At the management team meeting for a major hotel in a Northeastern city, the consensus is that the priority for the 2016 capital budget is to update the lobby. Earlier in the meeting, the facilities team presented a report on the state of the hotel’s core systems, including HVAC, lights and water infrastructure. The management team decides to do the lobby upgrade in 2016 and the HVAC/lighting and water conservation projects in 2017 and 2018. This is a very logical and thoughtful plan, with one hidden problem: The team just cost the hotel money. Funding the energy system upgrades now with third party funding and paying for the project out of energy savings would provide a higher net present value to the hotel ownership group than waiting and doing the project out of the capital budget over the next couple of years and keeping all the savings.
With respect to commercial buildings generally, the hospitality industry is way out in front on sustainability. Most major flags have robust and impressive sustainability programs. Guests and conference planners request and even demand strong performance in this regard. But too often, hotels that want to go farther and implement capital upgrades find that they cannot, due to competing demands on the capital budget. Since the downturn in 2008, many hotels have found that the higher capital upgrades and the energy projects with longer paybacks are not implemented. As a result, though hotels and major flags are making remarkable gains in productivity, they may not be meeting their energy use reduction targets. As a result they may be spending more on energy and they may be missing an opportunity to increase the net asset value of the building by lowering the operating costs.
Commercial building owners generally and hotel and resort owners specifically are beginning to embrace innovative financing mechanisms for implementing on-site clean energy and energy efficiency projects (“Why the Hospitality Industry Should Be Embracing PACE”—Green Lodging News, June 16, 2015), including Property Assessed Clean Energy (“PACE”). PACE is a great option for certain projects in the right jurisdictions. Even in places with robust PACE programs, there are other options that hotel and resort owners should consider in funding these projects.
The Energy Services Agreement
Another new approach to funding these projects is the Energy Services Agreement or “ESA”. Under an ESA, the ESA provider pays all design and construction costs for the project, and will design, build, commission and own the energy efficiency equipment/systems, requiring no capital investment from the owner. The monthly ESA payments are funded out of the savings created by the project and the remaining savings will immediately reduce the owner’s operating costs. Because the ESA provider is selling the energy savings, maintenance, monitoring and additional services to the building owner, the building owner has the option to treat these as an operating expense. As such the project is not on the balance sheet.
An ESA is distinct from a traditional performance contract with an Energy Service Company (“ESCO”) and from PACE programs in several important ways. An ESA does not represent new debt, and can be treated as an off balance sheet transaction. An ESA provider does not take a security interest in the building and this can make lender consent much easier. An ESA provider manages all of the project design and build process. The ESA provider is a partner throughout the term of the ESA and the interests of the building owner and the ESA provider are aligned. The ESA structure is also very flexible. Once an ESA provider and a building owner have signed an ESA, the owner and its ESA provider may add additional energy savings projects to the ESA and continue to improve the building performance.
With all the interest in sustainability in the hospitality industry, and all the progress, the next frontier is to implement longer term energy efficiency and other system upgrades. Third party funding can address the barrier presented by limited capital budgets.
Charlie Lord is a Principal with RENEW Energy Partners (“RENEW”). RENEW is an energy efficiency project development and finance firm with a focus on commercial, industrial and institutional buildings and in particular on the hospitality, senior and assisted living, warehouse and logistics and market rate multi-family housing sectors.
