By Tina Perinotto

23 August 2011 – There are plenty of people keen for the environmental upgrade agreement models to be finalised, but perhaps none more so than property and development consultants, Napier & Blakeley.

The company recently launched Verdigris Capital to capture some of the opportunities that could flow from the agreements.

Put simply EUAs are funding mechanisms for energy efficiency upgrades of older buildings.

They bring together a financier, a building owner, the local government authority – and indirectly, the tenants – in agreements to fund energy efficiency upgrades for older buildings.

What is ingenious about EUAs is that they elegantly leapfrog the so-called split incentive, where owners don’t want to pay for upgrade work because, initially at least, it benefits the tenant. What the agreements do is make the tenant pay for the upgrade through council rates, which become part of normal outgoings.

If EUAs work – and there are a lot of issues to iron out first – they could launch a potentially unlimited bonanza of investment opportunities and upgrade work at a time of uncertainty for the industry as a whole.  Most importantly they provide a tantalising promise of a new lease on life for second-grade, energy-guzzling buildings now facing a carbon-constrained future and potentially falling values.

But first the hurdles.

EUA legislation has been passed in Melbourne in relation to the City of Melbourne’s 1200 Buildings program and in NSW to cover the whole state.

Now comes the tricky part of carving out agreement models that suit local councils, owners, financiers and past and future potential mortgage holders, and which ensure that tenant rights are protected – that if they accept  the agreements they will be no worse off.

Joint managing directors of Napier & Blakeley, Peter Frith in Melbourne and Alastair Walker in Sydney are acutely aware of how difficult the process is, but can’t help wishing it would speed up. They ran through some of the issues in a recent briefing to The Fifth Estate in the company’s Sydney office.

The pair have been deeply embedded in some of the work so far, advising on the Melbourne 1200 Buildings program and acting as lead consultant on seven of 14 projects already up for consideration in the EUA process so far.

They join existing key stakeholders that currently include Federal Government agency Low Carbon Australia, which has funding to develop the model and to provide some limited direct finance for select projects, NAB, which wants to be a major provider of finance and is understood to have about $200 million lined up for the program, Eureka Funds Management, equipment leasing specialist Alleasing, and Sustainable Melbourne Fund, managed by chief executive Scott Bocskay, which is adminstering  the environmental upgrade finance mechanism for 1200 Buildings program.

Frith says it’s understandable that the details are taking longer than expected, after all, the scheme promises to be a global first. A version of the scheme was trialled in the US but Frith says he understands it has not gone well because of issues related to residential mortgages.

Finance
Security for the financier is certainly key. Plainly, says Frith, it will be one of missed opportunity for some players, too timid to work with a new form of property lending security.

Not for NAB, however. The bank has been at the forefront of development of the EUAs, Frith says.

[In fact NAB’s Sean Lucy, who is leading the work for the bank, recently told a Sydney investment forum that not only was the bank comfortable with the funding model, it helped shaped it.]

Frith has the same impression and says the big difference is the approach to what constitutes acceptable security for a loan.

“NAB is running it through its carbon solutions group,” Frith says. “Other financiers are looking at this through their property lending groups, who might find it more difficult to get around the security arrangement, being more comfortable with bricks and mortar.”

Clearly not every financier understands the concept of loan security that is tied to council rates.

Alastair Walker

Outstanding issues
Walker says that among outstanding issues is how these agreements will work in practice: how the councils will manage the agreements and the finer grained issues, such as what happens when properties are sold or if the owner defaults.

And what will the existing mortgage holder think when another lender can rank ahead of its security because its loan is secured by the local council rates and statutory outgoings?

Walker says the size of the funding agreements could vary from $500,000 to $10-15 million.

The loan to valuation ratios of the EUAs  could be three to four per cent of the value of the property as a whole, but an interesting issue is how the work will change the LVRs.

“If the building goes from two stars [NABERS Energy rating] to four stars, what impact on value does that have? Institutively I would expect that value to be more,” Walker says.

What are the clients thinking right now?

Unsure, to put it frankly, Walker says.

“We’re in the process of taking out some of the guess work.”

