Commercial brokers: We’re now over a year into the rollout of the Nonresidential Building Energy Use Disclosure Program. Read on for Part I of this series on the energy disclosure requirement to keep your clients compliant with energy benchmarking requirements to help them avoid money claims based on deceit, or worse, cancelled transactions.

Electricity, gas and other utility bills represent a meaningful portion of a property’s operating cost — up to 20% of the rent amount. Commercial property owners and their agents are required to disclose energy costs to buyers, tenants and mortgage lenders before entering into a binding agreement — a disclosure not yet mandated for home sellers.

The energy disclosure program was developed by the California Energy Commission to implement 2007’s Assembly Bill 1103. The program exists to incentivize property owners to improve their commercial buildings’ energy efficiency. Commercial buildings consume 36% of all electricity consumed in the state, according to a report from the Senate Energy, Utilities and Communications Committee. [20 Calif. Code of Regulations §§1680-1684]

Scope of the mandate

Disclosing energy use information is the responsibility of the property owner (or manager), and in turn their real estate broker as a duty of care owed the owner. The role of the owner’s broker is to guide the owner through collecting required information and delivering the energy report within the statutory timeline.

The energy disclosure scheme:

  • establishes a system that provides energy consumption data for all commercial buildings;
  • enables owners to evaluate their building’s energy performance with similarly situated buildings, called benchmarking;
  • enables owners to monitor energy costs; and
  • encourages owners to make energy-efficient improvements.

Editor’s note — For consistency’s sake, we refer to nonresidential properties as “commercial,” though the disclosure mandate applies to more than just strictly commercial properties, including churches, hospitals, etc., but does not apply to residential property.

Commercial property owners are required, and their agents duty-bound, to disclose their property’s energy usage to:

  • prospective buyers, at least 24 hours before accepting or countering a written proposal to enter into a purchase agreement [20 CCR §1681(k)];
  • prospective and existing tenants negotiating to enter into or renew a lease for an entire building (single tenant property), at least 24 hours before accepting or countering a written proposal to enter into a lease agreement [20 CCR §1681(l)]; and
  • mortgage lenders  at the time a loan application is submitted for financing to encumber the entire parcel. [20 CCR §1681(m); 20 CCR §1683(a)]

The leasing of space in multi-tenant commercial buildings does not trigger the disclosure of energy information since tenants occupy or will occupy only a portion, not all of the building. The sale of a multi-tenant commercial building does trigger the disclosures.

Compliance schedule and building types

These disclosures are part of a fast-evolving, more transparent era for commercial property brokerage in California. Coupled with the commercial agency law disclosure requirement effective January 1, 2015, state lawmakers have affirmed that the duties well understood in residential transactions apply fully and unequivocally to commercial transactions. [Calif. Civil Code §2079.13]

Related article: Agency law disclosure required for required for nonresidential property transactions

Expanded agency disclosures: the trade union balks at transparency

The energy-reporting disclosures are being implemented in phases based on interior building size, or gross floor area (GFA):

  • September 1, 2013 for buildings with a total GFA of more than 50,000 square feet;
  • January 1, 2014 for buildings with a total GFA of 10,001-50,000 square feet; and
  • July 1, 2016 for buildings with a total GFA of 5,000-10,000 square feet. [20 CCR §1682]

Editor’s note — The original compliance date for buildings with GFAs under 10,000 square feet was July 1, 2014. However, in September 2014, the state legislature gave small commercial building owners an additional two years to prepare for the new requirements. [CEC, Amendment to 20 CCR §1682(c), August 11 2014]

As a result, energy disclosures are already available for buildings with a total GFA of 5,000-10,000 square feet. Risk management principles suggest the disclosures be made on these smaller properties, especially if a sale is involved.

Owners of commercial buildings of less than 5,000 square feet GFA are exempt from the energy benchmarking and disclosure mandates.

