Using Loan Financing Successfully for Building Upgrades

Michael Tobias
4 Minutes Read
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    In many cases, property owners are convinced that building upgrades are beneficial, but they are held back by the initial investment. Homeowners and small businesses may be unable to afford the full cost of a new technology at once, and larger companies with more capital may prefer to invest their funds elsewhere. However, with adequate planning and technical analysis, building upgrade projects can be carried out successfully with loan financing.

    Even though a loan comes with interest payment, it allows construction costs to be spread over several years.

    • Consider that building ownership costs are very high in NYC: construction costs are the highest in the world as of 2018, and utility bills have a significant impact on monthly operating expenses.
    • Spreading the cost of building upgrades over several years alleviates cash flow, and projects that save energy or water can pay for their own cost by reducing utility bills.

    Identify the most promising upgrades for your building.

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    How Can a Building Upgrade Pay Its Own Cost?

    When loan financing is used for a building upgrade, the upfront cost for the property owner becomes zero, but the loan comes with the obligation of periodic payments to the bank. However, when the savings from a building upgrade are higher than debt service, the project basically purchases itself.

    • Assume you are considering an LED lighting upgrade that costs $200,000.
    • The projected savings are $5,000 per month, or $60,000 per year.
    • If you have access to a loan with a 5% interest rate, to be paid in 5 years, the monthly payment is $3,774.25.
    • The project pays off its own cost, while leaving $1,225.75 in monthly savings right away.
    • Once the loan is paid off, you start saving the full amount of $5,000 per month.
    • Also consider electricity price inflation, which results in higher savings each year.

    Loan financing works in this example because the savings are higher than the debt payment. Assume another scenario where the building gets the same LED upgrade, but the existing lighting is more efficient than in the first case, reducing the savings to only $3,000 per month.

    • The LED savings cannot cover the debt payment in this example, and the building owner must pay the difference of $774.25 for five years.
    • A 10-year loan with the same interest rate would work, since the monthly payment is reduced to $2,121.31, which is less than the net savings.

    Using debt to finance energy efficiency only works with a favorable combination of interest rate and repayment period. Otherwise, any energy savings achieved are consumed by interest payment. For example, using a business credit card to pay for efficient equipment is not recommended.

    Financing Energy Efficiency Measures in New Constructions

    If you are considering improvements for a project that has not been built yet, the outlook is even better. You can simply add the cost of the measures being considered to the overall project budget, and finance them through the same loan you were considering for the building itself.

    Another advantage of energy efficiency measures in new buildings is their lower net cost. In existing properties, you must assume the full cost of all building upgrades. However, in new constructions, they simply represent a cost increase with respect to your project baseline.

    Consider again the example of the LED lighting upgrade in the previous section:

    • In an existing building, the full price of $200,000 must be assumed.
    • The outlook is different in a new project. If you were considering a less efficient lighting system with a cost of $120,000, it represents an expense that would have been assumed anyway. Therefore, the upgrade only has a net cost of $80,000.

    In an existing building, a $200,000 project that saves $60,000/year has a payback period of 3.33 years. However, this is reduced to 1.33 years in the new construction, since savings are weighed only against the initial cost increment of $80,000.

    The Importance of Technical Due Diligence

    There are energy-efficient products that offer amazing savings, but keep in mind these may not apply for your property. For example, you may find LED bulbs with 80% electricity savings printed on their packaging, but that value may not apply for your building:

    • 80% savings with LED lighting are typical if you replace incandescent or halogen lamps.
    • However, if a building already has fluorescent lighting, the potential savings normally range from 30% to 50%.
    • The efficiency gap between LED and incandescent lighting is much larger than the gap between LED and fluorescent lighting.

    The same principle applies for many energy-efficient products that come with a savings value printed on their packaging. They apply for specific conditions, but only a professional energy audit offers an accurate estimate of potential savings. Consulting engineers can also help you ensure code compliance; there are hefty fines for building modifications that don’t follow codes.

    Keep in mind that energy efficiency measures and renewable generation systems may be eligible for favorable loan conditions and other incentives. For example, the NY State Energy Research & Development Authority manages funding programs for clean generation.

    In the specific case of solar power, you can even get cash rebates through the NY Sun program, which are even better than low interest loans. There are also various incentive programs from Con Edison, in case you live within their service area.

    Final Recommendation

    If you have access to favorable loan conditions for building upgrades, it may be possible to pay off the loan completely with the savings achieved. However, a good decision is only possible if the upgrade benefits are estimated with a professional energy audit of the property. Rules of thumb do not always lead to accurate decisions, since you will probably end with oversized or undersized equipment.


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    Tags : Building Upgrades project financing building performance

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