An EUA for 501 Swanston Street Melbourne. L to R: Scott Bocskay, CEO, SMF; Phil Morley, Eureka Funds Management; Kathy Alexander, CEO City of Melbourne; Vince Giuliano, MD of PDG

29 August 2013 — Australia’s latest environmental upgrade agreement announced this week in Melbourne will galvanise the market for these innovative finance mechanisms.

For a start, it’s big. The former Ansett building building at 501 Swanston Street will now enjoy a $7 million environment upgrade as part of its $40 million makeover in a deal initiated by NAB (represented by Robert White) and including Eureka Funds Management, and brokered by Sustainable Melbourne Fund’s Scott Bocskay for the City of Melbourne.

Most other EUA projects have been far smaller, hovering around the $1 million mark. The massive $26.5 million deal for One Central Park by Frasers Property is bigger, but it’s for a major trigeneration and associated plant in a new development.

But the deal is impressive for more than just its size.

The joint venture owners, under 501 Pty Ltd, are from an unfamiliar part of the retrofit market, not the cohort of owners and consultants who have been circling EUAs for more than two years since they were unveiled by the City of Melbourne.

One partner is Bobby Zagame whose Zagame Automative sells Ferrari, Lamborghini and Audi luxury cars, and will occupy a showroom that will be built into a five-level podium next to the tower.

The other partner is Vince Giuliano’s PDG Corporation, which has concentrated on residential development, with high profile apartment towers such as the 70-storey Prima Pearl in Southbank and The Abode at 318 Russell Street in the city, in partnership with the Schiavello group.

It’s Giuliano’s first foray into a major environmental upgrade in a commercial building, he told The Fifth Estate during an interview in his offices on level 17 of the 19-storey tower at 501 Swanston Street.

Perhaps it’s a signal that these innovative finance mechanisms are starting to resonate with the regular retrofit market and taking on their own momentum.

The people promoting the deals certainly hope so. And they’ve got reason for confidence.

The work at 501 Swanston Street and its 19,000 square metres of lettable space, will include a facelift, inclusion of a wellness centre and sleeping pods. Next door the five-storey podium building will have an extensive rooftop garden that can be used by all the occupants in the two buildings.

The EUA will fund a full upgrade of the plant room, chillers and boilers, and solar film for the windows to lessen the load on airconditioning.

A $2.5 million portion of the EUA will also fund new lifts, by Kone, that will include “regenerative braking” – an energy recovery mechanism – and smart controls that will drive lift allocations and save energy.

Sustainability engineers will be Simpson Kotzman.

Carbon emissions are expected to drop by an estimated 607 tonnes a year thanks to the EUA-linked upgrades, and more than $80,000 is expected to be cut off the building’s energy bills each year.

The deal is set to spur the market and prove that EUAs are not only viable and possible, but maybe even probable.

But these funding structures, essentially long-term loans that can be repaid through tenant outgoings, funded by energy savings, have struggled to find traction in a doggedly sceptical property ownership market.

Not only do the sceptics point to a cheap source of money from superannuation and other funds that can be used, but there is the inherent and deep fear from owners of dealing with tenants, which EUAs require.

A “good tenant is a quiet tenant” as one source put it in The Fifth Estate’s Tenants and Landlords’ Guide to Happiness.

So what are the views from the various parties that made this deal stack up?

The owner

According to PDG Corporation principal Vince Giuliano the EUA will enable a higher order of environmental outcomes than might otherwise have been achieved.

“It brought forward works we may not have been able to do and as part of the major upgrade efficiencies we’re doing it now,” he told The Fifth Estate.

PDG bought the building  and surrounding land about 10 years ago for $30 million and Giuliano says it’s his first commercial retrofit.

The building, constructed 30 years ago, was “top notch” at the time, Giuliano says.

“Over time things have moved and we want to bring it back to the premium building that it was, and keeping in mind green criteria.”

But the NABERS Energy rating will move from two stars currently to only three stars in the tower and four in the podium. Structural issues prevent greater gains in the tower, Giuliano says.

It’s the first commercial retrofit for PDG but Giuliano says his group has learnt much about providing amenity in its residential work and will aim to reflect this in its commercial work.

His experience is that residential clients are increasingly concerned with energy performance, the use of double glazing and elements such as recycled water.

“There’s a concerted effort to build to six and seven star [NatHERS] energy ratings. We’re very focused on those modern requirements and a lot of clients are very pleased with that.

“It’s a natural progression to move into that with office.”

Giuliano said a good relationship with the Melbourne City Council has helped.

“We do a lot of work with the MCC; we’re continually developing and we’re obviously keen to make sure we’re at the forefront whether it’s residential or commercial, and we’re glad they’re supportive of buildings being refurbished.”

In this case it will make 501 Swanston Street a “workplace of choice” for tenants, says Giuliano.

Asked if the tenants will be allocated the repayments that are provided for in the EUA legislation, given a proviso that tenants be no worse off than they would otherwise be, Giuliano says no.

This might change with future tenants but for now, it was a case of “let’s go down the path of least resistance”, he says.

“At the end of the day, at this stage, we want to see how things pan out.”

Asking rental will be $330 a sq m, he says. It was currently “north” of $280 a sq m.

One tenant will be the project builder Brookfield Multiplex, which, it turns out, likes the project so much it’s moving its headquarters into a 3000 sq m office in the podium. Giuliano says they were attracted by the extensive roof garden and the position near universities.

The work will take no more than 12 months and will be completed on a floor-by-floor basis as tenants move out and new tenants move in.

Robert White, NAB, foreground, at The Fifth Estate roundtable on EUAs for the EUA Guide

The Banker

The EUA was initiated by NAB.

