage and carbon dioxide emissions can create a significant impact.
With these statistics in mind, new commercial construction is greener, more sustainable and more energy efficient, with some new buildings earning Leadership in Energy and Environmental Design (LEED) certification. While new construction is increasingly energy- and water-efficient, 40 percent of our nation’s commercial buildings are at least 30 years old. These existing buildings are often far less efficient than their newer, greener counterparts.
In an effort to bring the inefficiencies of these older buildings to light, several large cities have begun to implement legislation that requires building owners to monitor, report and disclose the energy usage of their properties. The reported data is then compared to similar buildings in a process known as “energy benchmarking.” Energy benchmarking legislation is aimed squarely at existing buildings, with the hope that awareness and transparency will result in improved efficiency. These disclosure requirements alone have encouraged more judicious, energy-efficient behavior, leading to reported reductions in energy usage of about 6 to 7 percent. Eventually, retrofitting these existing buildings with more efficient systems may result in even greater energy savings.
Benchmarking ordinances have spread quickly among metropolitan areas nationwide. Washington, D.C., was the first U.S. city to pass a benchmarking law. New York City followed suit with a similar law in 2009 and now a number of other cities have such laws, including Philadelphia.
Philadelphia’s Energy Monitoring Legislation
On June 21, Philadelphia became the latest city to attempt to reduce carbon emissions by unanimously passing energy benchmarking legislation. Bill No. 120428-A, which goes into effect on June 1, 2013, and amends Chapter 9-3400 of the City Code (“Energy Conservation”), is aimed at monitoring energy and water use in commercial buildings. The legislation was co-sponsored by Councilmembers James F. Kenney and Blondell Reynolds Brown and dovetails with Mayor Michael Nutter’s Greenworks Philadelphia initiative, which aims to make Philadelphia one of the greenest cities in the country by 2015. The legislation establishes protocols for benchmarking and reporting energy and water usage of commercial and certain mixed-use buildings that measure more than 50,000 square feet.
Philadelphia’s Office of Sustainability will be responsible for implementing the ordinance when it goes into effect, as well as promulgating any necessary regulations. The Office of Sustainability will also be responsible for collecting the benchmarking data, analyzing the numbers and delivering an annual report on the energy efficiency of the city’s buildings to city council. In 2014, the Office of Sustainability will promote outreach and education programs to prepare owners for the new requirements. City officials have been working closely with officials in New York, where a benchmarking program has been under way for some time, to understand the best practices associated with implementing the legislation.
The ordinance will apply to any commercial building containing 50,000 or more square feet of indoor floor space. The regulation also applies to the commercial portions of mixed-use buildings with more than 50,000 square feet dedicated to commercial use.
All data will be collected and tracked by Energy Star Portfolio Manager, an Internet-based application created by the U.S. Environmental Protection Agency. Portfolio Manager is the most widely used benchmarking tool in the U.S., with more than 21 billion square feet of space benchmarked since 2000. Buildings are scored on a one to 100 scale that compares the building’s performance to those of similar buildings nationwide. For example, a score of 75 would indicate that a building was more energy efficient than 75 percent of similar buildings nationwide.
The data gathered includes energy usage (defined as electricity, natural gas, steam and heating oil), water usage and building characteristics and use attributes. Building use attributes include building age, size, operating hours, number of computers and refrigerators and percentage of the building area that is heated or cooled, among other items. While the burden of entering and reporting the data falls on the building owner, the owner may arrange for utility/energy suppliers to send usage data directly to the portfolio manager benchmarking application. Owners, however, will still be required to submit their own data on building characteristics.
All benchmarking data feeds into a statement of energy performance document. While the reporting requirement primarily applies to owners/landlords, tenants will be required to report usage information to their landlords if the tenants’ premises are separately metered, as is common for some office tenants. Tenants must deliver this information to owners/landlords in a timely manner to ensure that the owners/landlords meet reporting deadlines.
Owners must ensure that the requisite benchmarking information (energy usage, water usage, building characteristics) is entered into Portfolio Manager by June 30 of each year (for information relating to energy and water usage during the previous calendar year). Owners more than 30 days late in providing this information face a $300 fine and an additional $100 fine for each day thereafter that the report is not filed.
