Walk a Mile in a Building Owner s Shoes

“Seek first to understand, then to be understood” Stephen Covey The Seven Habits of

Agenda • Energy demographics and commercial building markets • Ownership structures and motivations • How to make (or not make) money in commercial real estate – – Property valuation Economic drivers • Lease types and the behaviors they drive • Events that create action • Strategies for success © 2010 Air. Advice, Inc.

Energy Demographics 58% 98% Source: Commercial Buildings Energy Consumption Survey (CBECS) 4 © 2010

Commercial Buildings Markets Source: Commercial Buildings Energy Consumption Survey (CBECS) © 2010 Air. Advice,

% of Total Floorspace Source: Commercial Buildings Energy Consumption Survey (CBECS) © 2010 Air.

Ownership Structures 1. Owner occupied • Employees of company owning the building occupy the space • Examples: – Corporate campuses, education, public • Company views property as an asset – May benefit from capital appreciation, but not primary motivation – Typically longer term view • Primary motivation – Profitability of business – Reduce costs associated with facilities © 2010 Air. Advice, Inc.

Ownership Structures 2. Investor Owned • Building owner leases space to other companies, who occupy the space • Company views property as a “box of leases” – Return on investment is primary motivation – May have very short term investment horizon • Examples: – Office buildings, warehouses, retail © 2010 Air. Advice, Inc.

How to Make Money in Commercial Real Estate $ Sell Price Profit on Sale

How Not to Make Money $ Purchase Price Negative Equity Sell Price Debt Equity

Even More Problematic…Refinancing $ Purchase Price Market Value Debt Cash Required for Refinance Debt

Example • IDS Center – 1. 4 million sf, 57 -story office tower – Bought in 2006 for $278 million – Successfully refinanced property in January 2010 • $125 million loan to replace previous $161 loan • Financing package required $36 million of additional equity • Term of loan: 2 years, with option to extend to 3 rd year • Property 98% leased © 2010 Air. Advice, Inc.

Distressed Commercial Properties • Between 2010 and 2014, $770 billion in commercial loans will

How Buildings Valuation is Determined • Commercial real estate is valued on the risk adjusted rate of return, or capitalization rate Net Operating Income Property Value = Cap Rate © 2010 Air. Advice, Inc.

How is the Cap Rate Determined? • By comparing NOI and sale price from recent sales of similar buildings, i. e comparable sales Cap rates will vary greatly: • Over time • By geographical market • By building type © 2010 Air. Advice, Inc.

Net Operating Income = Revenue – Operating Expenses • Revenue - Lease payments - Other fees • Operating Expenses - Management / leasing fees Insurance Janitorial Taxes Utilities © 2010 Air. Advice, Inc.

Where We’re Headed… • “Energy use is the single largest operating expense in commercial

Energy Savings Drive Higher Asset Value 20% lower utilities $3. 4 million higher asset

Turn Price Pressure into Gain Example: • 100, 000 sf building • $2 per sf in energy costs • $10, 000 cost of PM agreement Scenario 1 10% Reduction in PM Price Scenario 2 10% Reduction Energy Costs 50% Increase in PM Price © 2010 Air. Advice, Inc.

Economic Challenge for Building Owners Declining occupancy… Increases competition for tenants which drives lease rates down… Which reduces NOI… Which investors see as increased risk, increasing cap rates… Which results in lower asset values… Which limits access to capital. But it all starts with OCCUPANCY © 2010 Air. Advice, Inc.

Common Lease Types Lease Type Description Impact of Operating Expenses on NOI Gross or full service • Landlord pays all capital and operating expenses • Lower operating expenses result in higher NOI Net • Landlord pays capital expenses • Tenant pays operating expenses • No direct impact on NOI Full service w/ base year expenses • Landlord pays capital • If operating expenses and operating near base year, lower expenses up to “base year” operating expenses can amount result in higher NOI • Tenant pays operating expenses above base year amount © 2010 Air. Advice, Inc.

Behaviors Determined by Lease Type Gross Lease Year 1 Year 2 Net Lease Year 1 $0. 50 to Landlord $2. 00 per sf $1. 50 per sf Landlord generally motivated to reduce operating expenses Year 2 Gross Lease w/ Base Year 1 Year 2 $0. 50 to Tenant $2. 00 per sf $1. 50 per sf Landlord may not be motivated to reduce operating expenses © 2010 Air. Advice, Inc. $2. 00 per sf $1. 90 Base Year $1. 50 per sf $0. 10 to Motivation Tenant depends on $0. 40 to Landlord relationship of current expenses to base year

Must Understand Who Pays and Who Benefits Leased Space Owner Occupied Space Who Pays: Operating Expenses Capital Expenses X X Who Directly Benefits: Net Lease Owner Gross Lease Owner X X X Tenant Benefits Accrue to Owner Benefits Accrue to Tenant © 2010 Air. Advice, Inc.

