There’s more pressure than ever on building owners and employers to reduce energy and carbon emissions in buildings. But that doesn’t necessarily mean getting support for and paying for expensive energy upgrades is any easier. Corporate priorities focus on core business activities that deliver growth, so bottom-line energy efficiency projects aren’t always super-attractive. Some upgrades to systems like HVAC are significant investments that cause big disruptions with high initial costs and long payback periods. Plus, if employers don’t own their buildings, there’s the split-incentive conundrum where landlords are responsible for capital improvements while tenants take care of operating expenses. ESG is a hot buzzword in real estate right now, and change is coming, but actually getting these projects done can be like pulling teeth.
That’s why many building owners are becoming interested in a new way to get energy upgrades done: energy-efficiency-as-a-service. Efficiency as a service is an off-balance sheet financing solution that enables property owners to implement upgrades with no upfront capital cost. Instead, energy service providers pay for the project development, design, construction, and maintenance of new equipment. Then, when the upgrades become operational, building owners make service payments based on actual energy savings or other equipment performance metrics. Usually, this results in immediate reduced operating expenses. An energy services agreement is the most common arrangement, but different variations exist.
Efficiency as a service is not exactly a new concept, according to Timothy Unruh, Executive Director of the National Association of Energy Service Companies (NAESCO), a trade association. Unruh said the practice began in the 1980s with energy service contracts, mainly focused on government facilities. It never caught on with commercial buildings. This most recent iteration of energy as a service has developed over the past decade or so, and it’s become more popular for various types of facilities, including commercial, schools, hospitals, and industrial. Unruh says the service has gained steam because building owners realize they don’t have to own their equipment. Outsourcing energy upgrades to a vendor enables property owners to rely on them for their expertise and removes a significant barrier to getting upgrades done, which forks over the upfront capital expenditure.
“Energy as a service allows building owners to refocus efforts on their core business practices rather than the operation of the building,” Unruh said. “And when you go with an energy services provider, they specialize in this, so you get the expertise you may not have had access to. It’s also a turnkey service. So, by shifting the energy upgrades over to a third-party company, you let them take that responsibility from you.”
Most energy service agreements (ESAs) also come with a performance guarantee. That’s something a building owner wouldn’t necessarily have if they did the upgrade themselves and relied on their own property management staff. Most ESAs have a contracted period of about five to 15 years. The building owner pays the provider a charge per unit of energy saved below a baseline utility price, according to the Department of Energy. The provider retains ownership of the equipment, and at the end of the contract, the property owner can purchase the equipment, extend the contract, or return the equipment, which is rare. Building owners don’t bear project performance risk because they only pay for the achieved energy savings. The provider takes the risk since they’ll get paid less if energy savings are lower than expected. The energy service agreement is like an energy efficiency version of a Power Purchase Agreement, the finance mechanism common for renewable energy systems like solar panels.
One of the most attractive features of energy as a service is that it’s off-balance-sheet, meaning regular payments to the provider are treated as an operating expense similar to a standard energy utility bill. Providers will also do periodic maintenance on the upgraded equipment as part of the deal. The model has advantages for owners of multiple properties, too.
Many providers will bundle projects from different sites together into a single package. For example, a building owner with $500,000 projects at 10 sites can throw them all together for a single $5 million contract. Bundling energy projects together can also be done at a single building and often make the most sense, according to Bob Hinkle, President and CEO of Metrus Energy, a sustainable energy-as-a-service provider.
“Bundling upgrades with a mix of short and long-term paybacks maximizes energy savings and GHG reductions and allows building owners to implement a broader range of facility improvements,” Hinkle said. “When starting the process, we recommend clients begin with a simple preliminary assessment which a provider should offer at no cost.”
Still, energy as a service may not be a good fit for every company or property. Providers typically only look to do larger projects of at least $1 million, and some providers won’t consider projects in the $250,000 range. Unruh, the NAESCO Executive Director, says there are exceptions, but this is usually the case because smaller projects aren’t financially feasible for providers. Because of vendors’ overhead, high transaction costs mean they need to make enough money to profit. Building ownership constraints can also complicate projects. Energy as a service works in both leased and owned space, but they’ll only work in a leased space if the contract term doesn’t extend past the lease term. And keep in mind that some energy service contracts can extend up to 15 years. Transaction costs for these projects can also be high if the deals are heavily negotiated, leading to longer close times.
If building owners decide to try energy as a service, Hinkle advises looking for providers who offer flexibility and have documentation of successful projects completed. “In the vetting process, customers should make sure the energy service provider offers unbiased advice on project scope and products and only charges you for realized energy savings that are measured and verified,” he said. “It’s also important to talk to existing (past) customers that have worked with the provider.”
The estimated value of the energy as a service market in 2021 was $5.4 billion, according to a report by business consulting firm Guidehouse. The firm predicts the market to grow by 32.1 percent per year between 2021 and 2030, reaching an estimated value of $66 billion by 2030. Deferred maintenance backlogs and capital constraints, and layoffs from the pandemic are one reason the energy services market has grown, as companies and property owners likely need the expertise and manpower to complete complex projects and replace aging equipment. The energy services model still faces some barriers, though, mainly in lack of awareness, lack of standardization, and resistance of some property owners to give up control of energy assets and equipment. As Unruh told me, energy as a service will likely catch on, but some facilities may be reluctant to cede control to systems that could be mission-critical like HVAC.
Unruh added that energy as a service could also be construed as too-good-to-be-true because of the performance guarantees and no up-front costs. He said more standardization of the industry and more widespread use of energy services firms would likely allay fears property owners have, many of whom suffer from pitch fatigue from endless new product lines from vendors. Either way, property owners will probably hear more about this financing method for energy upgrades in the years to come.
“It’s become clear there will be no turning back from moving towards net-zero, so the energy as a service industry will increasingly be defined as Sustainable Energy as a Service where providers finance and implement energy efficiency and renewable energy projects that are climate positive,” said Hinkle, the CEO of Metrus Energy. “This matches the moment that we’re in as it relates to fighting climate change.”The as-a-service model has become commonplace in the business world, so it was only a matter of time before it emerged for energy efficiency. Energy efficiency as a service isn’t exactly a new concept, but it’s growing in popularity. The idea fills a need in real estate and property management when there’s increased pressure to achieve deep energy savings and possibly not enough internal capital to pay upfront costs for upgrades. Capital expenditures for energy upgrades are usually the most significant barriers to getting them done, so the as-a-service model can help solve this pesky problem. By outsourcing energy upgrades and gaining things like performance guarantees, getting energy efficiency projects done can become much less painful for property owners, less like pulling teeth, and maybe more like a routine checkup.