CREJ - Multifamily Properties Quarterly - August 2016
Census data shows that nearly 60 percent of multifamily properties were built before 1980, and more than half of multifamily rental units available are at least 50 years old. These aging properties are inefficient and, often, in need of significant rehab. A National Resource Defense Council study estimated $6.5 billion of net benefit (after accounting for costs) is achievable by implementing green retrofits in multifamily affordable housing across nine states. Scaling it nationally, achieving higher-efficiency standards for multifamily properties could be a game changer that not only provides billions in benefits but also significantly impacts the living standards of multifamily tenants by making housing safer, more comfortable and healthier, as well as making housing affordable by reducing utility, operations and maintenance costs. Despite these benefits of green rehab, the multifamily market remains underserved due to the unique nature of a multifamily property being a commercial building for residential use. There are two major barriers to green rehab. The first is split incentives. While multifamily owners usually pay for water use and utilities in common spaces, it is the tenants who pay the utility bills for their apartments. So, owners lack the incentive to invest in efficiency, because they do not benefit from the utility savings. The second is a lack of knowledge and resources at the ownership level. Green rehabs require assessing the property, hiring design and engineering teams, figuring out financing, overseeing selection of contractors and construction management, as well as other tasks that owners don’t have the time, resources or know-how to undertake. So when capital improvements are needed, multifamily owners typically seek the lowest cost, fastest solutions to bring their property back to full capacity. By hiring contractors who do not specialize in green upgrades, owners miss the chance to be made aware of the benefits, including financial incentives available for green upgrades. Since many of the projects are small, there is a high transaction cost and lack of volume efficiency in comparison to a new multifamily construction project or a total gut rehab. Most contractors prefer to work on a large project for which transaction costs are a smaller percent of the total project costs. Also, larger projects allow for volume efficiency, which lowers costs. Many contractors are unable to create efficient and sustainable services for smaller projects. Financing a green rehab for an older property has many unique challenges. A typical green rehab is a small transaction on a property with an existing mortgage, making a second position lien the best available option for financing. Banks and credit unions will not finance a project if they are not provided a first-lien position. In addition, traditional financial institutions do not like to fund small projects. Also, most financial institutions do not recognize the associated utility cost savings from a green rehab as a new income source for the repayment of the debt on the property, so they are unwilling to lend based on the benefits of a green rehab. A lack of control over tenant behavior is another challenge. Installing the most-efficient solutions won’t help if tenants leave windows open, lights on or taps running. Without the ability to control tenant behavior, many owners find themselves prohibited from undertaking green rehab. There are opportunity costs from free or “low-hanging fruit” programs available. To combat the hurdles, two primary green rehab programs have emerged to incentivize multifamily owners. The first is the Weatherization Assistance Program that provides grant funds from the Department of Energy and state agencies for green upgrades to multifamily affordable housing. However, with dwindling government funds, multifamily owners have a long wait to obtain WAP grants. The second is direct install programs that use funds from utility companies to provide free or highly subsidized solutions that usually are limited to the “low-hanging fruit” (i.e., low-cost, high-saving measures such as low-flow devices, CFL or LED lights, and pipe wraps). These green upgrades are inexpensive and have a high return on investment for the utility, but provide less than 5 percent in utility savings for the properties. Because these programs are heavily subsidized, owners often come to think that green upgrades should always be low cost or free. And since these programs don’t cover more extensive retrofits, property owners miss out on the larger ticket items that typically provide greater savings and other benefits.