Value and Risk Appraisal

This section identifies the various sources of value that can be created by energy efficiency projects including non-energy benefits such as increased asset value, increased productivity and increased health and well-being. All energy efficiency investments, whatever their size or nature, have various types of risk including several components of performance risk, as well normal counter-party risks, and this section sets out the categories of risk and how to mitigate them. An overall approach to risk appraisal is set out. This section is primarily aimed at risk teams but should also be of value to originators and project developers in two ways.


Energy efficiency investments create value in many ways, over and above the value of energy saved.

These multiple sources of value, or non-energy benefits, can include many factors such as; increased asset value, reduced operations and maintenance costs, improved productivity and improved health and well-being of employees or building occupants.

These multiple sources of value should be recognised, assessed, and where possible valued as part of appraising energy efficiency investments.

All energy efficiency investments have several types of risk including; performance risk, energy price risk and execution risks.

The risks of energy efficiency investments should be recognised and, where appropriate evaluated and understood. When underwriting projects and considering performance risks, financial institutions should bear in mind that:

  • under-performance of projects may put repayment at risk and if repeated at scale may carry reputational risk;
  • financial institutions counting the full improved cash flow from energy savings in credit risk assessment are implicitly taking performance risk and energy price risk
  • re-financing markets, specifically the green bond market, will require assurance that underlying projects are performing and having a genuine environmental impact.
  • better understanding of performance risk will allow the innovation of new products which take some performance risk for higher returns.

For large projects, various risk mitigation strategies exist including the use of performance guarantees, performance insurance, and the use of best practice standards such as those developed by the Investor Confidence Project.

For smaller projects, such as residential retrofits, the use of detailed risk appraisal modelling or post-investment Measurement and Verification, is very likely to be too high. In these cases, consider a portfolio approach to risk appraisal.

Energy efficiency financing has been shown to reduce risks but there is still little hard data linking energy efficiency performance and loan/investment performance. Banks and financial institutions can lead the market by putting in place procedures to identify and tag loans/investments with an element of energy efficiency. This will enable assessment of risks and better pricing in future.

Banks should encourage valuers to take energy efficiency into account in their property valuations.


  • Ensure all sources of value of energy efficiency projects are identified and where possible are captured and valued.
  • Identify the specific risks of energy efficiency investments.
  • Identify and tag projects that include an element of energy efficiency in order to facilitate assessment of risks in future.
  • For smaller projects e.g. residential loans, portfolio risk appraisal techniques should be used.
  • For larger projects implement risk analysis techniques that identify the input factors that have the greatest impact on investment performance.
  • Use risk mitigation strategies such as the use of performance guarantees.
  • Use risk mitigation strategies such as specifying the use of internationally recognised standards such as those developed by the Investor Confidence Project and the International Protocol on Measurement and Verification of Performance.


The underwriting process to assess value and risk takes inputs from the engineering, commercial and contractual development process described in The Project Life Cycle section of the Toolkit. The approach described here is applicable to larger projects but fundamentally all energy efficiency projects, whatever their size, whether they be stand-alone or embedded into larger refurbishment projects can produce multiple benefits and carry the same types of risks. The challenges with small projects is how to cost-effectively appraise value and risks. For projects embedded into larger renovation projects where the primary motivation is not energy saving the challenge is how to incorporate value and risk appraisal into the overall value and risk appraisal of the larger project.

The underwriting process

The inputs from the development process are incorporated into a financial model that is used to value the project and carry out risk analysis. The outputs from the model are combined with accounting and legal advice and credit risk assessment. The flow of information from the development process into the underwriting process is shown in Figure 1. In practice, there may be interaction as issues raised in financial appraisal and risk analysis for instance may lead to changes in engineering or commercial arrangements.

Figure 1: Information flows from development into underwriting

Financial model

The first task in underwriting is to build a financial model that reflects the costs and benefits of the proposed project. The primary input into the financial model for an energy efficiency project will be the output of engineering and cost-benefit analysis resulting from the project development process described in the Project Life Cycle section of this Toolkit.

Valuing energy efficiency

Energy efficiency projects can produce many types of benefits beyond just energy cost savings, both energy benefits and non-energy benefits. For any specific project, it is important to recognise all of these benefits and where possible value them and capture the value in any assessment. Benefits of energy efficiency projects also occur on three levels; the level of the project host, the level of the energy system, and the level of the national and international economy. For the purposes of financial institutions underwriting energy efficiency projects only those benefits at the project level that can be valued and captured are relevant, although national and international benefits such as reduced emissions, may be valuable as part of Corporate Social Responsibility (CSR) programmes and policies. In some jurisdictions, some of the benefits that arise in the energy system, e.g. the reduction in maximum electrical load which reduces the need to invest in new energy supply capacity (through larger cables for instance), may be passed back to the project host through payment schemes or special tariffs from the supplier, distribution company or grid company. Where this is the case it is important to identify, value and contractually capture these monetary benefits in order to maximise the returns of the project. In some cases, these benefits may not have been identified or valued by the developer, who is usually focused on energy cost savings, and the financial institution may identify them and propose ways to capture them through implementation contracts. The checklist in the Resources section summarises the benefits most likely to be produced by energy efficiency projects.

Energy benefits

Energy related benefits include:

  • energy cost savings: the most commonly discussed benefit and the main rationale for stand-alone energy efficiency projects.
  • reduction in effects of energy price volatility. Reducing energy consumption reduces the economic impact of energy price volatility which has a value to the project host.
  • demand response value. In some jurisdictions reduction in power load at certain times may be economically attractive through incentives payments, often in the form of payments from the grid operator or distribution company. 
  • reduced need to spend capital on energy infrastructure upgrades. Reducing energy demand can prevent, or delay the need to upgrade energy supply infrastructure such as boilers or cables.

