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REITs and Energy Management
The real estate investment trust (REIT) property management structure provides significant
incentives for investments in energy-efficiency.
BY GRETCHEN PARKER AND
MARK CHAO
Real estate investment trusts (REITs) are extent that they may help to improve occupant
corporations that buy, sell, manage, and comfort and productivity — could help in the
develop real estate of various types (see Fig. retention of existing tenants, the justification of
1). REITs currently own a large and growing rent hikes, and the attraction of new tenants.
share of the $1.3 trillion institutionally-owned For retail REITs, the non-energy benefits of
commercial real estate in the U.S. energy-efficient installations and services could
even help draw customers and increase sales.
Ownership is particularly large in sectors such
as retail malls (28%) and hotels (18%)1, and is While REITs have many features in common
predicted to grow to 30% of total commercial with conventional property ownership, we
property ownership in the next three decades2. believe that their economic and managerial
At present there are over 300 REITs, the structures present distinct advantages for
majority of which are publicly traded, with a investment in energy-efficient technologies and
total market capitalization of over $200 billion. services. This article discusses the economic
incentives, contractual procedures, and
Mortgage-Backed
5% Retail reporting methods that may make energy
18% efficiency especially attractive to this industry.
Industry/
office
27% To what degree do REIT property managers
Residential
already address energy-efficiency opportunities
17% in their buildings? How and why does the REIT
structure lend itself so well to long-term energy
Specialty management strategies?
1%
Self-Storage
Lodging/ 4% Measures of Performance
resorts Health Care
11%
Diversified REITs are measured by the same performance
9% 8%
indices as other industrial stocks — including
Figure 1: Types of REITs1 net income, net assets, and dividend payout
ratios. However, they also closely track funds
Like savvy traditional building owners and from operations (FFO).
property managers, a growing number of REITs
are recognizing that energy savings raise net FFO represents the company’s net income, not
building income. Many are also starting to including the effects of depreciation, nor the
realize that energy-efficient retrofits — to the cash gains and losses associated with the sale of
ENERGY & ENVIRONMENTAL MANAGEMENT
1
properties. FFO is the most widely-accepted property management arrangement, specific
measure of financial and management success in budget goals and objectives must be met in
REITs, and investors pay close attention to it as order for the company to be paid.
an index of the company’s investment value3.
In trying to increase FFO, REITs have a variety For example, in the contract agreement
of means at their disposal, including acquisition between Corporate Office Properties Trust and
and development of new properties (“external their consultant property managers, Corporate
growth”), and increased returns from existing Realty Management (CRM), the operation and
properties (“internal growth”). Since external maintenance budget doesn’t set targets for
growth is often difficult due to the limits of specific line items, but rather only for total cost.
obtaining new capital (REITs are required by Such an arrangement gives the management
law to distribute at least 95% of total income to company strong incentives to pursue the least-
shareholders), internal growth is a very cost opportunities to improve net operating
important factor affecting FFO. REITs pursue income (NOI) because they’re able to keep as
various internal-growth strategies, including profit any savings achieved from reducing
refurbishments and retrofits of their existing expenses at the various properties.
buildings. In terms of energy-related
investments, lighting and HVAC improvements In this example, the property management
are the primary choices among REIT decision- company begins each calendar year with a
makers. budget based on historical operation costs of all
the buildings, normalized for degree days —
Incentives, Approaches, and Success expenses are then reviewed for individual
Stories buildings on a monthly basis.
Many REITs will tell you that energy costs are
one of their largest operating expenses, at about CRM reports that energy is their highest cost,
20 to 40% of total operating costs. Those and is therefore the category they focus on
responsible for monitoring operating expenses most. They look at the payback features of
of the portfolio and making necessary various energy-efficient technologies, and
investments are the property managers, who are implement energy management systems with
either retained internally as REIT employees, or both short and long-term targets. For example,
externally, with a contracted professional they look at the energy efficiency of equipment
management company. With both internal and in the buildings, then offer recommendations to
external property management, REITs apply the REIT as to the timing and type of retrofits.
various methods for contracting and budget
planning. These arrangements create varying Incentives for innovation can be very significant
levels of incentives for pursuit of energy in such cases where external property
efficiency. management companies operate under specific
contracted objectives with regard to the
With internal property management, incentives operations budget, yet have a large degree of
may take the form of property managers’ discretion about how to reduce costs and
compensation programs that tie their pay to increase net income.