The total GFA is the floor area within the inside perimeter of the exterior walls of the building, called the building envelope. GFA is generally equivalent to usable footage. This includes interior corridors, stairways, closets, the thickness of interior walls, mezzanines, lofts and other features — any space which is fully enclosed by the building’s exterior walls and roof. The GFA does not include open shafts or interior courts without a solid roof enclosing the area. [24 CCR §1002.1]

In practice, the GFA requirement will have a standardizing effect on the inconsistent measurement of commercial square footage — the issue of lost square footage discovered after closing. Thus, sellers and brokers beware: the GFA used to calculate energy consumption reports reveals any puffing of dimensions – deceit – used in marketing and setting rent amounts.

Commercial buildings subject to compliance include buildings of the following occupancy types:

  • Assembly (A);
  • Business (B);
  • Education (E);
  • Institutional – Assisted Living (I-1, R-1);
  • Institutional – Nonambulatory (I-2) (hospitals);
  • Mercantile (M);
  • Residential – Transient (R-1) (for example, a hotel);
  • Storage (S); and
  • Utility – Parking Garage (U). [20 CCR §§1681(i), 1682; 24 CCR §302.1]

A property’s occupancy type is found on the building occupancy permit.

Residential (single- and multifamily housing), industrial uses and mixed-use properties (containing both residential and commercial uses) are not covered by the energy reporting mandates. [CEC Nonresidential Building Energy Use Disclosure Program FAQ]

However, warehouses and logistics facilities, though commonly called industrial property, are classified as occupancy type S (Storage) under the California Building Code. Thus, warehouses and logistics facilities are subject to the energy benchmarking and disclosure mandates. [24 CCR §311]

Residential rumors

Commercial property owners aren’t the only ones who stand to benefit from a fuller understanding of their property’s energy consumption patterns.

Portfolio Manager is also capable of benchmarking and rating multifamily residential properties. A rating for an apartment serves as a first step for the owner or manager to improve the energy efficiency of the property — and thus the marketability of the units. Large utilities have designed consumption data aggregation policies, useful particularly in multifamily residential situations where residential tenants may be less than eager to dig up and hand over their utility bills.

Similar tools are also available to single family homeowners. Home energy rating system (HERS) audits serve as a complement to an agent’s marketing package for particularly efficient homes. The information is also required when qualifying prospective buyers for an FHA energy efficient mortgage (EEM).

Additionally, Energy Star offers a residential version of Portfolio Manager called the Home Energy Yardstick. The yardstick helps owners target capital upgrades to reduce the carrying costs of homeownership.

For new commercial and residential construction and alterations, the CEC maintains energy efficiency standards, administered through local building codes. The CEC updates the standards periodically, with the most recent updates in 2013; new regulations for 2016 are in development now. [24 CCR §§10-101 et seq.]

In some way the Nonresidential Building Energy Use Disclosure program closes a loop left open by energy-efficient construction standards. While the commercial disclosure rules—unlike the efficient building codes—don’t actually mandate efficiency improvements, they make the opportunity for improvement known to owners, buyers and tenants.

Mandated disclosures

The procedure for measuring and disclosing a commercial property’s energy use to prospective buyers, tenants and lenders is readily available to owners and their agents through an online service called Portfolio Manager. Portfolio Manager produces an energy use disclosure called a Data Verification Checklist (DVC), available at the owner’s request.

The DVC is the primary reporting document owners and their brokers use to make energy disclosures to buyers, tenants and lenders in compliance with the Nonresidential Building Energy Use Disclosure Program. [20 CCR §§1681(b), §1683(a); 20 CCR APPENDIX A]

The DVC is easily comprehensible and functional. It describes the consumption patterns of all spaces within the building envelope. The DVC creates a vivid picture of energy operating costs for the prospective user from the outset of negotiations. All of the following building information is summarized on the document:

  • property name and address;
  • date of checklist creation;
  • owner and primary contact name, telephone number and email address;
  • ENERGY STAR® Performance Score, if available;
  • primary property function (such as office);
  • GFA;
  • year built;
  • occupancy and energy consumption characteristics for the whole property and each separate use within the property; and
  • data summarizing total building energy consumption as well as usage data for each individual energy type (electric, gas, etc.).

