Introduction
A lot of time, effort, and resources are devoted to ensuring that lease terms are set precisely to what the market can bear.
At the same time, a surprising number of assets are not maximizing cash flows because recovering utility costs from submetered tenants is still imprecise and largely ignored.
To exemplify this, we challenge our readers to take a set of electric meter readings (usually generated monthly), apply the utility’s tariff to those readings, and come anywhere close to matching the utility bill for that period.
Between peak demand, miscellaneous charges, taxes, and time-of-use pricing, what are the chances that monthly meter readings could produce an accurate representation of what the tenants should be charged?
The answer is zero percent.
The truth is that anything other than real-time meter readings cannot accurately incorporate the many factors that go into utility bills (and even with real-time data, it’s difficult).
Given this, it’s no surprise that questions such as “are you making or losing money from submetering?” and “what percent of cost outlays are being recovered?” are often met with blank stares. Even landlords that are confident they could get the answers to those questions either don’t know or don’t want to admit how long it would take to figure it out.
The answer to this problem isn’t to avoid submetering altogether. Submetering has all sorts of benefits such as creating a channel for tenant engagement and resolving split incentive issues that arise when tenants don’t care about consumption because they are charged a flat rate.
In fact, one study by the National Center for Housing Management (NCHM) found that submetered tenants have a 17% lower turnover rate than those who are direct metered.
If that’s not enough, new regulations such as New York’s Local Law 88 are requiring all non-residential buildings greater than 25,000 square feet to install electrical submeters for each tenant space greater than 5,000 square feet.
The point is, submetering is quickly becoming the standard across the industry. It’s about time to get good at it.
Each state has different rules, but here are the basics to make sure that monthly outlays of tens of thousands of dollars are fully recovered and potential profit centers are taken advantage of where possible.
Accuracy
To start, it should be known that the accuracy of meters drift a fraction of a percent every year. If the meters in a building are old and haven’t been commissioned recently, there very well be money left on the table simply from taking readings that do not accurately reflect consumption.
In some localities, owners and/or service providers are required to sample 3% of meters every year. If a certain percent fails, then 10% of meters must be sampled, and so on.
The exact rules depend on the locality and on the type of property (for example, in New York, this is only required for submeters tied to residential tenants).
The bottom line is that if periodic commissioning of meters is not required by law, there is a small likelihood that this process is happening. This should be addressed first to make sure that tenants are getting billed for what they use.
Lease Terms
Assuming the meters are accurate, it’s important to ensure that the lease terms are fair and can be executed given the level of granularity of the submetered data.
To see how complicated this can become, we’ll explore one aspect of the utility bill - peak demand charges - in an overly simplified example.
Pretend that a building has two tenants, each with one hundred 100-watt bulbs. That’s 10,000 watts (10 kW) of “demand” for each tenant.
If each tenant had their own electric meter, it would reflect a peak demand of 10 kW.
However, with both tenants on the building’s master meter, the meter will indicate a peak demand of 20 kW (assuming they run them at the same time).
Because utilities generally charge more for higher peak demand, let’s say the first 10 kW of demand charge was at $5 and above that was $10. The total bill to be allocated would be $15.
Should each tenant pay $5 (what they would pay as individuals)? Should each pay $7.50 (evenly split)? Should the tenant who turned its lights on first pay $5 and the one who turned its lights next pay $10 for the incremental cost of “adding” another 10 kW of demand?
A standard lease will likely have a rider along the lines of:
“If the cost of a particular utility service is also based on a demand charge, Tenant’s share of such demand charge will be based upon the average unit cost for such demand for the period covered by the Submetering Invoice.”
This would fall into the second instance above, where each tenant would pay $7.50.
But simply changing the word “average” to “individual” would shift to the first case and cause the recovery rate to drop by 33% in this example.
On the other hand, agreeing to charge tenants based on their time of use would mean that the recovery rate stays the same, but also means that a modern infrastructure is required.
If only manually-read analog meters are installed, fulfilling these lease terms would be impossible, opening the landlord to lost revenue and potential legal liabilities.
Premiums
There is another rider in the lease that is important to ensure full recovery of utility cost outlays - premiums.
Tenant consumption usually makes up between 70–80% of a building’s total consumption. But what about that extra 20–30%?
That is made up of the building’s “base loads” and common areas. Though not used directly in tenant spaces, occupants still benefit from the shared loads and should contribute to the cost of running these systems.
Without an accurate premium on top of the measured consumption charges, there’s an opportunity for waste and lower recovery rates.
What exactly should this premium be? That depends on the building type, size, age and many other factors that go into the ratio between base and tenant loads.
The ideal way to figure this out is with continuous energy tracking of base building loads; however, this figure can also be approximated with more manual methods as well.
Buy Whole Sale, Sell Retail
Now that the holes in the bucket have been fixed, we can explore tenant submetering as a profit center.
The way to accomplish this is to use the buying power of the entire building to purchase utilities at whole sale rates and then charge tenants at retail rates.
The difference is pure profit and tenants are getting charged the same amount as if they were being directly metered by the utility, so it is usually not an issue from the tenants’ perspective.
This “spread” is not insignificant either. Retail rates can be two to three times higher than wholesale rates!
Conclusion
Whether willingly or reluctantly, tenant submetering is becoming more and more common in commercial real estate.
Owners are taking on responsibility from the utility, but the benefits are going primarily to the tenants.
How can landlords ensure that they are being properly compensated for their effort?
It goes without saying that meters should be digital and remotely read, and the process should be automated to avoid the errors and delays that result from manual meter readings.
Beyond that, effort should be made to ensure that meters are accurate, and that leases are negotiated to avoid unfavorable terms, accurately include the costs associated with shared loads, and allow for the sale of retail electricity rates (depending on local laws).
Interested in maximizing the cash flow from your tenant submetering? Get a free ROI analysis from Enertiv today!
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