As with any rental property, the fundamental problem with my apartment is that I have to live in it. Oh, and I don’t own it. Therefore, the person who does own the building (i.e. my incredibly cheap landlady) has no real interest in investing money beyond that required to make the place meet the bare minimum standards. On the other hand, while I would love to launch a search and destroy mission against the mold in the bathroom, I have no motivation to sink large sums of money into a place that I do not benefit from financially (other than via cheap rent).

This is the wonderful quandary of the split incentive. It has been a serious roadblock not only to my personal mold removal dreams but also to the larger issue of improving energy efficiency in rental properties of all kinds. In the case of energy efficiency, the split incentive divides renters and owners in two possible ways. First, when renters pay the utility bills, owners lack the motivation to install energy efficiency upgrades and retrofits since they will not see direct financial benefit. Second, when owners pay the utility bills, renters do not have the necessary motivation to help with conservation measures such as turning off lights in vacant rooms and keeping the heat at a reasonable level. Renters can continue to waste energy without financial consequence, and this undermines any energy efficiency investment an owner might make.

In British Columbia, the BC Sustainable Energy Association has launched the Green Landlords Project to investigate the problem and develop solutions. Although they are focusing on rental housing, the solutions would be no less applicable to the commercial real estate rental market. Here is one of the most intriguing solutions identified by the BCSEA’s report.

Utility Bill Financing… Pay As You Save

Essentially, U-Bill or PAYS is a method for providing the necessary financing for energy efficiency, which steps around the split incentive problem. Think of it as the building itself getting a loan and implementing energy efficiency improvements, rather than an individual owner or tenant. The major stumbling block of personal debt is avoided. So is the ever-present question of “what if I move or sell?” The improvement, just like the loan, is tied to the property not the person.

Here is an example of how a U-Bill or PAYS system works. The building owner decides that he or she would like to install a solar panel on the rental property, so they sign on to the program offered by their local utility. The utility company sends over some dudes and installs the solar panel. The cost of this little project is $6,000. Ok. So the solar panel is installed, and the energy costs of the building drop as the solar panel provides ‘free’ electricity to meet a portion of the building’s energy needs. Let’s imagine that the energy costs of the building have dropped by $100 per month. Let’s also imagine that this particular building has 4 rental units, and that the tenants pay the utility bills. You will notice that no money has actually changed hands yet. But don’t worry, it will.

Each month, the $100 saved by the solar panel will go towards paying for that energy efficiency improvement. The tenants have each seen a drop in their utility bill of $25 per month- this money will be handed back to the utility through an extra fee on the monthly bill in order to pay for the solar panel. The trick to making this system appealing to everyone involved, is if the tenants still see some savings on their utility bill. So instead of paying the full $25 per month each, they could pay $20 per month. The utility would receive $960 annually (in the real world they would receive interest as well), the tenants would get $60 per year (with no effort whatsoever on their part), and after just 6 years or so the solar panel would be paid off and the building owner would be the proud holder of a green building. Tenant could move, the building could be sold, but still the energy efficiency upgrade would be in place and the new tenants/owner would pay the costs and reap the benefits.

There are two remaining issues to be addressed for this model to function:

1. Why would the utility company bother?

First off, the cooperation of financial institutions would be necessary to provide the utility with the initial funding for these types of projects. Since more and more banks are providing green loans of one description or another, this shouldn’t really be a hard sell. Once the money source is taken care of, motivation is the remaining question. Energy efficiency projects can often run into one more roadblock, and it is a big one. Utility companies make their money from selling energy. If consumers/buildings become more efficient, they are using less energy, and therefore the utility company would make less money, right? Sadly yes in many areas. This is a major issue that deserves an entire blog post of its own, so I will hold off on the details until next week when I can address it in full.

2. Why would the building owner bother?

Money. That’s why. Approving the installation of a green retrofit has the potential to increase the value of the property. It could also be the basis for raising rent in some situations. There is also the soft benefit of bragging rights. “What? Your building doesn’t have a solar panel? Mine does, and it is spectacular. I am so much more environmentally friendly, green, hip and happening than you are.” Don’t underestimate the power of peer pressure. This is another issue that I hope to jump into in a future post… conspicuous vs. subtle green.