The form has a provision for a licensed architect or engineer to certify the accuracy of the data; however, professional third-party evaluation is not mandatory. [20 CCR §1681(f)(n); 20 CCR APPENDIX A; see a sample Data Verification Checklist]

Supplementary energy reporting forms are also available. They may be downloaded and added to the marketing package, but are not yet mandated for use. These include:

  • the Statement of Energy Performance; and
  • the ENERGY STAR® Scorecard.

These supplemental documents may enhance the value of a property for others.  An agent uses them to promote a building’s exemplary energy efficiency. All documents are available through the Energy Star Portfolio Manager website, [20 CCR §1681(j)]

Unlike other property disclosures, however, the commercial property owner or broker does not fill out the DVC. This approach to the preparation of energy disclosures avoids omissions by owners and agents who might — deceitfully or negligently — omit information, such as occurs in the preparation of condition of property disclosures (TDS) and square footage estimates.

Instead, utilities and other energy service providers (e.g., solar energy providers) make energy use data for commercial properties available upon the owner’s request through the Portfolio Manager.

Content and timing of the disclosure

A DVC needs to be current when handed to the prospective buyer, tenant or lender. Each DVC expires 30 days after the Portfolio Manager creates it, not from the date downloaded for use.

The property owner or their broker also electronically submits a copy of the DVC to the CEC within 30 days of its creation. The owner may email a copy to [20 CCR §1684(a)-(d)]

To create and disclose the DVC, commercial property owners or their agent first register for a Portfolio Manager account. Although the DVC will be available for download immediately, it will not be valid for the purpose of making energy use disclosures until the Portfolio Manager account has been active for 30 days.

Editor’s note — Anyone may use Portfolio Manager to create an account, benchmark a building and generate a DVC regardless of whether the account has existed for at least 30 days. For the purposes of energy disclosures in California, however, the CEC requires 30 days to pass between account registration and DVC creation to allow energy providers time to comply with requests for data from Portfolio Manager users. Thus, a DVC created fewer than 30 days after an account is created does not meet California’s commercial building energy disclosure requirement. [20 CCR §§1684(a)]

Consider a commercial property owner and prospective buyer who intend to enter into a purchase agreement. The owner who has not yet created a Portfolio Manager account needs to:

  • activate a Portfolio Manager account;
  • wait 30 days to download a valid DVC;
  • download the DVC and hand it to the buyer; and
  • wait 24 hours after the DVC is delivered to the buyer before entering into a binding purchase agreement.

As a matter of best practice, the property owner and their broker create a Portfolio Manager account, complete the property profile and request data from energy providers immediately upon entering into a listing agreement. As always, it is best to have the DVC before marketing the property to locate a buyer or tenant.

When the broker locates a buyer or tenant who submits a written proposal the owner wants to accept or counter, the DVC needs to be immediately available to hand to the buyer or tenant. This starts the minimum 24-hour time period before acceptance.

Once the Portfolio Manager account is established, the owner and broker need to maintain the DVC at least every 30 days, until the owner has entered into a binding agreement to sell or lease or submitted a mortgage application.

No delay is experienced if a commercial property owner has already had a Portfolio Manager account open for more than 30 days when the property is put on the market for sale, lease or refinancing. The agent or owner is able simply to log in, update, download and hand the DVC to prospective buyers, tenants and lenders at a moment’s notice — at the very least 24 hours prior to entering into an agreement, as mandated, to permit the tenant or buyer to review the data before setting the price in a proposal.