Energy cost savings

The first and primary source of value from investments in energy efficiency is the value that comes from the reduced energy cost – usually called energy savings but more correctly energy cost savings. It is these cost savings that usually drive investment returns. These savings are calculated using the projected energy savings (in kWh or other energy units) multiplied by the assumed price of energy over the investment lifetime. It is important to remember that energy costs are made up of several elements including fixed charges and various levies (e.g. renewable energy levy) and taxes. Particularly in deregulated energy markets tariffs can be complex and large users in the industrial and commercial sectors are increasingly becoming more exposed to the wholesale energy market. All of these elements need to be considered in calculating the appropriate price per kWh used in savings calculations. Projected energy prices (“forward curves”) can be taken from various proprietary services. For large consumers exposed to the wholesale electricity market prices can in fact become negative at times – which makes technologies such as energy storage potentially economically viable.

Reduction in the effects of energy price volatility

Another source of value from improvements in energy efficiency is the reduction in the impact of energy price volatility. Energy prices are volatile and this volatility imposes a cost on building operators and industrial facilities alike. Reducing consumption reduces the exposure to energy price volatility.

Being better able to predict input costs also has a value to commercial organisations. One of the advantages of renewable energy sources such as solar or wind is that there is no price volatility – long-term fixed energy prices can be set based on capital cost, project finance costs and Operations & Maintenance costs. This removal of energy price volatility is often under-valued or ignored in assessing on-site renewable energy projects.

Value of demand response

As outlined above in some markets there is potential economic value from implementing demand response measures, either as a result of reduced energy costs at times of peak demand or by payments from the utility. Revenue is usually paid to the project host by the grid operator or distribution company and some demand response project developers take a share of the revenue produced. 

Reduced need to invest in energy supply infrastructure

Investment into energy efficiency may reduce or remove the need to invest in additional energy supply infrastructure such as increasing the capacity of power supply. An example of this is given by Costa Coffee’s roasting plant in London. In 2012 Costa implemented various energy efficiency measures that reduced energy consumption by 16%. This allowed production to be increased without the need to invest to upgrade the capacity of the electricity supply capacity. Without these measures the company would have had to pay a significant capital cost to the electricity distribution company to install upgraded cables. This type of benefit is likely to be particularly valuable in urban environments where replacing and upgrading electrical infrastructure (cables, transformers and sub-stations) is increasingly difficult and expensive.

Non-energy benefits

Work by the International Energy Agency and others has identified a whole range of non-energy benefits that may result from energy efficiency projects which are shown in Figure 2.

Figure 2: Multiple Benefits of Energy Efficiency

These benefits, and their monetary value, will be very situation specific and the allocation of value will be determined by agreement between the parties but it is important that the project development and underwriting processes identify and where possible captures the value of the benefits that fall to the host or the investor. 

Non-energy benefits have an important role to play in selling energy efficiency investments, however they are financed. The EEFIG DEEP database contains some information on non-energy benefits where these have been provided. Often the other sources of value may be considered by decision makers to be more strategic than just energy cost savings and therefore more likely to result in a decision to invest. Some of the main non-energy benefits are explored further below.

Impact of Energy Efficiency on Asset Valuation and external financing quality

One of the principal challenges of energy efficiency is that, while its impact on asset value can be real and measurable, energy represents a relatively small part of a building’s or company’s overall expense, (with the exception of facilities in specific energy intensive sectors), and energy systems a relatively small part of the real property. A common refrain among building owners asked about efficiency is “95% of the value is in the bricks and mortar.” As a result, asset owners often feel that returns to investment of staff time and effort may be greater if they are directed at leasing (in multi-tenant or residential property), or improving services (in healthcare or universities), or upgrading production systems and marketing (in industrial firms). Energy efficiency is not a core business or competence and is not regarded as strategic in nature compared to improving service or developing new products. 

Nevertheless, in buildings attention to energy systems can have an impact on the building’s value that is far from trivial. The level of impact of energy efficiency improvements on asset value will depend on the way that the building is occupied and the nature of tenant leases being used.

In some kinds of assets, particularly in multi-tenant commercial buildings, the energy savings from an efficiency project may not flow to a single beneficiary. While it is a consideration that is more important for the host asset than the lender or investor, it is nonetheless important for underwriting to understand how savings flow through the underlying asset. 

Operating costs in leases are best understood on a spectrum extending from a net lease where tenants pay for all capital and operating costs (more common in the UK and Europe) to a gross lease where landlords pay for all capital and operating costs (more common in the USA). Energy savings from a retrofit in a building with a fully netted lease will flow to the tenants. If the lease makes tenants responsible for capital upgrades (i.e. triple net), the landlord can make the retrofit and charge the tenants pro rata but may have little incentive to undertake the planning and development effort required given that it receives no savings. If the lease makes the landlord responsible for capital expenditures and tenants for operating, there is even less incentive to do so since the tenant will receive the savings having paid nothing for them. This is the landlord-tenant problem of split incentives.

Figure 3: Types of building lease

In a fully gross lease (also called full service gross) a landlord pays for all operating costs, typically excluding increases in property taxes, meaning that all energy savings from an energy efficiency project would flow to the landlord.

Asset Value Impacts

Energy efficiency can significantly improve valuation of an asset at sale and leverage ratios for financing. An illustrative example will be helpful. A large real estate firm buys a 25,000 m2 building in Berlin, with a hold period of 3 to 5 years at which point it plans to sell the property. An energy assessment on the 30 year-old property indicates that a comprehensive retrofit would cost EUR 2,500,000 and save at least 35% of energy costs. The building spends EUR 50/square meter on energy, or EUR 1,250,000 per year, meaning the retrofit will save EUR 440,000.




Net Operating Income (EUR)

Annual Energy Expenditure (EUR)

Retrofit Cost (EUR)

Retrofit Savings








For simplicity in this example, let us assume that all of the energy savings flow to the bottom line of the asset.

