Energy Efficiency and Commercial-Mortgage Valuation - Research Berkeley/Haas Professors

faculty.haas.berkeley.edu/jaffee/Papers/DOE2913.pdf  (58 pages)

Dwight Jaee, Richard Stanton and Nancy Wallace

September 13, 2011

Abstract

Energy efficiency is key to the future of the U.S. economy, and commercial buildings are among the largest users of energy. However, existing loan underwriting practices provide no incentive for building owners to make their buildings more energy efficient. In this paper, we develop a commercial-mortgage valuation, or underwriting, strategy that accounts for the energy risk of individual office buildings, this energy risk being a function of both the relative energy efficiency of the building and the characteristics of its location. Our method extends standard underwriting practices, which account for the expected dynamics of interest rates and office building prices over time, by including the expected dynamics of the electricity and gas prices as well as quantity dynamics appropriate to the location of the building. This allows lenders to explicitly take into account the effect of energy use and various alternative efficiency measures when underwriting commercial mortgages.