The 30-day energy disclosure window

Energy use and consumption reports are to be submitted to prospective users as early in the negotiation process as practicable. In commercial deals, the disclosure is best provided in response to a Letter of Intent (LOI) which marks the beginning of written negotiations leading to an acceptance and agreement. Energy use, utility bills and their effect on a property’s operating costs are fundamental to a buyer or tenant’s determination of a commercial property’s value. [See first tuesday Form 185]

However, the 30-day shelf life of the DVC presents a quandary for owners and brokers. Negotiations may run past the 30-day life of the DVC. When the DVC expires before the owner and prospective buyer, tenant or lender enter into a binding agreement to sell or lease, the owner or broker needs to update the property profile, download a refreshed DVC and attach it to further written negotiations and the final agreement.

Editor’s note — Uncertainty remains as to whether a DVC needs to be valid at the time the agreement is entered into, or simply when it is delivered to the prospective buyer, tenant or lender. first tuesday has reached out to the CEC for comment and will update this writing when clarification is provided.

No further energy disclosures are required after a current DVC is attached to the binding agreement to sell or lease, or is in the possession of a prospective lender. Final documentation and closing may take place without further DVC disclosures.

Editor’s note — For a detailed look at how to use Portfolio Manager to gather energy usage data and create the DVC disclosure document, see the forthcoming Part II of this series, “Unlocking commercial energy disclosures with Portfolio Manager.”

The role of the agent

At this stage of the energy reporting and disclosure program rollout, compliance is inconsistent and enforcement remains lax — a condition commercial agents and owners are reportedly exploiting.

Here, the broker plays a critical role — for both the owners and the users. Owner’s agents uniquely positioned to advise owners on the proper disclosures and when to make them. Likewise, agents representing users are in a position to affirmatively advise their tenants and buyers to absolutely insist on the energy usage reports the owners is obligated to hand them.

Agents who foster healthy benchmarking habits ensure their owners are compliant and prevent 11th-hour scrambles to untimely attempt to comply. An agent’s expertise in energy reporting compliance becomes part of the agent’s brand and allows them stand out from their peers.

Statutory penalties for noncompliance

The commercial broker’s primary role in the energy reporting and disclosure process is ensuring compliance with the requirements by:

  • assisting the owner with gathering required data and information;
  • helping to navigate the use of Portfolio Manager; and
  • ensuring timely reporting of required energy use data, as well as timely receipt and delivery of the reports.

The CEC has the authority to enforce these regulations. When a tenant or buyer files a complaint for an owner’s failure to comply, the CEC will investigate and respond within a 30-day review period.

The CEC may initiate civil court proceedings to enforce compliance by court order or an injunction. Alternatively, the CEC may require the parties to the complaint to enter into a negotiated settlement. Noncompliant owners are subject to civil penalties up to $2,000. [CEC Nonresidential Building Energy Use Disclosure Program FAQ; Calif. Public Resources Code §25321]

Unclear effects on the right to cancel

Despite civil penalties and investigative procedures set forth by the CEC, the statute is silent on the issue of liability when an owner and their agent fail, through negligence or deceit, to provide the DVC as mandated.

Disputes will inevitably arise for failure to disclose energy reports. However, just as inevitably, judges will find ways to make owners (and thus brokers) wish they had complied. There will be litigation over whether the user can:

  • delay closing a transaction until the disclosures are made;
  • cancel for failure to timely disclose; or
  • close the transaction and recover money (or close on a reduction in price or rent) for the cost of undisclosed energy inefficiencies.

Case law will eventually settle these issues, but not before the CEC has had a run at managing the regulations and enforcing compliance.

Operating costs—including utility bills, pegged to the building’s efficiency and consumption patterns — are well within the realm of material facts, conditions affecting the decisions of prospective buyers, tenants and mortgage lenders about a property. [Calif. Pub. Resources Code §25402.10(e)]

Stay tuned for the second installment of this series, Part II: Unlocking commercial energy disclosures with Portfolio Manager.