Cash flow

The first and most obvious impact of the retrofit appears in the cash flow, where reducing expenses is the net equivalent of increasing revenue. The economics indicate a “simple payback” on the cash outlay of 5.7 years. 

For commercial or other property, the appeal of this retrofit project may vary considerably based upon the investment strategy of the owner. An increase in asset valuation may not be relevant unless an owner plans to sell or refinance. A long-term holder of property may not find a return of capital in nearly six years as compelling as alternative investment opportunities. Such an owner may prefer to reduce the list of system improvements to those that return capital in three years or less. The owner of this particular asset, however, with a 3 to 5-year hold period, would be well advised to pursue the complete retrofit in light of the impacts discussed below.

Capped valuation

As a general first order estimate, commercial property prices are based upon the capitalised value of the income stream they generate. The capitalisation rate (a discount rate that is a proxy for the opportunity cost or the buyer’s cost of capital) at which assets trade rises or falls based upon many factors in the broader economy. In this example a cap rate of 4% is used. Dividing the stream of savings by the going cap rate yields the net value of the retrofit. All other things being equal, i.e. ignoring other factors that might affect valuation such as the credit quality and duration of existing leases, the retrofit will increase the value of the property at sale by 12%, a four-fold return on the capital spent on the retrofit.

Figure 4: Impact of a retrofit on asset value



Net Operating Income (EUR)





Total Change

Cap Rate


Cap Rate


in Asset Value

Sale Value (EUR)


∆ Value (EUR)



Price chipping / re-trade

During the negotiation process for purchase of an asset, a buyer typically adjusts the original offering price based upon information discovered during due diligence. This renegotiation process is called “price chipping” or “re-trading”. Deficiencies discovered as part of the Physical Needs Assessment (PNA) are often the source of price adjustments. In the example given here, it is likely that a PNA would identify aging energy systems as liabilities that would be passed on to a buyer, leading to a EUR 2,500,000 discounting of the offering price, as opposed to the three-fold return earned by the owner that retrofits the building. In other words, the change in value due to the retrofit is really closer to EUR 13 million than EUR 11 million. 

Loan to Value (LTV)

A change in LTV might rightly belong in the discussion of credit quality below, but it is probably more important to the extent it impacts an asset owner’s motivation to pursue a retrofit. Assuming an LTV for commercial property of 70% and a value of EUR 93.75 million, the maximum loan available for the buyer of the building, or to the existing owner seeking a refinance, is EUR 65.6 million prior to a retrofit. After a retrofit and the change in valuation, the 70% LTV would allow borrowing of EUR 73.3 million, or a EUR 7.7 million increase in borrowing, nearly three times the cost of the retrofit itself. The additional loan proceeds free up capital that can be applied elsewhere, to distributions or to the purchase of additional assets.

It is important to point out that, in addition to re-trade of the asset with aging systems, the buyer’s lender may reduce the amount it is willing to lend, require the buyer to reserve against the improvements, or use loan proceeds to install them, each of which has a similar net effect of reducing the value of the property to a buyer. 

Box 4.1 Energy efficiency and the valuation of buildings

The examples above show that improved energy efficiency can directly influence property value. This proposition is not universally recognised by valuers who operate on established methodologies that may not take into account improved cash flows. The methodology also of course does not apply to residential buildings where value is driven by many objective and subjective factors. The energy efficiency industry has long argued that a more efficient building – commercial or residential – has additional value.

There have been numerous studies and projects to assess the effect of energy efficiency on valuation and there appears to be growing evidence that a more efficient building is worth more than a less efficient equivalent, but this conclusion remains controversial with many property professionals and valuers ascribing differences in value to other factors. Banks and financial institutions lending to the property market have the opportunity to collect data to evaluate this question but this requires collection of energy performance data, either operational data or more likely asset data such as Energy Performance Certificates. Banks should collect relevant data as well as ensure that they are aware of the latest research. They can also actively encourage valuers to take energy efficiency into account in their valuation. This is now being done by some banks including, amongst others, ABN Amro ING and Berlin Hyp.

Credit Quality Impacts

While all of the asset value impacts described above have a positive impact on credit quality, lenders look at those changes differently from asset owners. This brief section takes a lender’s perspective on the energy efficiency project.

Debt Service Coverage Ratio (DSCR)

Lenders pay particular attention to debt service coverage ratios (DSCRs) as a measure of the health of an asset. For commercial property, for example, loan covenants typically require maintenance of a minimum coverage, often 1.25 or 1.3, below which a loan may be accelerated, reserves increased or other penalties applied. A loan that falls below 1.15 or 1.1 may be considered impaired although of course specific DSCRs will vary in each situation. 

Cash flow improvements from energy efficiency can significantly improve debt service coverages. An analysis of 550 multi-family residential buildings in the north-eastern United States tested the impact of 30% (hypothetical) energy savings on debt service coverage. On average, those savings would improve DSCRs by 0.245. For 10% of the assets, this improvement would:

  • shift them from a DSCR below 1 (i.e. unable to pay debt service) to positive coverage; or
  • move them out of an “impaired” coverage status closer to target minimum coverage; or
  • lift coverage ratios from at or below minimums typical in loan covenants to healthy coverages exceeding those minimums.

For a lender, an across the board improvement significantly reducing exposure in 10% of its loans is a dramatic result warranting close attention. On this evidence, lenders would be well advised, as discussed further below, to benchmark energy usage in their portfolios and track energy costs. Energy efficiency can be a tool for limiting defaults and improving credit quality across a pool of assets.

Default mitigation

As discussed above, the prices of assets are frequently reduced (“re-trading” or “price chipping”) during due diligence when deficiencies come to light. A buyer discounts the original price by the cost of remediating those deficiencies. In a default scenario, a lender seeks to recover as much of the principal and unpaid interest as possible from a disposition. An asset with aging energy infrastructure is vulnerable to re-trade and the lender therefore, vulnerable to lower recovery of capital. Assets with modernised systems are less vulnerable.

