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If These Walls Could Talk

Introduction

In response to rapidly growing concerns over greenhouse gas emissions and global climate change, green building practices have become more prevalent as a way for building owners to improve energy efficiency, thereby reducing emissions and lowering utility costs.  As a result, many commercial property transactions already involve some inquiry into a building’s energy efficiency, but this will soon be required under Assembly Bill 1103 (AB 1103), a new law which requires a formal report of building energy efficiency information to be provided in connection with the sale, lease or financing of nonresidential buildings in California.[1]  Specifically, owners will be required to provide the most recent 12 months’ worth of comparable energy-use information to prospective buyers or full-building tenants, as well as financiers, beginning in 2010. 

Assembly Bill 1103 was signed into law in 2007 and was originally scheduled to take effect January 1, 2010, but due to various feasibility issues, Assembly Bill 531 was passed in October 2009, which eliminated the January 1, 2010 deadline and delegated the task of devising a disclosure schedule to the California Energy Commission (“CEC”).  The most recent draft regulations from the CEC require disclosure for the largest buildings beginning July 1, 2010.  However, Gresham Savage has received information from the CEC that the initial implementation date may be further delayed until January 1, 2011 under the final regulations.  Gresham Savage will continue to monitor the status and provide clients with the most up-to-date information. 

What Does AB 1103 Require?

The required building energy-use assessment will primarily consist of a performance report reflecting a numerical 1 to 100 rating, generated by free online software from the U.S. Environmental Protection Agency’s (“U.S. EPA”) Energy Star Portfolio Manager. This report must be disclosed along with other transaction- and financing-related disclosures. 

In addition to the EPA Energy Star ratings, the CEC has created its own benchmarking system, called the “California Nonresidential Building Energy Performance Rating System” (“California Rating System”).  The California Rating System analyzes sources of inefficiency (known as an asset rating) rather than analyzing utility-bill data (known as a performance rating).  The California Rating System is provides an “A” to “G” rating, and because Energy Star is not applicable to all types of buildings, covers buildings that would otherwise fall within Energy Star “rating gap”.  Under the most recent draft CEC regulations, it appears that building owners will be required to obtain and disclose reports under both systems, although the California Rating System may be used where an Energy Star rating cannot be achieved. 

Impact on Building Owners

AB 1103 will impact only “whole building” transactions; under the draft implementing regulations, disclosure of energy use information will be required for a nonresidential building[2]: 1) when an owner presents a sales contract for the entire building[3] to a prospective buyer; 2) when the owner presents a lease for the entire building to a prospective lessee; and 3) when an owner presents a loan application to a prospective lender to finance the entire building.  

At least 30 days before a disclosure is required under any of the above circumstances, a building owner must open an account at the U.S. Environmental Protection Agency’s Energy Star Portfolio Manager website, and provide the following information:

1. Identify the building; and identify the utility company meters or utility company accounts that serve the building;
2. Supply building characteristics as requested (this will include such information as  gross floor area,  space use classification;  weekly operating hours; number of main shift workers; number of personal computers; percent of air conditioned gross floor area; and percent of heated gross floor);
3. Supply contact information;
4. Authorize each utility company serving the building to release energy use data for each meter to Portfolio Manager;
5. Request each utility company release energy use data for the most recent 12 months to Portfolio Manager; and
6. Authorize the CEC to access Portfolio Manager account information.

Within the same timeframe, a building owner must open an account at the CEC’s Nonresidential Building Energy Performance website, supply the U.S. EPA Portfolio Manager building account identification, and supply additional information regarding the building or its energy use, in order to generate a California Energy Performance Rating. 

After each of the utility companies serving the building have uploaded the building’s energy use data, the building owner will receive a “U.S. EPA Statement of Energy Performance” for the building, and a “CEC Nonresidential Building Energy Performance Report” for the building, for use in complying with the disclosure requirements. 

Both the California Rating System and EPA Portfolio Manager require detailed building and operational information; for simple buildings, this can often be provided by management staff or a building engineer, but for complex, multi-tenanted buildings, professional audit assistance may be required in order to compile the necessary information.  This potentially places a critical element of due diligence in the hands of third-party utility companies and tenants; thus, transaction schedules should include adequate time prior to closing, in order to account for any uploading and reporting delays that may occur. 

