Prior studies have shown that energy use is related to commercial mortgage defaults. This report presents the results of a new and tractable methodology to estimate the association between energy use and mortgage pricing sensitivity - specically the origination contract rate and points - of oce and multifamily mortgages. Source Energy Use Intensity (Source EUI) is our key energy eciency measure of interest due to its increasing availability through local energy eciency benchmarking programs and the potential ease of its construction from the utility bills of commercial buildings. Based upon an empirical model of mortgage default transitions for a sample of 610 securitized office and multifamily mortgages from Trepp, we simulate the loan-by-loan mortgage prices using a four factor dynamic model with: i) a measure of Source EUI that is scaled to the the net operating income of the property, called Scaled Source EUI, ii) the Electricity Price Gap, the cumulative dierence between expected and actual realized electricity prices, iii) loan-to-value ratio, and iv) the 10-year LIBOR rate. We find a statistically signicant positive association between mortgage default and Scaled Source EUI and a statistically signicant and negative association between the Scaled Source EUI of buildings and the simulated market prices of the mortgages written on those buildings. We then derive two sensitivity measures with respect to changes in Scaled Source EUI: i) the sensitivity of mortgage points to a 1% change in Scaled Source EUI; ii) the sensitivity of the mortgage coupon to a 1% change in Scaled Source EUI. We nd that sensitivity of mortgage points to 1% shocks to Scaled Source EUI is 7.71 and 4.0 basis points respectively for oce and multifamily loans. We nd that the sensitivities of mortgage coupons to 1% shocks to Scaled Source EUI is 2.10 and 0.84 basis points respectively for office and multifamily loans.

Energy-efficient homes save their occupants money through lower energy bills. These savings might be capitalized into higher home sale prices. They also improve the household’s net cash flow, which might make households better able to pay mortgage debt. The U.S. Department of Energy (DOE)’s Home Energy Score (HES) assigns a 1-10 score to homes and estimates annual energy bills based on modeled energy consumption. In this paper we investigated the relationship between HES metrics and two housing market outcomes: home sale price and mortgage performance. We found that the relationship was only statistically significant in places with a mandatory HES assessment at the time of sale. Using a sample of 26,291 home sales that occurred after HES assessments, we found that a one-point increase in HES in these locations was associated with a 0.5% increase in sale price, and an increase in $100 of estimated annual energy bills was associated with a 0.4% decrease. This magnitude of effect is consistent with estimated magnitudes of home sale premiums for other green or energy-efficient home certifications in the literature. We also found that a one-point increase in HES was associated with a 5.5% reduction in the odds of a loan going 30 days delinquent if the loan originated after the assessment occurred. Similarly, we found that a $100 decrease in estimated annual energy bills was associated with a 2.3% decrease in the odds of a loan going delinquent if it originated after the assessment occurred. Our results suggest that HES provides a valuable signal for housing market transactions in specific situations.

This paper presents new results on the link between energy factors and commercial mortgage default. First, we summarize results from an empirical analysis of the impact of source energy use intensity (EUI) and electricity prices on mortgage default. We used a unique data set that merges building-level energy use data from city benchmarking ordinances and financial data for commercial mortgages on the same buildings. We found that building source EUI and electricity price are statistically and economically associated with commercial mortgage defaults. Next, we present five case studies on the impact of energy use and price variations on default risk: three office buildings, a hotel, and a multi-family residential building. We use the empirical model coefficients to compute the default risk impacts due to variations in source EUI and electricity price over the course of the mortgage term. We found that variations in source EUI could raise or lower the default rates in these properties by between 5% and 40%, depending on the property type and geography. Electricity pricing has an even greater effect – roughly 60% change in default rate in the Denver area and nearly 90% in northern California. Finally, we propose an energy risk score that lenders can use to assess energy risk and inform mortgage terms. The score is being developed and piloted in collaboration with three mortgage lenders. We conclude with implications of this score as a market signal and mechanism for incentivizing energy efficiency investments through the commercial mortgage channel.

The commercial real estate mortgage market is enormous, with almost half a trillion dollars in deals originated in 2015. Relative to other energy efficiency financing mechanisms, very little attention has been paid to the potential of commercial mortgages as a channel for promoting energy efficiency investments. The valuation and underwriting elements of the business are largely driven by the “net operating income” (NOI) metric – essentially, rents minus expenses. While NOI ostensibly includes all expenses, energy factors are in several ways given short shrift in the underwriting process. This is particularly interesting when juxtaposed upon a not insignificant body of research revealing that there are in fact tangible benefits (such as higher valuations and lower vacancy and default rates) for energy-efficient and “green” commercial buildings. This scoping report characterizes the current status and potential interventions to promote greater inclusion of energy factors in the commercial mortgage process. It includes the results of a literature review and extensive stakeholder discussions with 40 lenders, owners, service providers, advocacy organizations and others. We present the following key findings related to current status of energy factors in the mortgage process: ● Energy efficiency is generally not a motivating factor for lenders. It is typically considered a very small piece of the overall risk profile. Furthermore, the commercial mortgage loan process involves high stakes, which creates a disincentive to do anything that deviates from the shortest path to “getting the deal done”. ● Although energy costs are part of the NOI calculation, there is currently very limited awareness and analysis of their impacts in underwriting. ● Underwriting is not standardized across the industry and lenders have considerable discretion in underwriting practices. ● The Property Condition Assessment (PCA), a detailed engineering report that lenders usually require, generally does not include information on energy performance. Furthermore PCAs are often ordered too late to influence the basic mortgage terms. ● Most appraisals do not consider existing or planned energy efficiency features in property valuation, and have limited if any access to this information. ● There have been several studies claiming a positive impact of energy factors on building value, but many owners have not been able to discern this in their own portfolios. ● Context matters: all real estate is local. The impact of energy factors on valuation vary significantly by location, building type, quality, and current market conditions. Overall, current commercial mortgage practices do not fully account for the risks and opportunities that may be associated with the energy-use of buildings. As a consequence, energy efficiency is not properly valued and energy risks are not properly assessed and mitigated. Commercial mortgages are a large lever and could be a significant channel for 2 scaling energy efficiency investments. We present seven potential interventions to properly account for energy factors in the commercial mortgage lending process: 1. Demonstrate to lenders how and where energy factors “move the needle” on the key underwriting metrics, such as default risk, NOI (and thus, implicitly, valuation, LTV and DSCR), and economic or functional obsolescence. 2. If intervention #1 is successful, provide simple, seamless ways to incorporate energy factors into underwriting - ideally as simple as a score to characterize energy factor risks. 3. Include energy performance in the PCA and move it up in the process. If PCAs included investment-grade information on energy efficiency opportunities, they could be used to facilitate funding for improvements through the mortgage loan. 4. Owners need to demand consideration of energy performance by appraisers and lenders and provide the data. 5. Include energy metrics more explicitly in ARGUS software. Given ARGUS’s widespread use in the real estate industry - it’s a de facto standard - a possible intervention would be to introduce more explicit energy metrics into its analytics package. 6. Get appraisers to properly value energy factors. There are already several efforts under way on this front, including DOE’s Appraisal Working Group. 7. Consider interventions in ancillary products and services such as mortgage insurance premium discounts for energy efficient buildings. These interventions are technically feasible and could have significant impacts, with benefits to lenders and owners. However, it is also true that the nature of the mortgage lending process – with multiple stakeholders, high stakes and risk aversion – does not lend itself easily to changes. Therefore, these interventions will need to be piloted carefully and modestly with highly motivated early adopters. Wider deployment will likely require aggressive education/awareness efforts and stakeholder engagement and support through relevant industry organizations.