Lower tenant turnover/faster leasing or sale

Stable, credit worthy tenants are an important measure of credit quality. Retaining existing tenants is generally far preferable to vacant space in search of new ones and improved levels of energy efficiency can help to ensure that those stable, high quality tenants renew. Increasingly governments, private businesses, institutions and non-profits have made commitments to sustainability and environmental conservation which can affect their choices over property. Energy efficiency improvements by an asset owner may help meet some of those commitments while reflecting stewardship of the building that can help to retain tenants. They can also improve health and comfort, as discussed further below, providing further benefits to tenants. As well as helping to retain tenants a high level of energy efficiency may reduce the time taken to fill voids. Retaining tenants and faster rental/sales both have a direct financial impact.

Modernisation/diminution of building obsolescence

Brokers and management firms often classify buildings according to their physical condition, location, level of amenities and other factors. Some still use labels such as Class A (for new or modernised buildings in good locations with many amenities), Class B (older, less well maintained buildings with fewer amenities), and Class C (old buildings in need of significant renovation). These distinctions have an important impact on perceptions of tenants and potential buyers of property. Modern energy systems are an important element of Class A status. Buildings that cannot maintain an adequate indoor environment, experience system outages or constant repairs, or cannot accommodate supplementary systems from new tenants will struggle to retain top tier marketability. Furthermore, as discussed in the Financial Institutions and Energy Efficiency section of this Toolkit tightening regulations on energy performance may well make less efficient properties unsaleable.

Other non-Energy Impacts

As well as the energy benefits and the non-energy impacts described above, investments in energy efficiency can have other benefits. The types of benefits that may occur include:

Reduced costs of compliance with regulatory programmes such as the EU Emissions Trading Scheme (EU ETS). 

Reducing energy use for a large energy consumer within EU ETS will reduce the costs or produce income which should be captured in any energy services contract.

Reduced Operations and Maintenance costs.

New equipment often reduces O&M costs as well as energy costs, the best known example being the long life of LED lamps which greatly reduces relamping costs compared to fluorescent lamps.

Improved health and safety

Better lighting levels for instance can bring about better health and safety. As well as the reduced O&M costs referred to above the longer life of LEDs reduces the need to work at height – therefore reducing on-going health and safety costs as well as reducing the risk of accidents. This will have a value to an organisation and of course there is societal benefit.

Production increase

Some energy efficiency projects can bring about the removal of production bottlenecks. This would have a financial impact that should be captured in the financial assessment of any energy efficiency investment.

Improved Productivity

Some energy efficiency projects may bring about an increase in productivity. Improving comfort conditions in an office building for instance can increase worker productivity. The Center for Building Performance and Diagnostics at Carnegie Mellon identified 12 studies linking improved lighting design decisions with 0.7 – to 23 per cent gains in individual productivity[1]. Other studies have shown similar results. Some industrial projects can improve production levels by removing bottlenecks or constraints.

Health and well-being

There is evidence to show that low energy or green buildings can promote health and well being which itself can bring economic benefits through reduced absenteeism or reduced health costs. The value of this in commercial real estate is only just beginning to be recognised and valued[2]. In the residential sector, there is a clear link between poor levels of energy efficiency, resulting in fuel poverty (the condition of being unable to afford to keep one's home adequately heated), and health care costs. Typically, however, energy efficiency capital budgets and health care budgets are not linked although there are some interesting pilot projects where this has been achieved[3].

The challenge in underwriting these non-energy benefits is three-fold: a) identifying them b) estimating the resultant benefits and c) capturing the cash flow benefits. If they can be identified and estimated, and a contractual means to capture them put in place, then the cash flows should be included in valuation calculations. There is no standard way of calculating the value of these benefits although a number of initiatives are underway.

Risk analysis and risk mitigation

Having identified sources of value and entered them into a financial model the next stage of the underwriting process is to carry out a risk analysis.

Energy efficiency projects have in the past been presented as no or low risk. In fact, like any investment project they include risks which need to be understood and evaluated. Many of the risks present in energy efficiency projects are familiar to underwriters of other kinds of real property investments. Ultimately all energy efficiency projects, whatever their size, have similar types of risk but obviously for smaller projects the amount available to spend on due diligence and understanding risks is smaller. Better understanding, and ultimately quantification of the risks, should ultimately lead to tighter pricing and the development of innovative finance products. The following section describes the common risks in energy efficiency projects and identifies mitigation strategies.

Performance risks

Performance risk is essentially the technical risk that the project does not produce as many units of energy saved as forecast and it can occur for a number of reasons which can be split into: intrinsic – those factors that are within the energy efficiency measure or technology itself, and extrinsic – those factors that are external to the project itself. Intrinsic risks include design and equipment risks, extrinsic include factors such as weather or hours of occupancy. The gap between projected savings and actual savings that are achieved in practice is known as the “performance gap”.

Text Box 4.2 The performance gap

One of the major issues in energy efficiency is that there is often a significant difference between the projected savings and the actual savings that are achieved in practice. This is known as the “performance gap”. A US study on energy efficiency projects[4] in over 230 multi-family housing buildings carried out for Deutsche Bank showed that the realisation rate – the actual savings compared to the projected savings was 61% with a 90% confidence level of +-14%. This comes about due to a number of factors including; poor baselining, poor design, and use of unrealistic assumptions on key parameters such as run time of equipment.

The performance gap can be addressed through careful selection of engineering teams and the use of standardised development processes such as those of the Investor Confidence Project (ICP). ICP’s Investor Ready Energy EfficiencyTM certification for projects requires trained project developers to follow the ICP Protocols and for the project to be independently verified by an ICP Quality Assurance professional.

The reality at present is that for most energy efficiency investment or lending the financial institution is not explicitly taking the performance risk. This either resides with the project host or a contractor through some kind of performance guarantee. Nevertheless, we consider that an understanding of performance risk is important for six important reasons.