Currently, the legislation requires the statement of energy performance to be furnished to prospective purchasers and tenants upon request. The legislation, however, makes reference to the eventual availability of such information online, where it can be viewed by prospective purchasers and tenants, as well as the general public. The online, public availability of citywide benchmarking data will have significant implications for commercial building owners, tenants and stakeholders in Philadelphia’s commercial real estate market. The specifics of online availability have yet to be disclosed.
Implications for Commercial Real Estate Stakeholders
Building owners are likely to experience the greatest impact from this legislation. Whether the impact is viewed as positive or negative will depend on the owner’s existing efforts in promoting energy- and water-efficient operations. Because benchmarking information will likely become publicly available, owners will be able to assess their buildings’ energy and water efficiency compared to those of their competitors. Owners who have espoused energy-efficient practices and invested in green building retrofits should expect to receive higher Portfolio Manager scores than those of their counterparts in unrenovated existing buildings.
While there is no direct financial penalty for a low Portfolio Manager score, it is not difficult to imagine the potential consequences for a low-scoring building in the market. Less efficient buildings may be seen as undesirable to future occupants or purchasers. Accordingly, building owners/landlords may become motivated to make capital improvements to their properties, investing in more efficient HVAC equipment, water-efficient plumbing fixtures, insulation and, in some cases, on-site renewable energy sources such as solar panels. Furthermore, owners/landlords may elect to make their buildings more efficient with a few simple, low-cost measures like adjusting heating and cooling schedules, installing LED lighting and timers and requiring that equipment be turned off each evening.
Energy and water efficiency will likely become a consideration as tenants cross-shop buildings and landlords in the pursuit of new space. A more efficient building will reduce operating expenses, which are typically paid by tenants, and will make such buildings more attractive and cost-efficient than comparable, less efficient buildings. Tenants, however, would be well advised to consider that the scores based on the buildings’ performance can change based on the usage patterns of the building’s tenants/occupants.
The ‘Split Incentive’
While the reduced operating expenses associated with energy- and water-efficient buildings typically benefit tenants, the building owners/landlords are usually responsible for the cost of the improvements that yield such greater efficiencies. This phenomenon is known as the “split-incentive barrier.” As earlier noted, even if owners/landlords take measures to make their buildings more efficient, the tenant’s behavior can heavily influence a building’s score.
Adapting Lease Provisions to Benchmarking Requirements
There are ways to overcome the split-incentive barrier. Lease provisions may be drafted to create pass-throughs that allow owners/landlords to recover capital costs of efficiency upgrades from tenants. In fact, other cities, such as New York, have gone so far as to work with industry and environmental stakeholders to develop language that allows landlords and tenants to share in the benefits and savings of capital expenses that improve efficiency. Furthermore, owners/landlords may also draft leases to mandate practices such as submetering and the use of energy-efficient equipment and methods.
Beyond the split-incentive barrier, parties to a lease may wish to proactively manage potential issues when drafting the document. Owners/landlords would be well advised to include lease provisions that clearly indicate protocols for access to submeters. The new ordinance requires tenants to provide access to submeter information, but contemplating access to a tenant’s submeters in the lease may eliminate confusion in the future. If the tenant has any privacy concerns or if the release of such information requires internal approvals by the tenant’s management, the lease should lay out a detailed framework and timeline for obtaining the requisite permissions.
A Greener Future
With its passage of Bill No. 120428-A, Philadelphia joins a growing list of cities dedicated to creating a greener, more energy-efficient landscape. This legislation represents an evolution in the way cities address carbon emissions and will likely cause commercial buildings and Philadelphia’s real estate market to evolve as well. Philadelphia’s future is not only more green, it’s about to become more transparent.
Mitchell A. Sterling is an associate in Morgan, Lewis & Bockius’ real estate practice. Accredited as a LEED Green Associate, Sterling focuses on real estate transactions involving green building and sustainable development. He counsels a variety of real estate owners and stakeholders in connection with the ownership, use and financing of real estate. He is resident in the firm’s Philadelphia office.