Frith says that it’s things like: what happens if the energy savings are not as good as we expect? What will my first mortgagee say and do? What happens if I sell the property? Does the new owner find it easy to get their financier to recognise the encumbrance? Will the financier roll over the loan easily or not at all? Can it, or should it, be paid out when the property sells?

“It might be a fait accompli they approve the new owner, given the length of leases and quality of tenants, but they might reserve the right to object,” Frith says

Peter Frith

Tenant agreements
Another issue is that the City of Melbourne was determined that the legislation would stipulate that each tenant in a building agrees to the the agreements before they can go ahead . In NSW, tenant acceptance is not a requirement – although the legislation requires that the tenant  be no worse off as a result of the agreements.

The Melbourne model might prove difficult to put into practice.

The Property Council of Australia’s Victorian executive director, Jennifer Cunich, recently told The Fifth Estate that her members spoke at length to the city council to see if the design of the legislation could be changed but to no avail.

That’s how the council wants it, she said, and what it could mean is that some tenants who don’t sign may get a “free ride”.

Walker says there could also be a bit to fear, too, from feisty tenant representatives who get wind of an impending agreement and try to use it to leverage more advantage for their clients.

On the other hand, it may be that the EUAs suit single tenant buildings or buildings occupied by government or corporate tenants wanting to make an important sustainability statement.

“If it’s a Rialto with a mix of tenants, in terms of size and type, it could be difficult; the perception is not to bother trying,” Frith says.

So how do quantity surveyors fit into such a scheme?

Verdigris Capital – named for the oxidation process that turns copper from brown to green – is designed to offer a full suite of advisory services to clients interested in the EUAs and also to advise tenants who will sign up.

It’s a good fit, claim Frith and Walker, and will complement an existing suite of services that Napier & Blakeley offers, from tax depreciation to due diligence work that in recent times has included an estimated 75 per cent of the big global investment deals into Australia.

On the team are a range of technical people, from engineers to cost consultants, who can calibrate a building’s future potential: the costs and benefits.

“We can advise on the condition of the various elements in a building, its future operating costs and future capital expenditure needed for prospective purchasers should they purchase the building,” Walker says.

“It’s asset management: you need to know the position of an asset and what it’s capable of.”

From there it’s a small step to add in a sustainability and energy efficiency angle to the profile. And in fact over the last 18 months the sustainability angle has figured far more prominently in demand for due diligence work.

“It’s certainly been stimulated by mandatory disclosure,” Walker says.

“We look at the plant, the air-conditioning, the rating in terms of NABERS, and you look at the existing asset. If it’s two stars, is it capable of getting to four or five stars? And we can predict the cost of getting there.”

Frith says the team’s approach has come from dealing with mainly private non-government clients keenly focused on direct value for sustainable elements.

“Part of our style is borne from private investor class, which is to look at what’s real value in a sustainable upgrade,” Frith says.

It’s also about seeing past the “sexy new build stuff like wind collection systems on the roof or whatever it might be,” he says.

“We like to be practical and find real value solutions for individual buildings.”

Scott Bocskay

Even more pertinent, the company recently handled several Green Building Fund grant applications for a number of owners, including Local Government Super, from initial consultation to project management of the work. In terms of the type of work that the EUAs will apply to, the experience can’t get more focused.

There is also the work with the City of Melbourne.

“We provided some commercially based feedback to the Melbourne 1200 draft environment upgrade legislation and others … and we’ve been involved with the evolution of these documents in Melbourne, which has just started up again in NSW,” Frith says.

So what value does Napier & Blakeley plan to take to parties in an EUA?

A good track record, for a start, says Frith.

“We should have some credibility with tenants in terms of explaining how it is all going to work,” he says.  As tenants the firm recently retrofit its offices at its own cost using new lighting technology in order to demonstrate what can be achieved, so it’s had some direct experience as well, Frith says.

“We should also be seen an as independent party and therefore believable in explaining they will be better off.”

So much for the tenant side. All that remains now is for the major parties to strike the right agreement note, and the property industry could be set for another stimulus package of its own making.

See also recent articles on EUAs in The Fifth Estate:

and

The Fifth Estate – green buildings and sustainable property news

We can’t wait for the future