Energy Efficiency Linked to Mortgage Default Risk: Will Lenders Take Note?
Energy efficiency has a direct impact on many of the factors that determine asset value and financial performance in commercial buildings, from net operating income (NOI) to tenant comfort and satisfaction. According to a recent study, commercial real estate (CRE) businesses might soon add mortgage rates to that list.
In September, researchers from the Lawrence Berkeley National Laboratory—a US Department of Energy (DOE) lab managed by the University of California at Berkeley—released findings from a study of the correlation between mortgage default rates and energy costs and energy efficiency for three office buildings, one hotel, and one multi-family real estate property in the Denver and northern California regions, where reporting ordinances provided access to reliable energy usage data. The study evaluated both energy use intensity (EUI) and electricity price variations in these five buildings, finding that variations in each metric had a significant impact on mortgage default risk.
Overall, the researchers found that variations in EUI "could raise or lower the default rates in these properties by between roughly 5% and 40%," while electricity price variations were shown to increase mortgage default risk by as much as 60% in the Denver region and nearly 90% for the properties in northern California.
For example, the study evaluated the impact of both facilities management parameters—defined as the actions taken to improve energy efficiency by facilities staff—and occupancy behavior on EUI. For a 92,000 square-foot office property in Sonoma, California, the study found that effective practices in both areas could result in a 40% reduction in EUI and a 161 basis point (bp) reduction in mortgage default rate. Even if the building encountered average occupancy behavior—of which facilities managers have less control—effective facilities management practices could result in an 18% reduction in EUI and 63 bp reduction in default rate, according to the study. Conversely, the study found that poor practices across the board would result in 183% higher source EUI and a 331 bp increase in default rate for the property.
While the study was based on a limited sample of properties, the researchers point out that the findings could have a potential long-term impact on the CRE industry. The aim of the study was to determine whether lenders, who typically evaluate risk as carefully as possible, should consider energy efficiency and costs when making lending decisions for commercial properties. The researchers even went as far as presenting the findings directly to three lenders, all of whom "indicated that these findings are meaningful, i.e., that the range of default risk variations are material," according to the report. Additionally, the researchers made official recommendations for lenders to "request an estimate of energy cost variations as part of the loan application" and to "develop a simple-to-use energy risk score that can be used for underwriting."
Their efforts may have had an impact. At least one lender expressed interest in considering energy costs and risk as part of the company’s loan process, and all three "indicated that they would be willing to pilot such a score on new loans," according to the report.
Visibility into energy performance has become a critical concern for CRE businesses of late. Investors are increasingly expecting access to buildings’ sustainability data, while research has shown that tenants may be willing to spend more for space in buildings that show energy efficiency certification. The possibility that lenders may factor energy efficiency into their decision-making is just the latest sign that a strategic approach to energy management is becoming a competitive advantage.