company profits, giving them a personal stake in
the REIT’s performance. Under one external
ENERGY & ENVIRONMENTAL MANAGEMENT
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Like Corporate Office Properties Trust, Arden This is particularly true, of course, with net lease
Realty is also a large office REIT trying to agreements between REITs and their tenants,
differentiate itself with energy-saving success where any increased expense incurred with
stories. Their stated internal growth strategy is respect to the operation of the facilities is borne
to achieve economies-of-scale benefits through by the tenant. Likewise, the tenant reaps any
portfolio-wide installation of lighting retrofits, savings achieved, versus the bottom line FFO at
computer-driven energy management systems, the REIT level. The property manager of a
and replacement of HVAC equipment. medical office REIT with this arrangement
recently explained that while he does track
Other aggressively-managed REITs have energy costs for budget purposes, any energy-
developed energy management plans on either a efficiency retrofits or commissioning performed
portfolio-wide or building-by-building basis. In is done to maintain tenant satisfaction rather
cases where buildings are deemed too old or than to reduce operating costs per se.
otherwise unworthy of new investment, some
REITs restrict operating hours to achieve their Other reasons for the general lack of attention
energy-cost saving goals. to energy efficiency among REIT property
managers appear to be their unfamiliarity with
A few REITs have gone a step further in the technologies and services (such as
addressing the link between energy efficiency commissioning, building tune-ups,
and increasing FFO, and have conducted comprehensive maintenance), and a perception
energy analyses of all their facilities. Equity that the upfront costs of energy-saving
Office Properties Trust has established itself as equipment and services would be especially
a leader in energy conservation, having prohibitive for REITs.
launched an aggressive program including
routine energy audits, wholesale lighting Contrasts Between REITs and Traditional
retrofits, and installation of energy management Ownership
systems. Their efforts were rewarded with $1.7 After extensive review of REIT structures and
million in savings after installing lighting retrofits property management practices, we submit that
in 28 buildings. REITs have at least three particular advantages
for pursuing energy-efficient products and
Untapped Opportunities services.
While the energy-cost saving benefits and
FFO-raising potential of improved building The first energy-related opportunity inherent to
performance are well established and well REITs is their ability to achieve economies of
rewarded for some REITs, investment scale resulting from owning multiple properties
opportunities in energy-saving measures and in certain submarkets and maintaining
services appear largely untapped industry-wide. centralized accounting systems. Such
In fact, only three of 26 randomly-chosen economies of scale can be applied to
annual reports even listed utility costs in the purchasing energy-efficient components and
financial statements, indicating that most REIT equipment at reduced costs; bulk procurement
property managers may give energy costs of electricity in deregulated markets; or to
relatively low priority. securing commissioning services. (Some
traditional owners of multiple properties may
ENERGY & ENVIRONMENTAL MANAGEMENT
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similarly take advantage of economies of scale Thus, not only may energy-efficiency
benefits.) Further, since REITs hold buildings investments yield immediate payoffs in
for longer periods of time, on average, than shareholder dividends, but to the extent that
private building owners, the argument for they can help maintain steady growth patterns in
making such investments is multiplied4. FFO, energy efficiency may yield longer-term
benefits to the firm and its shareholders in the
REITs are accountable to shareholders and form of rising share price and stable or
investors in a way that traditional building expanding access to capital.
owners aren’t. Like other publicly-traded
stocks, REITs are obliged to keep and disclose The basic incentives for efficient energy
detailed financial records. Therefore, performance and accompanying non-energy
information on the financial benefits of energy- benefits are strong and generally well aligned
saving investments in REIT buildings appears to among all key stakeholders: investors, REIT
be more rigorous and widely available than with management, and property managers
directly owned buildings. Although most REIT themselves. And for REITs on the whole, telling
annual reports don’t contain specific information the story of successful experience with
on energy costs, energy savings will still be commissioning and energy management can
reflected directly in bottom-line figures that are score points with investors and analysts by
reported, such as FFO. providing compelling narrative evidence of a
company’s aggressiveness, creativity, and
Furthermore, REITs may be able to turn commitment to raising FFO.
expectations of future energy savings into up-
front cash. Since stock prices are linked to Gretchen Parker is a research associate and
investors’ judgments on prospects for future Mark Chao is a program manager with the
FFO, achieving rising FFO can be immediately Institute for Market Transformation (IMT), San
rewarded in the form of increased share prices Francisco, CA, a non-profit organization that
when the REIT makes a public stock offering. promotes energy efficiency and environmental
Increased share prices mean more immediate protection. For more information, visit
capital, which REITs can then apply to further www.imt.org.
growth.
REFERENCES
1
The Payoffs Prudential Investments. Tracking Public
In sum, pursuit of high performance in buildings Market Commercial Real Estate Penetration
is an attractive internal-growth opportunity for from 1995 to 1997, August 1998.
2
REITs, for energy-related and non-energy National Association of Real Estate Investment
reasons alike. Though energy savings and non- Trusts, www.nareit.org, May 1998.
3
energy benefits may not appear directly in the Block, Ralph, Investing in REITs, 1998.
4
financial reports of the trust, these benefits do Cho, Soyong, NAREIT researcher, Pers. con.
directly affect FFO and other bottom-line 6/10/99.
parameters that investors and existing
shareholders closely watch.
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