  1. For consumer loans consumer credit laws may make the provider of finance ultimately responsible for the performance of financed equipment.
  2. Even when there is no legal or contractual responsibility for performance risk project under-performance will lead to customer dis-satisfaction and possibly disputes that can put the investment or loan at risk.
  3. Some financial institutions are including the full increased cash flow that should result from energy efficiency projects in their risk assessment. This effectively means that they are indirectly exposed to some performance risk. Under-performance will reduce the cash flow improvements expected and therefore the risk of default.
  4. Failures of project performance at a large scale may lead to reputational risks. In the US Property Assessed Clean Energy has been receiving negative press coverage due to a small percentage of under-performing or mis-sold projects. Similarly in the UK there has been recent press coverage of under-performing energy efficiency projects.
  5. As the energy efficiency financing market matures and is better understood more investors/lenders will be willing to take some or all of the performance risk in return for an upside. This has already happened in some other energy markets such as wind power where some debt providers are willing to take on shared performance risk for higher returns – effectively a debt/equity hybrid product.
  6. Ultimately many financial institutions will want to aggregate energy efficiency loans or investments and re-finance them through securitisation or the growing green bond market. The green bond market, driven by socially responsible investing, requires the underlying projects to have real environmental benefits

For these reasons we consider performance risk to be important and discuss it at length here.

Design risks

Design risks concern the failure of the energy modelling, selection of energy efficiency measures and engineering design to accurately predict the energy savings, all other factors being equal. This failure may come about for a number of reasons including design error and the inaccuracy of design models. A design failure may be difficult to establish unless it involves a clear mathematical error or obvious mis-specification. Design failures can occur in single measure or technology projects but are more likely in complex multi—technology projects where there are interactions between measures, interactions that are sometimes difficult to accurately model or predict. The issue of actual energy performance not matching design performance in buildings is called the performance gap.


Engineers typically will not accept savings risk associated with their designs. Professional Indemnity (PI) (also called Errors and Omissions) insurance will not therefore cover savings, but it will cover mistakes in calculation or specification. There are several standard practices that should be observed that will mitigate design risk including:

  • Engineers working for the developer should share all data, calculations and simulation files. Their awareness that this information will be on file will compel a higher degree of care. 
  • Third party engineers experienced with retrofits should be tasked with review of all design work. For larger projects financial institutions often require independent engineers to carry out technical due diligence.
  • The use of appropriate national or international standards in project development and documentation such as the Investor Confidence Project Protocols should be specified. Use of the Investor Confidence Project’s Investor Ready Energy EfficiencyTM project certification system brings with it the added confidence of an independent third party verification that best practices have been followed in project development.
  • Lenders and investors should consider reducing savings projections, or investigate the methods the developer may have used in the design process to reduce them. Where simulation programs are used to model building physics, the level of confidence in the model calibration needs to be considered. The magnitude of any reduction, or “de-rating”, of the savings will depend on the degree of interaction among measures, the difficulty of the retrofit, the extent to which the technologies are proven, and other factors identified by the third-party engineer.

A note on design techniques, integrated design and over-sizing

Although not a specific technology the choice of design approach can seriously impact on the energy efficiency of buildings and processes. Traditional engineering follows codes and practices which although existing for good reasons, sometimes work against energy efficiency. An example is the separation of architects and building services engineers. The energy efficiency of a new building can be significantly affected by this separation in which traditionally (and to a certain extent this is a stereotype for illustration), the architect designs the building and then “hands it over” to the building services engineers. This may result in lower than optimum efficiency for a number of reasons e.g. the effects of building orientation and massing decisions, or simply the positioning of plant and equipment rooms.

Furthermore, even within building services engineering there is the issue of separation or “silos” where mechanical engineers dealing with HVAC design may be separate to lighting engineers – even though lighting and HVAC can interact to affect energy use. There is also the conservatism factor. Engineers are conservative for good reasons but this often produces the “here is one I did before” syndrome rather than real analysis of problems, opportunities and solutions to reduce energy use. This factor is exaggerated in projects with strict timelines and strong cost pressures. Cost pressures themselves also result in sub-optimal energy use when clients seek to minimise capital cost rather than life time cost. This can result in certain energy efficiency measures being cut out of designs to reduce costs. 

Integrated design seeks to find design solutions that fulfil multiple functions and have multiple benefits and has been found to often produce savings in capex as well as opex, which goes against the commonly held view that reducing energy costs inevitably requires increased capital costs.

Text Box 4.3 Examples of integrated design in buildings and industry.

The 2011 renovation of the Empire State Building in New York has been widely recognised for its use of integrated design. The building was subject to a USD 500m renovation project to bring it up to date and counter increases in voids. The owner of the building made a firm commitment to achieve high levels of energy efficiency but only under a strict rule of achieving a three-year payback period on any capital invested. Conventional engineering approaches were unable to fulfil this return criterion but through the use of integrated design significant gains in efficiency were achieved, as well as reductions in capital costs compared to conventional design solutions, which combined produced the required return. The net result of the energy efficiency measures was an additional capital cost of USD 13m with energy savings of 38%, resulting in a three year payback period on the marginal capital. The level of savings is significant given the historical nature of the building. The use of integrated design techniques as part of a wider renovation project allowed a significant increase in energy savings and reduction in capital costs compared to the conventionally engineered alternatives which were first proposed to the owner. 

An example of integrated design in industry is given by Lakeland Dairies in Ireland. The company had a process requirement for additional cooling capacity which was estimated to cost EUR 100,000. Based on advice from SEAI the company undertook a process integration study which used pinch analysis (a technique for identifying the minimum energy requirement of thermodynamic processes). The analysis eliminated the requirement for the additional mechanical cooling plant, saving the EUR 100,000 capital expenditure, optimised the overall performance of the process by investing EUR 90,000 in heat exchangers and piping resulting in an annual saving of EUR 164,000.

