Building Operation and ESG Mistakes That Kill Your NOI

In each of the hundreds of assets that the Enertiv Platform has been deployed in, there have been at least one or two issues which stood in the way of maximizing net operating income.

These can be put into broad categories:

1. ESG Issues - jump to this section

2. Maintenance Issues - jump to this section

3. Technology Issues - jump to this section

4. Productivity Issues - jump to this section

5. Budgeting Issues - jump to this section

With the ongoing uncertainty about cash flows, finding and fixing as many of these issues as possible is gaining priority.

ESG Issues

1. Not knowing how to get ESG projects across the finish line

Perhaps the most salient reason to deploy a building operations platform would be to increase NOI by decreasing operating expenses.

In a perfect world, all the recommendations that come from the software would be immediately actionable and intuitive to operating staff. While this is true for the low-hanging fruit, maximizing ROI requires technical collaboration between on-site teams and data experts, as well as leadership from management.

2. Not knowing how to communicate ESG setbacks to tenants and investors

The business case has been settled: robust and well-executed ESG programs protect and enhance returns. Unfortunately, COVID-19 has created significant headwinds to the progress that’s been made.

Many commercial assets are designed to operate with about 20% outdoor air and 80% recirculated air in the building. This promotes efficiency because outdoor air is much more expensive to heat or cool than recirculated air.

Now, buildings are expected to forgo those efficiency gains by significantly increasing the outdoor air mix to flush out droplets and aerosols potentially carrying COVID-19.

While the exact increase in costs for this change depends on the size of the building, HVAC configuration, climate, and other factors, the financial and ESG costs are often significant.

In one example pulling from Enertiv’s dataset, increasing outdoor air mix from 20% to just 30% caused HVAC costs to shoot up by 14% despite temperature staying within a narrow band. ASHRAE and CDC are recommending increasing outdoor air all the way to 100%!

3. Not understanding how buildings are performing since reopening began

Many people started working from home before the stay-at-home order was enacted. Likewise, many people have not returned to the office even when the governor initiated Phase II. But from a building operations standpoint, it doesn’t really matter. If tenants can be in the building, you essentially must operate it as if it’s fully occupied.

In addition, following ASHRAE and CDC guidelines means increasing the amount of outdoor air brought into the building and using higher-grade filters. These measures are known to increase operating costs, but by how much? That’s what this analysis intends to answer, by looking at granular data in office and multifamily buildings in New York City while accounting for outside factors such as increasing summer temperatures.

Maintenance Issues

1. Assuming maintenance and repair costs are fixed

For most asset managers, “maintenance and repairs” is no more than a line item on the P&L that increases a small percentage each year. This is understandable, if costs stay reasonably close to the forecast, most asset managers don’t mind being spared the details of how it is spent.

But the impact of maintenance practices extends far beyond a share of operating expenses. Ineffective maintenance can negatively affect the tenant experience to the point of influencing leasing decisions. Equally as bad, improper maintenance can shorten the life of equipment, leading to large capital expenditures not sufficiently covered by reserve funds.

To reduce operating expenses, diminish risk, and ensure tenants receive what they’re paying for, maintenance practices should be proactive and transparent. Unfortunately, most operators do not have the necessary tools to make this reality.

Related Article: 10 Things Wrong with Real Estate Maintenance

2. Unintended consequences from COVID-19 operational changes

When it comes to modifying a building’s HVAC system, it can feel like a Catch-22. Changes to reduce risk of viral transmission can increase the risks to tenant health in other ways. Worse, many of these adverse effects – higher moisture levels, continuous temperature fluctuations, and mold growth – may not immediately come to light because of the intense focus on the COVID-19 crisis.

With rental revenues falling and operating expenses increasing, it’s critical from both a cash flow and tenant health perspective that owners and operators fully understand the nuances involved in complying with these guidelines. To do so, efforts should be made to move towards remote operations, where the best engineers have access to the details of every building, regardless of where they are currently located.

3. Not taking advantage of a building’s “steady state” just after construction

Data can drive the strategy and daily decision making from the beginning of the building’s lifecycle. The case for digitizing operations early is simple; at no other point will there be the level of concentrated engineering or design intellect put into the asset.

In this “steady state,” equipment is in mint condition, controls and settings are optimized, and supporting documentation is well organized. From then on, every aspect of the building and associated operations will begin to degrade, either quickly or slowly depending on how it’s managed.

There’s also a degradation of organizational knowledge, where information goes from explicit (documented and accessible) to tacit (learned and personal). Usually, this leads to deferred maintenance, which ultimately causes equipment failure and a depreciation of the asset.

According to Clinton Capital Management, nominal cap rates (cap rates before necessary maintenance CapEx) still dominate the real estate market. But if quoted nominal cap rates are achieved because of skimping on CapEx, the property usually later sells at an impaired price. At the end of the day, the economic cap rate (with necessary maintenance CapEx included) represents the true economics of the property.

Sooner or later, maintenance must be paid for, either as ongoing operational and capital expenses, or in the form of a depressed sales price. The more the processes and configurations that drive these costs are aligned with the original specifications, the lower they will be.

Technology Issues

1. Being paralyzed by technology buzzwords

Technology and real estate companies often speak different languages, which leads many professionals to feel like they’re trying to drink from a fire hose.

One major problem is buzzwords. Terms like “machine learning” and “artificial intelligence” are easy to throw on marketing materials but don’t tell landlords much or help them differentiate platforms.