Rob White, who took part in The Fifth Estate’s roundtable for the EUA guide published last year, is associate director environmental financial solutions for NAB Advisory.

He says the 501 Swanston Street deal is thanks to a switched-on client relationship manager within the bank who had been dealing with the PDG projects in the past and suggested that, given the scope of the work, the partners might like to have a chat with White.

White says the main compelling reason for the deal, given the overall major scope of the retrofit, was “why not make the whole building more sustainable?”

“What I like about it is that it’s a decent size and when you’re doing a much broader development it makes sense to ring-fence the sustainability element.

“We approached Sustainable Melbourne Fund and had a number of discussions to reach a tripartite agreement –  SMF are always very helpful.”

One of the requirements for funding is that it drive a higher environmental outcome than might otherwise have been possible.

But how much is hard to quantify. “You’ve got a baseline for the old building but you don’t have one for what could have been done otherwise,” White says.

Another big issue around EUAs is that cost of funds are historically low right now so how can EUAs look attractive?

Cost of funds

White points out that cheap funds might look good now but it’s generally hard to get a term of the loan to be beyond three years.

If you have to repay and refinance after three years, as we saw during the GFC, “that can cause issues”, White says.

“If you go out in tenor the rates can be very high. What you’re exposed to in the short term will grind up over time.”

In this deal the EUA is “an amortised 10-year tenor [or length of loan] that will pretty well mirror the depreciation of the main equipment being installed – chillers and so on,” White says.

The deal took almost a year.

“These projects take time,” White says. “There are so many variables; it can take so long to educate the market.

“Putting EUAs to one side, energy efficiency is an incredibly complex project to pull together. There are so many stakeholders to pull on board. Who’s the champion to help?

“It’s incredibly hard and it’s very easy to sit on the fence and do nothing because of the complexity of energy efficiency.”

White says there’s a lot more interest in EUAs in NSW right now.

“The best way to convince people on this is to do deals.

“And nothing speaks louder than a case study.”

Scott Bocskay in Melbourne this week

The facilitator

Sustainable Melbourne Fund’s Scott Bocskay, who plays a kind of third party broker in Melbourne CBD deals on behalf of the City of Melbourne, says the more people get to understand how EUAs work, through real live case studies, the more interest there is.

EUAs have the potential to “fundamentally change the market”. Mostly for the requirement and inducement they contain to talk to the tenants.

Bocskay says he has about 15 projects that he’s juggling right now, all at various stages of interest.

Owners of buildings are attracted but cautious, he said.

“We’re seeing higher level of interest, but the reality is it’s taking 12, 18 months,” he says. In some cases even longer.

Bocskay is pleased it was NAB that drove the deal.

“We want to see the market driving these. It enables better understanding on how you add value to a project like this; so you get a bigger sales team out there.

“When we talk to the building owner some of the feedback is that it sounds too  good to be true.”

The scepticism is to be expected. Except that the promise is true. The deals work by using the energy savings to pay back the cost of the investment.

Bocskay says his team is becoming a “trusted brand”.

“We come with commercial hat. Our role is to act on behalf of local government.

“We’re also a second point of reference to working with the financiers, to say that this is a good product.”

That’s not to say SMF can make comments on the performance of the environmental work – it can’t – but it can point to the mechanism, and how “it’s a good way to fund these projects”.

Because of the accumulated knowledge bank, SMF is working with other jurisdictions to offer some advice and models. South Australia for instance.

The agency can’t operate outside of Victoria, but it can absolutely offer advice, Bocskay says.

It’s helped outline the business case in SA, for instance.

And it’s looking to leverage its skills by investigating a licensed business model.

The biggest challenge Bocskay can see is turning the game around to have tenants initiate EUAs, much the same way as occurred at 10 Valentine Street in Parramatta, Sydney, where the tenants wanted to pay for a new lighting system, which is generally the responsibility of the owner.

The EUA roundtable, for The Fifth Estate, EUA Guide

“We’ve had conversations with the building owners; they would like the tenants to come to them.

“There’s been a big focus on tenants in the last 12 months. Vacancy rates are going up, incentives are going up. There’s real opportunities to leverage those negotiations to get better environmental outcomes and trying to work with tenants.

“My job is to teach people to use this tool, to make carpenters of people. It means people have to relate to each other in a fundamentally different way.

“Without this tool you do a base building upgrade and the tenants work out the rest. But as an owner now, the real opportunity is for me to work with my tenants and find out, ‘How do I use this to my commercial gain?’

“It does sound too good to be true,” Bocskay says, “because it allows the owner to go in and work proactively with the tenant.”

In some cases tenants are looking to spend their own capital outlay on items such as lighting – typically supplied by the owner – in order to achieve environmental and cost savings outcomes.

An EUA can jump in as an enabler of this.

Bocskay points out some jarring anomalies in the ratings of a building.

A building might have a 4.5 star NABERS energy rating but the lighting might use 20 or 25 watts a square metre when the Building Code of Australia recommend seven watts and best practice is five watts a sq m.

Sometimes it’s the case of the owner saying, “I’ve done what I needed to do to get the NABERS rating; as for the tenants and their lighting, that’s their problem.”

“There’s $2 billion in opportunities just in the city of Melbourne,” says Bocskay.

And there’s even more opportunity outside of the CBD.

“EUAs are 100 per cent project finance that can do all of it. It’s a very attractive pot of money.”

But EUAs can also be a driver of the economy – in manufacturing, in jobs, he says.

He points to US data showing that building retrofits tend to stimulate a high intensity of local jobs – roughly 17 jobs per million (US) dollars.

The cost of money argument is “part of the education”, Bocskay says.

Bankmecu is offering 20-year fixed tenor. Other financiers include Eureka Funds Management and ANZ.