The Western Australian property industry is urging the State government to make changes to the Local Government Act 1995 (WA) that would enable financiers to enter into environmental upgrade agreements with commercial building owners and local councils.
If introduced, these changes will help cut carbon emissions and provide a solution to the growing number of underutilised older commercial buildings in the Perth metropolitan area.
Environmental upgrade agreements
An environment upgrade agreement enables financiers to provide funding to building owners to carry out environmental upgrade works to improve the energy and water efficiency of commercial buildings. Examples include the installation of energy efficient (LED) lighting, solar PV, HVAC optimisation, glazing, external shading and green infrastructure such as green walls and ground cover. Traditional property finance facilities, which require security and shorter loan terms, can make funding of these projects unviable.
Under an environmental upgrade agreement, the building owner must make regular payments to the local council in the form of a building upgrade charge (charge). The council forwards these payments onto the financier to repay the debt. An environmental upgrade facility does not usually affect a building owner’s borrowing capacity because the land is charged with the repayment (in the same way that council rates are charged against the land). However, if there is a registered mortgage, mortgagee consent may be required for the land owner to borrow the building upgrade finance. Consent should generally be forthcoming, given the positive impact on the value and marketability of the building that is expected to flow from the upgrade works.
Local councils in New South Wales, Victoria and South Australia are already able to enter into environmental upgrade agreements. In those jurisdictions, the agreement must include three parties: a building owner, a financier and a local council. Also, the agreement must specify:1
- the environmental upgrade works to be carried out by the building owner;
- the amount of the advance to be made by the financier; and
- the arrangements for repayment of the advance.
Participation by building owners, financiers and local councils is voluntary. The charge is collected by the council in addition to regular council rates and passed on to financiers as loan repayments. Councils can also recover administrative costs through a service fee on the relevant owner if desired.
If a building owner does not make the required payments to the local council, the council will not be liable. However, the council must use its best endeavours to recover the charge from the building owner. If a building owner becomes insolvent or the land is sold, any unpaid charge is ranked as a priority ahead of mortgages, taxes and other charges on the property. The unlevied component of the initial funding will remain with the land to be paid by future owners.
Current barriers to energy efficiency retrofits
There are two main barriers that impede energy efficiency upgrade retrofits to commercial buildings. The first is access to capital. As many energy efficiency projects can take up to 10 years to complete, longer funding periods are required to carry out the work. By charging the land rather than taking security over the business, financiers are generally able to provide funds at lower interest rates and for longer terms.2 The second barrier is known as the ‘split incentive’. Environmental upgrade works are typically paid by the landlord and enjoyed by the tenant through lower power bills. As a result, there is little incentive for building owners to invest in measures to improve energy efficiency. Environmental upgrade agreements overcome this barrier as owners can pass-through the charge to tenants under their existing lease arrangements (subject to relevant tenant protection laws and existing lease terms). The cost of the charge to the tenant is ultimately offset by lower energy costs.
When the environmental upgrade works are fully repaid, tenants enjoy lower operating costs and the owner enjoys a building with greater market desirability. Depending on the equipment installed, building owners who have used environmental upgrade finance have reduced their base building energy costs by up to 50 percent.3
Local Government Act review
Since the softening of economic conditions in Perth after the resources boom, many long-term leases have ended with non-premium commercial building stock having average vacancy rates of around 25%.4 This provides an opportunity for the use of environmental upgrade agreements to incentivise building upgrade work.
The Property Council of Australia is advocating for legislative reform which will prescribe minimum local council involvement, mortgagee considerations and tenant pass-through criteria. The scheme could be implemented as part of the current review of the Local Government Act by the WA State government. Phase two discussion papers are expected to be released for public comment in the coming months. More information on the review process is available at the WA Department of Local Government, Sport and Cultural Industries website.
A new approach to building upgrade finance will assist with improving the quality of non-premium building stock in the Perth metropolitan area. The Federal government’s Commercial Building Disclosure Program requires owners of commercial office space of 1000m2 or more to disclose the NABERS energy efficiency rating to prospective buyers and tenants. Legislative reform that allows building owners to enter into environmental upgrade agreements may facilitate upgrade works to achieve a higher NABERS rating, improving the value and marketability of commercial buildings while reducing energy costs and carbon emissions.
This article was written by Charmian Barton, Partner and Niamh Breheny, Partner.
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1See, for example, s.54G Local Government Act 1993 (NSW).
2NSW Parliament Hansard, Local Government Amendment (Environmental Upgrade Agreements) Bill 2010 second reading speech, https://www.parliament.nsw.gov.au/bill/files/1687/LC%2011010.pdf
3Clean Energy Finance Corporation, Finance for Environmental Upgrade Agreements, p. 5. https://www.cefc.com.au/media/76243/cefc-factsheet-nab-cefc-ef_eua_lr.pdf, accessed 27 July 2018.
4City of Perth, Building Upgrade Finance Factsheet, p. 6. https://emarketing-au.s3-ap-southeast-2.amazonaws.com/72933/DhWESlO2STFnOlsJAVvEYUncMXfheopOh4PV0v2ZspQ/2887261.pdf