AB 1103 Implementation Schedule

On and after July 1, 2010[4], a building owner shall disclose the Portfolio Manager Statement and the CEC Nonresidential Building Energy Performance Declaration for nonresidential buildings that are (as defined by Portfolio Manager building types), as illustrated in the table below:

Penalties

Although the draft regulations do not contain penalties for noncompliance, the CEC has informed us that enforcement will consist of a complaint and investigation process by the CEC, as provided under existing law.[6] According to the CEC, most complaints are resolved informally and there are no fines or separate enforcement mechanisms currently proposed in connection with AB 1103 implementation.  Thus, enforcement will largely be industry-driven, as any penalty will depend on complaints being filed with the CEC.  In most instances, parties to transactions would be the only individuals with knowledge as to whether the required disclosure took place.  Despite the apparent lack of any harsh civil penalties, compliance with the law is important to avoid the potential risk and costs associated with any administrative hearing, and may also serve to insulate against claims of fraud associated with the transaction.

Potential Issues and Practical Considerations

Customer Privacy

Earlier roadblocks to implementing AB 1103 were in part due to privacy concerns; since most lease structures require the tenant to be responsible for utilities, the tenant is considered the utility “customer” rather than the building owner. Thus, in response to a request from a building owner, a utility company would have been required to obtain customer consent before releasing the data.  As a solution, the draft implementing regulations provide that upon authorization of a nonresidential building owner or operator, an electric or gas utility will be required to upload all of the energy consumption data for a building to the U.S. Environmental Protection Agency’s Energy Star Portfolio Manager, but this must be done “in a manner that preserves the confidentiality of the customer”, meaning that the information will be released to the owner under a nondisclosure agreement, and will not be publicly released (as was initially proposed under the draft legislation).

Economic Impacts

AB 1103 will essentially result in a commercial valuation of energy usage during a financial transaction, just as square footage is valued. Owners of buildings that score well could demand a higher premium for the sale or rental of the property. Conversely, receiving a low score on either report could result in devaluation of buildings, and chill real estate transactions overall at a time when too many buildings are already vacant.  The high rates of currently vacant commercial and industrial buildings in the current economic climate raise another issue: how can benchmark data for the past twelve months be established for a building which has been vacant or under-tenanted a substantial portion (or all) of that time? 

Real property agreements involving energy usage disclosures will require skilled negotiation by those who are familiar with the concepts and technology behind building energy efficiency, as well as the existing and proposed uses for the building. Otherwise, parties run the risk of “greenwashing” in lease and purchase and sale agreements, which can occur through unsubstantiated claims that a building will result in a certain level of cost-savings based simply on a numerical score, without taking other factors into account. In addition, landlords and prospective sellers may be pressured to undertake certain improvements during negotiations in an attempt to achieve a higher building rating.  While energy efficiency improvements should be encouraged, it is important to allocate responsibility for all such work and costs in the transaction documents, and perhaps even more importantly, verify through an energy audit that any such improvements will actually have a tangible, corresponding benefit.

Another area that could present issues is the rating of buildings which have multiple varying uses in the same space (such as manufacturing and warehousing), or changing retail uses that might render the benchmark data meaningless.  A prospective purchaser or tenant should be aware that their operations and building usage may require more or less energy usage. 

Steps to Take in 2010

Building owners who have leases nearing their expiration date, or those who are delaying capital improvements and retrofits, should re-examine the implications that AB 1103 will have on upcoming transactions.  Many financial incentives and rebate programs now exist to assist owners with the upfront costs associated with energy efficiency retrofits. In addition to a wide variety of local incentives and utility rebates, tax benefits in the form of an “energy efficient commercial buildings deduction” under Internal Revenue Code Section 179D have recently been extended until 2013.  Building owners may be eligible for a maximum deduction of $1.80 per square foot of building space for certain improvements and upgrades to interior lighting systems, heating, cooling, ventilation, hot water systems and building envelope that meet energy efficiency targets.   

[1] California Public Resources Code § 25402.10 (2009).
[2] “Nonresidential Building” means a building of an occupancy type other than Residential Group R-2, R-3, R-3.1 as defined in the California Building Code, title 24, section 302 et. seq. (2007).  Such building types include, but are not limited to offices; retail and wholesale stores; restaurants, theaters, churches, K-12 schools, factories, hotels and motels; and storage facilities.
[3] “Entire building” is defined as a physically integrated building with a single owner.
[4] The July 1, 2010 date is set forth in the most recent publicly available draft regulations; however, please note that Gresham Savage has received information from the CEC indicating that this date may be delayed until January 1, 2011.
[5] Owners of these buildings will only be required to disclose the CEC Nonresidential Building Energy Performance Report.
[6] 20 CCR 4.1 (2009).  Complaints may be filed by “any corporation or person, chamber of commerce, board of trade, labor organization, or any civic, commercial, mercantile, traffic, agricultural or manufacturing association or organization, or any body politic or municipal corporation.”