Another deleterious design phenomenon to be aware of is over sizing of equipment which is extremely common and occurs for a combination of reasons. Engineers make design calculations of loads (thermal or electrical), and then add a safety factor (usually determined by engineering codes and industry practices). Often a second safety factor is added (“just in case”) as well as redundancy, and then the next size of equipment up is selected from a catalogue, with the net result of more over-sizing. These technical and cultural factors are further encouraged by traditional contracting and consulting contract structures that incentivise maximisation of capex and not the reduction of long-term operating costs. These engineering and financial factors result in gross over-sizing which is significant because most engineering systems operate at low efficiencies when running at low loads which results in un-necessarily high energy consumption. Careful design techniques, based on data collection on actual demands, coupled with incentive structures that encourage low energy designs can help to reduce the worst effects of over-sizing.

Text Box 4.3 Combatting over-sizing

An example of this is shown by a case study from a brewery where a proposal to replace an existing steam boiler installation with 50 tonne/hour capacity was being considered. Conventional engineers had proposed a straight replacement with new boilers with 50 tonne/hour capacity. Detailed analysis of actual demand showed that the steam load could actually be met by 2 x 10 tonne/hour boilers. The final investment decision was to install 3 x 10 tonne/hour boilers with one providing backup. This resulted in a) reduced capital cost compared to the original proposal and b) significant energy savings (c.40%) resulting from the plant running at a higher capacity factor.

Equipment risks

Equipment may not perform to the manufacturers specifications or it may fail altogether. In recent years there have been examples of LED lamps not living up to the manufacturers’ specified lifetime, sometimes associated with poor choice of supplier. Contractors will not generally assume risks associated with equipment that they were not responsible for manufacturing but instead will pass on manufacturers’ warranties. Insurers may take on equipment risk but the premium will be driven by their perception of the specific manufacturers in question.


Contractors or borrowers should negotiate for the longest warranties they can obtain. Suppliers of equipment should be chosen carefully to ensure high quality equipment is procured from reputable manufacturers. Finance providers can specify certain manufacturers. Contracts should ensure that adequate insurance is in place. The contract should also compel operations staff to strictly follow the maintenance requirements established in the operations manual provided with the equipment. The same contract should allow for review of maintenance logs by the contractor or lender to confirm those procedures were followed.

Operations and Maintenance risks

No energy efficiency project will achieve its savings projections if the new systems are not operated or maintained properly. It is the biggest single risk for contractors and borrowers alike, particularly since contractors installing a retrofit virtually never manage the building and the host asset owner may utilise a third-party facilities management firm. Typically the longest, most detailed section of an Energy Performance Contract is the one governing operator failure. Legal disputes that arise when a host asset calls a savings guarantee frequently hinge on accusations of operator error. 


The following essential practices should be followed to manage operational risk. 

  • Measurement and Verification (M&V) protocols should be put in place as part of the project and maintained during the project life time.
  • An Operations Manual should be provided with the retrofit that outlines as clearly as possible how the new systems should be operated and should be accompanied by training.
  • The contract must provide for maximum visibility into operational behaviour, via operational logs, uploads of data, or real-time links to the building management system. Operational failure cannot be proven without evidence. 
  • The contract should include some kind of on-going commissioning to ensure that the level of savings does not decay. On-going commissioning can help identify operator errors and other problems that lead to savings decaying over time.
  • Operations and maintenance contracts can be written to include performance warranties based on up-time or even energy performance.
Text Box 4.4 The importance of Measurement & Verification and IPMVP

Another issue with many energy efficiency projects is that the quality of Operations & Maintenance and Measurement & Verification can vary from low (or completely absent) to very high and this affects the project outcome itself and of course the ability to monitor the outcome. Many energy efficiency projects do not include M&V and therefore the actual outcome is uncertain. In this case savings may be over or under – stated and may indeed be illusory as they could be caused by other external factors such as weather and changes in production levels.

The International Performance Measurement and Verification Protocol (IPMVP) sets out methodologies for determining energy and water savings. Good practice requires that M&V is integrated into the process of identifying, installing and operating energy efficiency measures. IPMVP methodologies should be used to measure the performance of all energy efficiency measures and for larger projects, and particularly complex energy services contracts, an independent professional firm specialising in M&V should be appointed. For more details on IPMVP see Text Box 3.1 in the Project Life Cycle section of this Toolkit and:

Weather risks

Weather can have a significant impact on achievement of energy savings. If, for example, a retrofit is designed to dramatically reduce the consumption of fuel for heating and the winter following installation is mild, savings will be less than projected, everything else being equal. While energy bills will remain lower than they would have been without the intervention, and the impact on the host asset is still positive, contracts underwritten based on achieving the savings may experience a shortfall. 


An energy performance contract will include formulae accounting for weather and should generally not penalise the contractor if weather limits savings. Where the cash flow from savings is required for return of and on capital, the best insurance against weather risk is a long contract. Most variations in weather will balance out (i.e. upside gains will compensate for downside losses) in contracts longer than three or four years. The weather risk can also be mitigated by careful selection of the baseline, ideally baseline energy consumption will be based on three years data. Where weather risk is considered particularly significant, it is possible to purchase hedges against weather in insurance markets. Finally, the discounting of savings described above will help manage weather variations. An additional option that could be considered is weather insurance or hedging contracts.

Changes in hours of use, production volume, patterns of building usage

Any calculation of energy savings will be based on a baseline consumption. As energy use is affected by many factors including: changes in the hours of use, changes in production volume or product mix, changes in number of building occupants etc., any projection of savings is based on an assumption that conditions remain as they were in the baseline, which of course they may not. In this case energy savings will not be as predicted. Normalisation through the use of techniques such as Measurement and Verification may be possible. Any contract based on a projected level of savings must allow for these changes and should specify a method of normalisation or a process to reach a new baseline. The most extreme change that can happen to affect savings performance is of course closure of a building or a facility. This will lead to contract termination and financing contracts must allow for this, usually through the use of termination clauses which result in capital being repaid by the user who has taken the decision to close the facility.


