A Third Way (to Profits) for Greening Buildings

So far, the consensus on how to make money from retrofitting existing buildings has involved an unsustainable logic: you need government money and you need to work at small scale. That logic is about to change.

Bill Clinton invested his foundation dollars and Mike Bloomberg invested his political capital in the idea that we must tune up the buildings we already have to keep our cities going in the climate we expect to confront. Yet since Clinton’s $5 billion retrofit fund announcement in 2007 and Bloomberg’s retrofit law earlier this year, we’ve seen bupkis from the private market to encourage retrofitting on a broad scale. In part, the silence has reflected the financial system’s hesitancy to make any commercial loans. But it’s also reflected a deeper perversity in commercial real estate: mortgages keep owners from borrowing money to make big efficiency upgrades, and leases keep owners from realizing cost savings from the upgrades they can afford. Steve Gossett is peddling a remedy. I don’t know enough about real-estate finance to grade it, but I know it deserves a slow look. Here’s the idea:

Gossett’s company, Transcend Equity, makes its bones by taking over retrofit projects from landlords and tenants. A tenant expects to save $x from an energy fix. It pays Transcend that money. Transcend raises capital to realize the project (which may involve a new boiler, or new chillers for water  management, or something else.) If its contractors and staff calculate correctly, Transcend realizes enough savings to pay the energy utilities, pay back its lender, and pocket some money for itself.

Contrast this with the model Clinton embraced, which relies on energy-services companies. These are multinationals that audit a building, propose a schedule of fixes, get paid for making those fixes out of promised energy cost savings, and maintain huge staffs and overhead. Under the Clinton Climate Initative’s retrofit program, a pool of money from big lenders enables mayors around the world to hire these “escos” for a range of projects from retooling New York’s public housing to greening Paris’s schools.

Gossett departs from this model by promising that he stays “engaged” with a greening project from month to month because he makes money when savings occur. Gossett says the company, which operates out of Dallas, does enough business that it only needs to forecast 75 percent of its savings accurately to make a profit. And he says it’s been accurate in 95 percent of projections. Now, Transcend is partnering with a New York consultant, Cycle 7, to reform commercial leases around the idea that a third party like Transcend can help landlords and tenants improve their buildings right away and see prompt rewards. They call their model “MESA,” for “managed energy services agreement.” And they’re talking it up to landlords around New York.

Gossett says that even in this blasted lending environment, private equity firms like the model deeply enough to capitalize it. And he forecasts a New York office deal soon, which would break the company from a pattern of working for mainly government-owned (and, as Gossett says, “recessionproof”) landlords in the DC suburbs.

To be sure, Gossett echoes Clinton in being a Southern charmer with a knack for making people feel like confidantes. (After 40 minutes with him, I was babbling about how I raise my daughter and how much I hated middle school.) And like Clinton, he may be hiding pivotal consequences in niceties. Just because landlords and tenants can expect savings doesn’t mean they can agree on how to divvy them, for instance. And just because private-equity funds may be investing in Transcend’s model now doesn’t prove that the energy savings Transcend promises will meaningfully move property owners to scalable methods of retooling their buildings. It depends what the meaning of green is.

Over the next few years, though, the climate will grow scarier right when many major office tenants negotiate new leases. Without the ducats to promise marble lobbies or Pinot-on-demand, landlords will have to lure these tenants with something that hits their bottom line. That makes energy savings a compelling investment opportunity. It may be that efforts like Clinton’s create case studies for superstars while companies like Gossett’s stoke the rest of the market.

“Subsidy will help a lot when you have a model greening structure in place,” says Cycle 7′s Sean Neill. “Until then, raising money is very expensive.” But promising savings – that, Gossett hopes, is just good business.