In a report released last September, Lawrence D. Raiman, an analyst at Donaldson, Lufkin & Jenrette, Inc., pointed out that individual REIT sectors will be impacted differently. "Retail REITs are more exposed to rising energy prices than most others because high costs take hard dollars out of the pockets of consumers, thereby hurting retail sales growth," he says. "Office and apartment REITs will carry average exposure, and given the triple-net lease nature to the industrial sector, industrial REITs will be the least exposed. So look there first if you are looking for a good place to hide."
Investment bank UBS Warburg also released a REIT report last September. The firm concluded that industrial, office, mall and strip REITs will have minimal exposure to rising energy costs, while multifamily and manufactured housing REITs will have more exposure, albeit still modest. But UBS predicted that there is no expected duration of high energy prices, but there could be a prolonged period of high-energy costs.
In late 1999, NAREIT entered into an agreement with the United States Environmental Protection Agency (EPA) to educate its members about the EPA's Energy Star Program, which encourages REITs to use energy efficient technologies to lower operating costs. The goal of the program is to make REITs more competitive, profitable and valuable, which can also improve shareholder value.
"REITs are increasing their focus on energy-efficient properties, including support of the Energy Star Program," said Steve Wechsler, president and CEO of NAREIT. "It's indicative of sound and efficient-energy use practices."
REITs' ability to shift—or pass through—any increase in utility costs directly through to the tenant will work in their favor. "The increase in energy prices will have an impact on all sectors of the economy," adds Wechsler, "but REITs generally structure their leases such that increased costs are borne by tenants, so in many instances the impact will be moderated."
"REITs are very well insulated because the way the leases are structured," says Richard Paoli, senior analyst at UBS.
Stuart Brodsky, national program manager of the EPA's Commercial Real Estate Sector, points out there is an advantage for a REIT to engage in energy-efficiency spending. "We have calculated that a dollar invested in an energy efficiency upgrade can result in a two-to-three dollar increase in a building's assessed value," he says. "At the same time, these upgrades establish a good relationship between tenant and landlord, and position the landlord well when it comes time for lease renewal."
According to the EPA, utility costs make up nearly one-third of a typical office building's operating expenses. A thirty-percent savings in energy costs can translate into a six percent increase in net operating income. "Energy efficiency is a low-risk investment for a REIT with immediate returns because the investment can be shared with tenants," Brodsky adds.
The ENERGY STAR program provides participating REITs training to turn energy savings into financial value. This includes offering a software tool called Portfolio Manager to help a REIT property monitor its energy usage and efficiency.
"It's a web-based scale that measures the energy consumption of an individual building based on weather, size and occupancy density and operating hours," says Brodsky. "The measurement is laid out in a statement of energy performance along with information about the changes in cash flows represented by this increased energy efficiency."
There are 26 REITs participating in the ENERGY STAR program that are implementing energy improvements at their properties.
"Our new office development projects are designed with energy-efficient mechanical and lighting systems with mechanical controls with electrical usage monitoring capability," explains George Smith, Director of Operations at Highwoods Properties in Raleigh, NC. "Highwoods is using Avista Advantage utility payable service for consolidated billing, financial reporting and cost and use analysis on all electrical accounts that allows quick analysis for any building or group of buildings and furnishes load requirement information that will be need in a deregulated environment."
Smith explains that Highwoods is targeting projects with a period of under three years for its existing building energy retrofits. "Each property is being evaluated for operating hours, mechanical controls setup, proper utility rate schedule and equipment operation. We have completed preliminary energy audits to create a short list of vendors that match our objectives. Most leases are structured to allow pass-through of energy costs, but our focus is on furnishing a quality building and controlling the total occupancy cost to the tenant."
Banyan Strategic Realty Trust in Chicago is also involved in energy-efficiency. "Most of our properties have had lighting retrofits," said Chip George, asset manager at Banyan. "We replaced lighting ballasts with energy-efficient bulbs. We also have computer-controlled systems that turn on heat and lights, as well as more insulation and new rooftop units at older properties."
Other REITs have recently signed on with the program, such as Bedford Property Investors, Inc. in Lafayette, CA. "We want to become more sophisticated in our understanding of factors that bear on energy-efficiency," said Bedford executive vice president and COO Jim Moore.
Moore stresses the importance of REIT involvement in energy-efficiency. "As the markets in which we operate become increasingly mature, we are approaching a point where the rate of top-line growth will slow. To accommodate this, we need to look closely at all aspects of property operations and begin to focus more closely on the cost side. Energy costs are a major contributor."
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source: nareit.com
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