The most common mitigant to address this risk is to have some minimum production level or set pattern of building use that the project host is willing to guarantee. This may affect the balance sheet treatment of associated capital cost and accounting advice should always be sought on this matter. Energy service companies and investors are naturally unwilling to take on risks that really sit with the project host, e.g. their production volumes/sales and it is unreasonable to expect them to do so.

Performance Risk Profile Over Time

The technical performance risk of energy efficiency projects that are well developed and managed tend to become more stable over time. The first year may involve fine-tuning and calibration to optimise performance of the new systems. After two or three years, the average savings are likely to present a fair approximation of the savings that can be expected for the remainder of the contract, assuming that on-going commissioning and any replacements of equipment that age out during the contract period are provided for. For this reason, energy efficiency projects that are mature make good candidates for aggregating and refinancing through securitisation or green bonds.

Performance Guarantees

Many of the contractual arrangements described in the Financing Energy Efficiency section, of this Toolkit, particularly Energy Performance Contracts and related structures, are designed to address some or all of the risks described above. Performance guarantees should be carefully examined and considered. It is worth noting that:

  • contractors will not generally assume risks that they cannot manage in a very direct fashion.
  • savings guarantees will shift unbounded risks to other parties.
  • savings guarantees will usually be well below the achievable savings in order to build-in risk protection for the contractor.
  • guarantees always carry a cost.

As well as performance contracts project hosts and financiers should consider the use of energy efficiency risk insurance which is increasingly available. 

The role of insurance in performance risk

The energy efficiency insurance market is an emerging field. Specialised insurance companies such as HSB (part of Munich Re) offer products to cover some or all of the performance risks including poor design and implementation and the use of these insurance projects is expected to grow in the future. Insurance is available for most commonly used energy efficiency technologies. This insurance can help reduce the cost of capital by providing additional certainty that loan repayments or projected capital returns will be made.

Energy price risks

Monetary savings will be predicted on the basis of an assumed energy price but of course energy prices change, both up and down, affecting the level of savings achieved. Often the buyer of an energy efficiency project believes savings have failed to materialise when in fact they have been partly or wholly subsumed by rising energy prices. While this perception is unfortunate for the contractor forced to explain the issue, energy price risk is managed relatively easily and reporting systems should include reference to energy price changes.


Energy Performance Contracts guarantee savings and Chauffage-type contracts generate billings in terms of historical energy usage, i.e. in kilowatt hours and BTUs, not in currency. Energy prices are not usually relevant to guarantees of savings. Indeed, as prices rise, savings also increase, meaning the host property may pay more than projected for certain kinds of contracts. It is sometimes possible to procure longer-term fixed price energy contracts. Another option for both the host property and for a contractor managing procurement is to purchase a hedge on the commodities markets or establish caps and collars on the energy price that will be used in the calculation of monetary savings.

Construction risks

As with host risk, construction lenders are already well versed in managing risk associated with contractors. This brief section reviews some of those methods with specific reference to how they are typically managed in energy efficiency projects.

Execution Risk – Time, Cost, and Quality

Some retrofit projects may take place in mechanical spaces and cause relatively little interference with the rest of the building. Others may require entry into occupied spaces to replace lighting, wiring, thermostats or other systems which will cause disruption or need to be scheduled for out of operating hours, possibly at extra cost. Energy efficiency projects generally must be scheduled carefully with the host building to ensure the least possible disruption and the fastest possible execution. Host properties that execute their own energy efficiency projects are accustomed to these risks, since many engage contractors for new tenant fit-outs or renovation projects on a regular basis. Indeed, some are more comfortable managing this risk than handing it off to ESCOs. 


Energy Performance Contracts generally make the ESCO responsible for delivery of the project on time and on budget. A host property may increase the security associated with the ESCO’s commitment by requiring that the project be bonded (i.e. a payment and performance bond gives the host property access to capital to hire an alternative contractor to complete the work should the ESCO fail) or that the contractor pay liquidated damages. Liquidated damages might reflect the expected savings foregone during the period when construction exceeded its schedule completion date. It is also possible for contractor or building owner to purchase insurance policies to mitigate construction risk.

In some cases it may be possible for an ESCO to permit a host property to utilise its preferred contractors and to manage construction, and to take a fee for doing so, but these concessions will require corresponding adjustments in other parts of the contract, e.g. should savings guarantees be compromised by delays in host execution of construction.

Credit Risks during construction/installation

Management of cash flow across different projects is the biggest challenge for most construction contractors. Those with smaller balance sheets are at higher risk of failing to execute a project.


As part of the submission of bids, contractors should be required to submit their financials as well as their ability to post performance bonds or warranties. Management experience and track record in similar projects are important factors that should be considered.

Risks associated with other costs and benefits

If other costs or benefits identified in Section 2.5.3 are valued and included in the project assessment any risks associated with those cash streams should be considered in the underwriting process and mitigation options considered, just as with other risks. As these other costs and benefits tend to be situation specific it is not possible to provide generic guidance on how to assess and mitigate them, only to record that they will exist.

Regulatory risks

Energy efficiency projects do not typically involve a high degree of regulatory risk. Energy efficiency standards for buildings and equipment have generally tightened across the world and this trajectory looks set to continue. Efficiency projects are more likely to bring buildings into compliance than to violate codes or regulations. Nevertheless, some new technologies or management strategies may not yet be anticipated in code. Recycling of indoor air, for example, may be treated differently across jurisdictions. Co-generation projects will sometimes require specific environmental permits that allow for fossil fuel combustion in urban areas.

