Post contributed by Aaron Fairchild:

Welcome to the residential world of green home living.  You can now buy a green built home with a variety of different certifications. From LEED for homes to Built Green 3, 4, and 5 stars to Earth Advantage homes, environmentally green homes are more and more available to interested home buyers. In fact, in the Seattle region 25% of all new residential home construction is built to a green building certification. But what about homes for rent? While there has been a lot of attention paid to “green leases” in the commercial real estate market, if you are in the residential rental market, and concerned about your utility costs and environmental impact, there are next to zero green rental options available to you. What gives?

The issue of “split incentives” is the culprit. In a capsule the issue is that the landlord generally doesn’t pay the energy bill and wouldn’t benefit from lower energy costs that come from investing in enhanced energy efficiency, and the tenant doesn’t own the home and is therefore unlikely to invest in energy efficient appliances or systems. This issue is of particular interest to me.

I am the Managing Partner at G2B Ventures, LLC. G2B is establishing an energy efficient residential real estate investment fund. The Efficient Real Estate Fund will buy primarily single family homes at deep discounts and then refurbish them with an eye toward energy efficiency. Once the investment properties are acquired and refurbished we will be renting them out to capture rental income during the life of the Fund.

Our property management team will tell you that newly refurbished or constructed homes generally command higher rents. While this helps us at the Fund, we will eventually recapture all of the costs of energy efficient and general improvements when we sell the properties.  But how do we increase our rents to help recapture the costs of energy efficient up-grades more quickly?

We are currently developing a model that shares the benefits of energy efficiency between the landlord, which in our case is the Fund, and the tenants. Here is what we are working on:

Step 1:

The landlord must start with an understanding of the energy costs associated with normal or average energy consumption and then baseline the property. For example, the landlord determines that during the winter months the average utility bill runs roughly around $250 and in the summer the rough bill is $200.

I am using easy to absorb numbers and I know this is a rough analysis so read on…

Now the landlord does the energy improvements and using the kWh savings for every measure installed she can easily calculate the monthly cost savings. Using our data for the Seattle area we roughly calculate that a smart $10k investment in energy efficiency can save roughly $50 per month. Using a $50 dollar per month savings we can now assume that during the winter months the average home occupant will spend $200 per month and during the summer he will spend $150.

Step 2:

The landlord will now offer the home for rent that includes the utilities within the rent payment. The rental rate is determined based on market rents plus the pre-retrofitted utility cost projection.  Rent including utilities is normally avoided because the tenant is not incentivized to conserve energy, which could end up costing the landlord dearly. However, in our model, if the tenant uses less than the baseline utility monthly expense ($200 in winter and $150 in summer), the landlord will share the savings with the tenant 50/50. Instead of a split incentive, we are aiming for a “shared incentive.” For example, if the tenant’s bill in the month of January were only $150, the tenant would receive a check for $25, and the remaining $25 would go back to the landlord.

Clearly this model requires enhanced sophistication on behalf of the landlord. Good tracking systems and transparency are absolutely necessary. However, the benefit is clear for the landlord…

Cons

•    Difficulty tracking
•    Cost of retrofit
•    Calculating the savings borne through efficiency

Pros

•    More quality tenants
•    Better relationship with tenant
•    Enhanced property cash flow
•    Enhanced asset value

…and for the tenant.

Cons

•    Generally higher rental rates
•    Landlord knows the utility consumption behaviors
•    Greater interaction with the landlord

Pros

•    Newly refurbished / clean / healthier rental
•    Rental characteristics align with values
•    Ability to receive energy savings checks every month the energy costs are below baseline.
•    Greater interaction with the landlord