How Many Miles Per Gallon Does Your Building Get? The Ratings Game Comes to Buildings

According to EPA, buildings account for 36 percent of total energy consumption and 65 percent of electricity consumption in the United States. In the absence of comprehensive legislation that would put a price on carbon, which would give building owners direct incentives to implement cost-effective efficiency measures, a number of jurisdictions have started looking into and in some cases implementing requirements that at least commercial buildings be subject to energy efficiency ratings.

Last week, the Institute for Market Transformation (now isn’t that a name to put fear into the hearts of Tea Party members) released a report on the state of building rating programs in the United States. It makes interesting reading. First, while California, Washington, and Massachusetts have either enacted rating legislation are considering some kind of program, most of the action on building ratings isn’t even at the state level, it’s at the local level. This differs from EPA mileage or Energy Star ratings.

Second, most of these programs are triggered by some kind of transaction involving the building, such as sales, leases, and financings. Using a transaction trigger is understandable in that it avoids the avalanche of complaints that would likely follow any program that applied broadly to all buildings over a certain size. However, at a time when the real estate industry just led us into the worst downturn since the great depression, and prices are still low in many markets, I can certainly imagine some in the real estate industry being concerned about imposition of additional requirements that might discourage real estate transactions.

A related point is that, in markets where much of the building stock is old, many in the real estate industry are concerned that such ratings will be like putting a scarlet letter – perhaps an I for “inefficient” – on older buildings.

The IMT report describes rating and disclosure as a:

market-based policy tool to help overcome informational barriers to energy efficiency. Systematically assessing or “rating” building energy performance puts important information in the hands of owners and operators, helping them identify opportunities to improve energy efficiency. Disclosing ratings empowers tenants, investors and banks to identify and compare the energy performance of buildings, unlocking the market’s ability to drive demand and competition for energy-efficient space. The premise mirrors transparency rules in other market sectors, such as nutritional labels on food and fuel economy ratings on vehicles, which are recognized around the world as consumer protections and keystones of free and fair enterprise.

Real mom and apple pie stuff. Who could be agin’ it. Sarcasm aside, I’m not even against it (or agin’ it). The question though, is which market failure building ratings are trying to address. If the purpose of the rating program is simply to address the information failure described above, then it should unambiguously be a good thing. Indeed, if that is the case, all other things being equal, such programs should actual lead to increases in prices, as previously unrealized but available cost-effective efficiencies are implemented.

However, if the purpose is to impose on building owners the cost of the externality created by building energy consumption, one would expect building prices to decrease compared to those in jurisdictions that do not force building owners to internalize that externality, and I would suggest that a local patchwork of such regulations would not be a good thing.

I don’t even know if would be feasible to do an econometric study examining the impact of such programs on building prices. They are a lot of variables for which an economist would have to control. It will be interesting to follow this issue over the next few years. I’m keeping an open mind at this point. I don’t doubt that there are market failures resulting from imperfect information. If the programs are truly focused on remedying those failures, they might be a long-term boon – and reduce GHG emissions a bit on the side.

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