You want to include a major
HVAC renovation in the plan for this year. How do you convince an owner to complete a retrofit that the building needs? You need to demonstrate, first, how the upgrade will improve the building and, second, how this increases the value of the building for the owner.
Some managers may think it is simple to convince an owner to spend thousands of dollars on an upgrade. They assume that an owner will want to complete a project so the building remains state-of-the-art. However, most owners — institutions, for example — view the building as an asset similar to stocks or bonds. They need to see the value of the property increase as a result of their cash outlay.
A second reason commonly given by managers to owners is that the office building will operate more efficiently after the retrofit, thus reducing utility costs. However, tenants usually pay their share of the building’s operating costs based on the amount of space they occupy.
Therefore, the tenants, not the owner, will benefit from the reduced utility costs. The owner pays for the renovation at the time the work is done. The cost of the work is then amortized and passed through to the tenants over the lifetime or payback of the project. The owner will spend the money today and only recoup it over time while the tenants will experience the immediate benefit.
This is the challenge faced by a fictional facility manager we’ll call John Philips, who is responsible for the hypothetical Spencer Building. Built 10 years ago, The Spencer Building is a class A office building in a downtown market. Like many buildings in the marketplace, the 240,000 rentable square foot building is 100 percent occupied with no major leases rolling over for seven to 10 years. Philips is aware that the owner’s objective is to hold this building for at least two to five more years. Although only 10 years old, the building’s HVAC system has two problems. First, the energy management system is not state-of-the-art and does not provide the building with efficient operation and sufficient control. Second, the parts of the mechanical equipment are expensive to maintain.
Philips has recommended upgrading the EMS system and installing variable frequency drives (VFV) on major equipment motors. The upgrade of the EMS system will include new power supplies, bases, transducers, wiring and associated relays. The existing temperature sensors will be replaced and new direct digital controllers will be installed for the interior and exterior air handling units, 24 in all. Static pressure controllers, solar load sensors and control relays will also be added to the EMS, giving the operating engineers more control points to ensure tenant comfort levels and increased monitoring capability. All of the new sensors and relays will be linked by a networking cable in a user-friendly package to a desktop computer with a Pentium microprocessor, graphics card, high-speed modem, color monitor and color printer.
VFDs will be installed on all motors and pumps. VFDs provide a staged start-up of equipment, preventing “spikes,” or sharp increases in electric demand. Motor speed can also be controlled by a VFD to operate more efficiently when equipment is at part load. Other advantages to VFDs are increased equipment life, decreased maintenance costs and automatic restart of equipment after power failures.
The system upgrade was bid to five companies with the recommended vendor bidding on this work for $326,978. The vendor has also given the option of a lease of this system at $422,100 at 11 percent for 60 months. This cost includes energy accounting, bill auditing and benchmarking reports for the first year.
The economic analysis that follows is based on the upgrade package just described; however, a similar approach can be taken with any HVAC system upgrade.
Owner’s Plans
Because the building may be for sale in the next two to five years, Philips knows the owners will want an increase in value at time of sale and a quick return on investment. To prove the increase in value, Philips will rely on the income-capitalization method of appraisal. The income-capitalization method is based on the net operating income (NOI) — the result of subtracting the operating expenses from rents received. If rents go up or expenses go down, NOI increases; higher NOI means higher value.
What’s more, an HVAC retrofit may make a building more appealing to tenants than other buildings in the area, thus increasing rents. Further, a retrofit project usually decreases utility costs.
The income-capitalization method divides the income by a cap rate, defined by market conditions, to find value. Based on the NOI for the building and a cap rate of 9 percent, the current value of The Spencer Building is $50,666,666.
At the Spencer Building, occupancy is already 100 percent with no major leases expiring until the year 2015. Therefore, the upgrade will not attract new tenants so no increases in rent as a result of the project are expected.
However, if the building had vacant space and was located in a competitive market, it might have an edge in leasing over buildings with higher utility costs. A tenant pays operating expenses over a base year. A base year may be set at $10 per square foot. The tenant pays all operating expenses in excess of $10 per square foot; the owner bears the cost up to that amount. If the operating costs are $14 per square foot, the tenant is paying $4 per square foot. If the retrofit reduces costs by $0.50 per square foot, the tenants’ costs fall to $3.50 per square foot. The owner’s costs are not reduced. The benefit to the owner is that the tenant may be happy with the reduced costs and be more inclined to renew the lease.
Cutting Costs
The retrofit at the Spencer Building will reduce costs in several ways. The EMS will improve staging of equipment during start-up and shutdown schedules and increase detail of temperature sensing and automatic adjustment. The VFDs will reduce utility costs by operating at only the speed required to satisfy the comfort load; the current system provides constant volume and constant speed flow. Based on a review of the equipment and historical electrical data, energy savings are estimated at:
- EMS base system utility savings: $96,154
- VFD installation utility savings: $40,872
- Total estimated annual utility savings: $137,026
- Savings per square foot: $2.570
The system costs $326,978. As outlined above, the annual utility savings are $137,026, creating a payback period of 2.39 years. Annual utility savings will increase NOI by $137,026. This, in turn, produces an increase in value based on the income-cap method of $1,522,511. The new value of the building is $52,189,177.
Range of Benefits
Philips can present this project to the owner by citing the benefits of the upgrade. The physical improvements include:
- Improved system control through installation of state-of-the-art equipment
- Cost savings due to VFDs and improved response to temperature
- Ease of operation by use of “point and click” methods
- Reduction of engineering staff time required to program the system and to check concerns through the system rather than a physical site inspection
- Reduced maintenance cost
More important are these financial benefits:
- A payback period of less than 2.5 years
- An increase in value in excess of $1.5 million dollars
- Lower operating expenses for tenants
To win approval for capital projects, a facility manager must have two things: knowledge of the owner’s objectives and the ability to prove the improvements meet those goals. After this upgrade, the Spencer Building will have a state-of-the-art HVAC system and be worth more than before the renovation. This combination will make the building more attractive to potential purchasers. Based on the numerous benefits, the owner would probably approve this upgrade at the Spencer Building.
