Financing Your Next Commercial Building Upgrade 1

Friday, August 21st, 2015
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Environmental Upgrade Agreements
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Around Australia, options for financing and funding of commercial building upgrades have expanded in recent years as instruments such as environmental upgrade agreements (EUAs) have come onto the market and traditional forms of finance have become more readily available for clean energy upgrades from sources such as major banks and the Federal Government’s Clean Energy Finance Corporation.

With this in mind, it is important for those undertaking such retrofits to understand the options available and some of the advantages and disadvantages of each for different types of projects.

Essentially, options boil down to three categories: private finance, government incentives and self-financing. While the last of these is self-explanatory, options regarding the other two are outlined below.

According to Dermot Duncan, in-house counsel and head of carbon markets at Melbourne-based environmental credits trading outfit Greenbank Environmental, it should also be noted that it is possible to use a combination of each, and that the suitability of any of them will depend largely upon the type of project involved.

“First of all, it is important to choose the funding option that is right for you,” Duncan said. “That’s the starting point.”

“There is also a mix and match approach, so one funding option may not be the right option for the whole capital upgrade. If you were considering upgrading a large commercial building in the Sydney CBD, for example, you may want to do a mixture of financing arrangements. If you think of the façade of the building, it is high capital cost, and so an EUA may be great for that. Then you look at some of the whitegoods and the photocopiers. For those sorts of equipment, you could look at leasing structures – whether it be an operating lease or a finance lease.”

Below is an outline of the main options and their advantages and disadvantages.

1) Private Financing

Options for private financing include EUAs, energy performance contracts and basic conventional financing.

Environmental Upgrade Agreements (EUAs)

A relatively new form of financing, EUAs are debt-based instruments which aim to provide financing for energy efficiency upgrades at lower rates of interest than would otherwise be the case as a result of the involvement of local councils.

Under this arrangement, commercial property landlords borrow funds from financial institutions in order to upgrade the building’s sustainability profile. Instead of repaying the lender directly, however, the landlord instead repays the loan through an environmental upgrade charge levied through council rates, which local councils then pass on to the lender.

Because loans are secured to council rates, this arrangement represents a lower form of risk from the viewpoint of the financial institution (and thus a lower interest rate for the building landlord) than would otherwise be the case with a straightforward loan. Loans may also unlock longer term financing than would be available through traditional lending, enabling the more effective matching of the term of the loan with the duration of the benefits derived from the landlord’s perspective. Finally, to an extent EUAs allow commercial landlords to share part of the cost of the upgrade with their tenants, though the share paid by any tenant is limited to the value of the resulting energy cost savings. If traditional financing methods were used, the Commercial Tenancies Act would prevent this from happening.

Thus far, seven such agreements have been entered into, the most recent of which was signed by commercial landlord Intrasia Oxley (RDB) Pty Ltd and the City of Sydney in June. That agreement involves a $1.2 million upgrade of the landmark Readers Digest building in Sydney’s Surry Hills including new LED lighting, a new building management system and energy efficient chillers.

Despite the advantages, however, the extra administrative costs involved from a financier’s point of view mean this type of arrangement is best suited to larger upgrades. In practice, meanwhile, the ability of landlords to share the cost of the upgrade with their tenants could be limited in the case of multiple tenancies with differing lease expiry terms or in the case of strained tenancies. Also, for now, EUAs remain restricted to a limited number of councils in Victoria and New South Wales, although legislation to introduce EUAs in South Australia is currently before Parliament in that state.

Energy Performance Contracts (EPCs)

A second option revolves around energy performance contracts, in which an energy service provider performs an upgrade – say of lighting or for HVAC – at no up-front cost, with payments to be made out of future energy savings.

From the landlord’s perspective, this type of arrangement essentially delivers a risk-free upgrade as the costs involved are paid only through direct savings made as a result of the upgrade. Where the life of the upgrade exceeds the time frame needed for repayment of the cost plus interest – say, the upgrade lasts for 20 years but the loan is repaid within seven – the landlord essentially derives the benefits of the cost savings throughout those remaining years for no cost.

Largely as a result of the administrative costs involved, along with a lack of enthusiasm from energy service providers who assume a significant volume of risk, however, the volume of these type of arrangements entered into outside of those entered into by public-sector clients has thus far been limited.

Conventional Asset Financing

For less extensive upgrades, other options which are becoming increasingly available are more conventional asset financing options such as chattel mortgages (mortgages on a moveable item or property), operating leases or finance leases – the main difference between the latter two being that finance leases allow the building owner (the lessee) the option of acquiring the asset at the conclusion of the lease term.

These operate in a similar manner as in the case of other corporate related equipment such as motor vehicles, and are most often used for fixtures which are easily detachable such as solar panels, LED lighting, and HVAC.

While these types of options might not have the same cost advantages over EUAs or EPCs, their advantages revolve around the ability to enter into loans with longer terms compared to traditional commercial loans (say, seven years against three years) and the relatively straightforward nature of the instrument along with  the lower administration costs involved.

2) Government Schemes

As well as private financing, a number of state and federal government schemes which provide incentives for the upgrade of commercial buildings are available.

These include:

  • The Energy Savings Scheme (NSW), which allows landlords who undertake initiatives to improve the sustainability of their buildings to receive energy certificates. These certificates can be sold (at a market price) to electricity retailers, who are obliged under the scheme to purchase a certain number of energy certificates.
  • The Victorian Energy Efficiency Target Scheme, which allows accredited businesses to offer discounts on selected energy saving products and appliances, such as energy efficient commercial lighting in residential and commercial premises.
  • The Retailer Energy Efficiency Scheme (SA), which allows businesses to receive upgrades such as energy efficient lighting and water efficient shower heads at discounted prices.
  • The Energy Efficiency Improvement Scheme (ACT), which was recently extended from residential to commercial premises and covers commercial lighting and appliance upgrades for commercial premises.
  • The Emissions Reductions Fund (FED), under which registered businesses can submit bids to receive funding for approved projects on a reverse auction basis, with the regulator purchasing admissions through the fund at the lowest possible cost.

Advisors stress that the above schemes are mutually exclusive and that it is not possible to receive both state and federal funding for the same project.

In a recent comparison of schemes, Henry Adams, director of clean technology policy and strategy advisory outfit Common Capital, said the appropriate option depended largely upon a number of factors, including the technology in question, the geographic distribution of projects, the timing of project costs and the landlord’s access to project financing.

For smaller projects, he suggests state-based schemes offer more generous terms of up-front financing for more up to 10 years’ worth of savings (the federal scheme is capped at seven years of savings and payments are made in arrears of savings being made), but says the federal scheme could be better where landlords have the ability to combine multiple projects across multiple sites in different states.

“Choosing between these schemes depends on the technology you are interested in, the geographic distribution of your projects, the timing of project costs and your access to project financing,” Adams noted.

“State-based schemes may be a more attractive choice if the projects are not national, financing certificate revenue is not possible, or the projects involve simple activities that are deemed under state schemes (e.g. commercial lighting, building fabric, packaged appliances).

“The key advantage of the ERF is scale. The benefits of combining projects across multiple national sites may outweigh the lack of forward creation if financing can cover future certificate revenue. The ERF energy efficiency methods are very limited at the moment, but are expected to expand soon.”

As commercial pressures to achieve higher NABERS and Green Star ratings continue, so too does the push to retrofit commercial buildings.

Those looking to undertake these types of activity have a number of options to from which to choose.

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  1. Matt Ryan

    Good luck getting finance for your next investment thanks to APRA's 10% cap