Pass Throughs • A common lease clause, even in net leases, allows the building

Events that Drive Action © 2010 Air. Advice, Inc.

Lease Renewal • • Buyer’s market Building owners are willing to invest for the

Case Study • 30, 000 sf office building in Kirkland, WA • 3, 000 sf tenant lease renewal – History of comfort complaints • Contractor proposed $30 k project – Energy service agreement – Test and balance – Duct insulation • Building owner accepted proposal on the spot © 2010 Air. Advice, Inc.

Case Study • What’s at risk? – 3, 000 sf x $30 per sf = $90, 000 per year in rent – 7 year lease = $630, 000 of guaranteed revenue • If tenant leaves? – Minimum 6 to 9 months of lost rent = $45, 000 to $67, 500 Building owner’s perspective: $30, 000 to solve problem doesn’t seem so bad © 2010 Air. Advice, Inc.

Sale or Refinance of Building • Building finances will be heavily scrutinized – – • Revenues Operating expenses Cash flow Condition of systems 1 -2 years leading up to event is prime time for action © 2010 Air. Advice, Inc.

Property Condition Assessment (PCA) • Evaluation of major systems in building – Roof, parking lots, mechanical • Lenders may require cash escrow for items found deficient – Immediate lump-sum reserve – Ongoing monthly reserves above NOI line • Replacement of major systems prior to refinancing can be cash flow positive © 2010 Air. Advice, Inc.

Energy Benchmarking Legislation • Legislation requires benchmarking: – Sale of building – Refinancing of building – Lease of building to single tenant • Most notable legislation passed in: – – State of California State of Washington New York City Washington, DC © 2010 Air. Advice, Inc.

Energy Benchmarking Legislation © 2010 Air. Advice, Inc.

Key Outcomes in Current Economic Climate 1. Occupancy is critical – – Building owner is increasingly willing to invest for the benefit of the tenant Improve marketability of space 2. Investment horizon is extending – Falling asset values forcing building owners to hold properties longer 3. Vacant space strategies – Building owners pay operating expenses for vacant spaces 4. Cash is king – – Maximize asset value Minimize capital expenditures, unless it can be passed through to tenant © 2010 Air. Advice, Inc.

Strategies for Success © 2010 Air. Advice, Inc.

Strategies for Success 1. Sell to the right level – Financial decision makers, not

Tips for Selling to the Right Level • Ask financially based questions • If your contact doesn’t know the answer, ask them to who would – Gain a warm introduction to financial decision maker © 2010 Air. Advice, Inc.

Target the Correct Decision Making Level % of Time Goal Position 10% 20% CFO / COO / Controller 20% 30% VP Finance, VP Operations, VP Facilities 60% 45% Facilities or Plant Manager / Director or Property Manager 10% 5% Building Engineer/Operator What Motivates Them Why Talk to Them • Overall operating cost and corporate objectives • Needed to approve decision • Can direct activities • Reducing operating costs (management pressure) • Decision maker for service (but not final say on capital expenditures) • Happy tenants • Looking good to their owners • Minimizing downtime • Reduced complaints © 2010 Air. Advice, Inc. • Can influence decisions • Partner with them to go upstairs • In the loop w/ current service provider • Close to mechanical equipment • Need to win them over • May have veto power

Strategies for Success 2. Understand financial drivers – Lease types – Upcoming lease renewals – Investment horizon • • Sale Refinance – Willingness to pass-through operating expenses and capital expenses © 2010 Air. Advice, Inc.

Strategies for Success 3. Change the buying criteria – Offer something different © 2010

Change the Buying Criteria • Current – Price of maintenance agreement or project •

Strategies for Success 4. Key off action-driving events – Lease renewal – Sale /

How To? Energy Services Delivery Model © 2010 Air. Advice, Inc.

Walk a Mile in a Building Owner’s Shoes • Owner-occupied & investor owned properties are motivated differently • #1 priority: Occupancy • Different lease types drive different behaviors – Understand who pays and who benefits • Events that create action – Lease renewal – Sale or refinance of building – Energy benchmarking • Strategies for success 1. 2. 3. 4. Target the right level Understand financial drivers Change the buying criteria Key off action-driving events © 2010 Air. Advice, Inc.