Energy Conservation in the Toronto Multi-Residential Market
More and more, building owners are viewing energy conservation as an investment as opposed to “something nice to do for the environment”. A common way to valuate a building is by using the capitalization rate, or “Cap Rate”.
Cap Rate is defined as the annual net operating income divided by the value of the building. The net operating income is the building earnings before accounting for interest and corporate taxes, (EBIT – Earnings Before Interest and Taxes).
According to Colliers International, the Cap Rate for the first quarter of 2016 for Toronto Multifamily High-Rises was between 3.50% and 4.75%. This means that if you purchased a multires building in Toronto for $1M at a Cap Rate of 3.5% to 4.75%, you could expect earnings (EBIT) between $35,000/yr and $47,500/yr.
If, however, you used that same $1M and invested it in energy conservation projects across your portfolio, you could reasonably expect a simple payback between 5 years and 10 years. The utility savings would therefore be between $100,000/yr and $200,000/yr.
If we look at this another way, let’s assume that we invest $1M in energy conservation measures at a 7.5 year simple payback, our annual savings would be $133,000/yr. This amount increases our EBIT by the same $133,000/yr. The value of our buildings then increase by between $2.8M and $3.8M.
Investing in conservation makes perfect sense when viewed in these terms. They make even more sense when you consider the following:
- Rent increases to existing tenants is around 2.5%.
- Rent increases when an apartment is leased to a new tenant is not restricted, and can therefore be set at whatever the market will bear. Turnover rate is very low, limiting the ability for EBIT to grow faster than 2.5%.
- Electricity rates are growing much faster than 2.5%.
Therefore, investing in your current buildings will increase your earnings and the value of your building. And from an altruistic standpoint, it is the right thing to do.