A to Z of Smart Buildings

F: Financials

Posted by The Comfy Team on May 31, 2016

The financial motivation to invest in smart building technology is multi-fold. Different players in commercial real estate operate under varied financial structures and incentives. Every project is unique and some players take on multiple roles simultaneously, but for the sake of simplicity, the chart below summarizes some of the main roles, financial structures, and advantages that each party in the CRE world can potentially gain with smart buildings.

DeveloperOwner/ManagerTenant*
Role Build and sell building. Offer space and services to tenant. Keep occupants happy and productive.
Profit Driver Realize profit on sale of improved building. Keep tenant satisfaction high while keeping operating costs low. Efficient use of The 3-30-300 Rule.
Smart Buildings Facilitate a faster sale and higher sales price. Fulfill efficiency mandates. Reduce operating costs. Attract and retain tenants. Increase employee productivity, wellness, and retention.

*Includes owner-occupier

Developer

Real estate developers typically buy land, develop the building program and design, obtain public approval, secure the necessary financing, oversee construction, and ultimately sell the property. Of all the stakeholders in the commercial real estate world, developers assume the greatest risk in the creation or renovation of a building project. Developers also stand to reap the greatest financial gains—especially if they can increase market value and sell at a high price.

How Developers Measure Profit
Profit = GDV - GCC 

Where:
GDV (Gross Development Value) = the market value of the property
GCC (Gross Construction Cost) = construction cost + cost of land + fees

For commercial office space, factors such as a desirable location, prestige, minimal operating expenses, and a positive working environment can all increase the value of a building. It's naturally within a developer's interest to explore the latest smart building tech in order to facilitate a speedy and profitable sale.

In addition, mandatory standards for new developments, plus advances in consumer technology, are rapidly shifting baseline expectations about what new commercial buildings should include. Obviously not every newly constructed building will look like The Edge, but we are seeing more and more "normal" office buildings implementing smart building tech because it’s financially rewarding for developers. 15 years ago, many features associated with LEED were still fairly uncommon. Today, LEED certification is a major selling point that correlates with higher market value, and is generally expected in premier properties. The smart building industry is following a similar trajectory. Developers who don't meet the technological expectations of today's modern tenant may find themselves struggling to sell and fill their buildings, and experience a lower Gross Development Value.

Fortunately, the cost of technology—like sensors, LEDs, and other pieces of hardware—continues to drop, and it is becoming more cost-effective to implement smart building technology in new and existing developments. In addition, governmental policies and building codes, like the IECC, Title 24 in California, and Green Building Codes across the country mandate adoption or offer financial incentives to adopt energy-saving technology. 

Owner/Manager

Building owners and managers share two primary concerns: keeping their building filled with satisfied tenants and running the building efficiently. A property's market value is directly linked to rental and occupancy rates. Pure market dynamics tells us that the benefits of smart building technology give building owners and managers an edge over standard commercial buildings, and tenants are willing to pay more for a better work environment.

Owners receive income through rent and increase profit by keeping operating expenses low and occupancy rates high. They often refer to a property’s Capitalization Rate to determine their Return on Investment on owning and operating a property. Capitalization Rate is the income after expenses (known as Net Operating Income) divided by the building’s price. When the owner can improve a building’s NOI by increasing income from rent or by reducing costs, they can see a dramatically improved Capitalization Rate. Smart buildings have the ability to both increase income from rent and greatly reduce operating costs.

How Building Owners Measure Profit
Cap Rate = NOI ÷ Building Price

Where:
Cap Rate (Capitalization Rate) = ROI for owning/operating property
NOI (Net Operating Income) = rent - operating costs 

From an operational standpoint, smart buildings have a lower total cost of ownership than buildings that lack automated systems. Smart buildings unlock the ability to integrate work-order management applications; pull equipment repair and maintenance data into performance analytics; and pinpoint equipment issues to a degree otherwise not humanly possible. These systems can detect and resolve building issues before equipment failures and capital expenditures ensue, and can help owners and operators determine where equipment replacements will increase the Net Operating Income. 

The resulting savings, according to two major corporate energy management studies produced in 2012 by The Economist Intelligence Unit (EIU) and Deloitte, have become increasingly essential for a building to remain financially competitive in the marketplace. Here’s an iconic example of how smart buildings can deliver long-term asset value: New York City’s Empire State Building once consumed as much energy in a single day as 40,000 single family homes. Since undergoing a retrofitting project in 2009 to make it “smarter,” the Empire State Building saw a reduction in energy consumption by 40 percent and savings of as much as $7.5 million in just three years. Like developers, building owners also stand to save under these regulations. Under the 2005 Energy Policy Act, the U.S. Department of Energy offers significant tax deductions of up to $1.80 per sq ft for adoption of energy-saving HVAC and lighting systems. Everyone likes a rebate!

Tenant/Occupier

All of these smart building investments that developers and owners are implementing also result in great workplaces. Tenants are looking for office environments that keep their biggest investment—their people—productive and inspired.

The 3-30-300 Rule is a commonly used concept that provides a meaningful and actionable breakdown of finances from a tenant's point of view. It shows that on average, commercial buildings spend $3 per sq ft on utilities, $30 per sq ft on rent, and $300 per sq ft on payroll. Doing the math: A 2% energy efficiency improvement would result in savings of $.06 per square foot, but a 2% improvement in employee productivity would deliver savings of $6 per sq ft. Any investment affecting employee wellness and productivity will have exponentially greater value, because it can increase the company's revenue while decreasing expenses related to human capital.

How Tenants Measure Profit
Profit = Revenue - Expenses

Where:
Revenue = money received in exchange for goods and services
Expenses = rent + utilities + payroll + other operating costs 

As the World Green Building Council asserts, “a healthy, happy workforce is a vital component of a productive, successful business in the long-term...What may appear a modest improvement in employee health or productivity, can have a significant financial implication for employers.”

What does the annual $300/sq ft on payroll represent, and what kind of investments can be made to reduce these costs and improve ROI? Productivity investments come in a range of categories including (but certainly not limited to) lighting, temperature, air quality, biophilia, noise, space utilization, amenities, design, wellness, and more. Research and surveys conducted by the Pacific Northwest National Laboratory, PNC Financial Services, and Smith Carter have revealed 50-75% increases in employee satisfaction and significant improvements in both absenteeism and turnover rates after companies moved into newly renovated offices. In today’s competitive job market, employers must keep employees productive and happy in order to keep profits and retention high—and smart building technologies are a great tool to do so.

Providing the Financial Sweet Spot for Everyone

In reality, the lines between various roles in commercial real estate are not always as clearly defined as above. Sometimes developers continue to hold onto their property or even actively manage it after it has been built. In owner-occupant situations, the tenant is also the owner, and the property manager may or may not be a third-party entity. However, one thing is clear. Regardless of whether you are a building developer, owner, manager, or tenant, an investment in smart building technology is one of the best investments you can make. Smart building technology has the ability to improve your operations and provide significant value to your bottom line.


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