Worse, the real-world applications of these terms actually represent amazing technological leaps that could greatly benefit real estate companies.

2. Not understanding the limitations of BMS data

With the growing excitement around the possibilities of tomorrow’s buildings, there is faith that “building management systems are the backbone of smart buildings.” Owners and operators are envisioning ways in which the traditional BMS can be expanded to become the source of data for how a portfolio of buildings is performing.

As such, a number of solutions have been developed to extract and visualize the notoriously dense BMS data for building operators. Armed with this data, the theory goes, operators will be able to produce the ideal environment for occupants in a more effective and precise way than currently possible, all while reducing wasted operating costs.

However, there is an issue with this vision of the future: there are severe limitations with the data that can be captured by building management systems, and thus a limitation on the extent to which BMS data can facilitate the future envisioned for tomorrow's buildings.

Related Article: 4 Limitations of BMS Data

3. Not understanding how smart buildings actually work

Since the first building management systems went into commercial real estate in the early 1980’s, “smart buildings” have been touted as the next industry standard.

Individual technologies have advanced quite a bit since then, but smart buildings remain just around the corner. Meanwhile, day-to-day work like maintenance rounds and expense forecasting are often still reliant on manual, paper-based processes. Why is that?

A major reason is that both the commercial real estate industry and newer PropTech players have tried to force a top-down approach to technology development and adoption. At a high-level, this approach takes all the systems, HVAC, lighting, access and security, etc., and categorizes them into their subsystems, data sources, and use cases. The thought process is that an integrated platform that connects every disparate system will harmonize and automate how these systems react to tenant preferences and changing conditions.

Related Article: How Smart Building Technology Actually Works

Productivity Issues

1. Not being prepared for when skilled operators retire

As the rest of commercial real estate becomes more data driven, physical assets are still being operated based on intuition. Fortunately, in most cases there is a building engineer with decades of experience who can be counted on to do the leg work necessary to operate the building efficiently without jeopardizing tenant comfort.

The value in that experience cannot be overstated. Building operations is a complex undertaking, where dozens of systems work in tandem to create a healthy and comfortable indoor environment.

Each of these of systems, supply fans, boilers, chillers, elevators, pumps, etc., have electrical and mechanical components that can fail at any moment. Diagnosing the root cause of issues requires deep knowledge about how each piece of equipment works, and how these systems work together.

This deep knowledge, while extremely valuable, is also perilously held in the minds of experienced engineers. Unfortunately, technically skilled professionals are declining as a share of the overall workforce; 55% of engineering managers are over the age of 55 and 86% are over the age of 45.

Replacing retiring engineers with the younger generation doesn't solve the problem either. Gen Xers change jobs twice as much as Baby Boomers, and Millennials move jobs four times as often. This translates to less time for developing the deep knowledge necessary for managing complexities of building operations. The effects of this are already being felt; 62% of firms report trouble filling technical positions.

2. Still relying on pen and paper for tenant submetering

Many Commercial Real Estate (CRE) companies bill their tenants each month based on the amount of electricity, water and/or gas they consume. Generally, this is a smart business move. Not only does it guarantee that management won’t underestimate their tenants’ consumption and end up on the hook for the difference, increasingly savvy tenants are including utility billing as a factor in lease decisions.

There’s just one little problem. The current process of billing tenants for their actual consumption is inefficient, inaccurate, frustrating and costly.

3. Not being able to find critical data fast

With everything that’s happened this year, it goes without saying that accelerating the digital transformation and enabling remote building operations have become top priorities for commercial real estate.

Unfortunately, “smart building” discussions have become so abstract that they’ve become completely divorced from the reality on the ground.

The truth is, the building data that operators need to do their job better today is not a cutting-edge digital twin, often it’s simple things that can be digitized today.

Budgeting Issues

1. Making broad budget cuts instead of targeted adjustments

The pressure is on for operators and asset managers to cut expenses, and to do so quickly.

When the clock is ticking, it’s tempting to make broad changes that undeniably have the desired effect. Even before COVID-19, many properties were run this way. If a tenant needed overtime HVAC for a couple hours, operators would run the systems 24 hours a day to make sure they were covered.

But following the same approach with budget cuts is like using a sledgehammer instead of a scalpel to remove a pinky. It will certainly have the desired result, but it carries a significant risk of collateral damage.

A full audit takes time that portfolios don’t have. Cash flow is under threat today and any decisions are better than no decisions at this point. Unfortunately, this often means letting people go. While this sledgehammer approach effectively reduces costs, it also eliminates institutional knowledge that has been built up over decades and cannot be replaced.

On the other hand, data can serve as a scalpel, expanding the options for which operating expenses to maintenance service contracts, parts inventory, CapEx reserves, and utilities. This allows operators and asset managers to make cuts that don’t undermine long-term performance.

Of course, the value of data is conditional on the actions that can be taken. To do that, you need to be able to quickly surfaces and test hypotheses.

2. Not knowing how to earmark for PropTech investments

Every budget season, this one in particular due to the challenges caused by COVID-19, owners and operators ask:

“There are too many technologies… Where do I even start?”

It’s a fair question, especially given the need to submit budgets quickly in a time of great uncertainty. With rental revenues slipping, the focus has been on cost-saving technologies. But if you start consuming information about “smart buildings” and “digital twins,” the rabbit hole can quickly lead to some very overwhelming and misleading advice.

In years past, this often led to paralysis by analysis. While not ideal, this was acceptable because times were good.