Another form of regulatory risk that should be considered occurs when there are government subsidies or feed-in tariffs that are essential to ensure the sound economics of the project. In some jurisdictions, retrospective changes to feed-in tariffs for renewable projects have occurred and these have severely impacted project returns for all investors and lenders. As well as the risk of retrospective changes to feed-in tariffs the risks of changes during project development need to be considered. Other regulations may also affect project economics.


There are a set of standard practices that should be followed to address regulatory concerns. First, engineers should perform a comprehensive code review of the retrofits proposed and prepare a schedule of permits or variances that will be required. Second, to the maximum extent possible, permits should be obtained before construction begins and significant funds are expended. Finally, conditions precedent can make receipt of certain permits or regulatory approvals mandatory before releasing funds.

Host Credit Quality

Evaluating host credit risk does not need extensive discussion as it is part of the core business of lenders and investors. Real property investing is many decades old and practices for evaluating risk associated with a real estate asset (or corporate debt in the case of an owner-occupied asset) are well established in banking and investing. An energy efficiency guide has nothing to add to these considerations, with two caveats. 

Payments for energy efficiency projects will generally come before distributions to equity (contract review should ensure this is the case); they will appear as an above-the-line operating expense in the case of a service contract or a below the line debt service in the case of a loan to the host property. Evaluating a building’s capacity to pay operating expenses is very different from evaluating its debt-carrying capacity or its ability to generate returns for investors. Operating expenses are paid before debt service, and are therefore less likely to default than a loan. Debt payments are made before any profits are distributed. For some energy efficiency arrangements, the analysis needs simply to confirm that the building will be solvent long enough to discharge operating or debt service payments, a lower bar than other kinds of credit analysis. 

Some banks are beginning to take the improved cash flow from energy efficiency into account in credit analysis. This should be encouraged as there is a real effect. The only caveat is that by taking into account the impact of savings the lender is implicitly taking some performance risk and energy price risk, which therefore suggests that a good understanding of these risks is even more important in this cases. 

A challenge for some lenders pursuing efficiency concerns the typical size of the transaction. Many lenders will have a staff devoted to credit analysis of real estate assets, but their typical transaction is likely to be far larger than the staff executing energy efficiency transactions. It may be difficult for them to secure some of the time and expertise of the real estate staff. Lenders and investors may be well advised to develop a streamlined process for analysis of host credit that taps in-house expertise without over-utilising it.

Legal Review of Contracts and Contract Structure

Lenders and investors will conduct a legal review of the contracts to be used between host and developer or host and contractors, as the case may be. This review will inform the depth and breadth of other underwriting processes by revealing where investors and lenders have exposure under the proposed contract structure. As the contract structure diagrams presented in the Financing Energy Efficiency section of this Toolkit demonstrate, contractual relationships among the parties may vary considerably. In some cases payment of debt service is the responsibility of the host asset, while in others it is the responsibility of the project developer. In the former case, underwriters will focus more attention on the ability of the host to carry the additional debt. In the latter, they will scrutinise closely the entities that stand behind the project specific entity (the guarantors and the contractors). Contract review should consider carefully how each of the risks detailed in this section is dealt with and which party carries the associated exposure. Other standard considerations include the transferability of contracts and performance guarantees.

Consumer credit law risk

In some jurisdictions, where individual consumers are being offered loans, consumer credit protection laws mean that the provider of finance is responsible for failures or defects. This presents a particular problem for financing home retrofits as it means that the finance provider will be responsible for the equipment and systems installed for the life of the loan. This means that credit providers need to either pass on the risk to their supply chain (which is problematic for long-term loans with terms of 7 to 15 years which is longer than most manufacturer/supplier warranties), or find a way to insure the risk. Insurance companies may not be able to take these risks as there is a lack of data on real performance.

Accounting Review

For some types of contracts, the balance sheet and/or fiscal treatment of the contract may require review. If the host asset owner or developer have not engaged an accounting firm for a review, investors and lenders may do so to assess cash flow risk.

Risk analysis

Having built a financial model and collected all other relevant information a risk analysis can be carried out to test the sensitivity of financial outcome to changes in the input variables. Normally this would be carried out a high level on inputs such as projected energy savings (in kWh or other energy unit), energy prices, capital costs and O&M costs etc.

There is almost a complete absence of real performance data on individual energy efficiency measures but a number of recent initiatives have sought to address this problem. The DEEP database, created with support from the European Commission, ( as of 1st June 2017 contains data on more than 7,500 projects across Europe covering both industry and buildings. DEEP, along with other similar databases, does not contain many projects with verified energy performance data. The Curve ( collects information from industrial and building energy users on their efficiency (and related) projects. Again, most of the more than 650 projects in the Curve do not include verified energy consumption data. The industry should move towards collecting verified performance data in a standardised, usable way (as has been done in the US through the Building Energy Data Exchange Specifications - BEDES) and banks and financial institutions can push the industry in this direction. 

The advent of cheaper monitoring and computing power and communications opens up the possibility that performance data at an energy efficiency measure level will become more available over time, and as this happens different commercial models that properly consider and price performance risk are likely to emerge.

Even without detailed performance data on individual measures it is possible to carry out a sensitivity analysis on specific energy efficiency measures in order to identify the most critical risk factors which can then be focused on.

Such risk analysis can be used to identify those input factors where changes will have the biggest effect on expected return. This information can lead to requesting additional information which could include deciding to spend money on additional temporary monitoring. If for example, the most sensitive input factor is judged to be hours run, consideration should be given to installing temporary monitoring that logs the hours run directly, either a light meter in the case of lighting or electrical monitoring of the specific circuits in question.

[1] Building Efficiency Initiative. (2013).

[2] See for example: PWC (2008). Building the case for wellness.

[3] Burns, P. & Coxon, J. (2016). Boiler on Prescription Trial Closing Report.

[4] Recognizing the Benefits of Energy Efficiency in Multifamily Underwriting