Evidence Matters: Measuring Sustainability | Article 1 | Sidebar

Split Incentives

Even if better performance data and ready capital were available for retrofits, they would not completely solve the problem of split incentives, which depress owner demand for retrofits. The biggest cause of split incentives is that in individually metered units, the benefits and savings from retrofits go to tenants, not owners. In addition, owners face several hurdles when trying to use energy savings to justify rent increases. Owners need accurate data on tenant-paid utilities to project the expected savings from their investment and advertise them to potential renters and buyers; this information is often hard to come by. Even if an owner can accurately predict expected utility savings, raising the rent of an occupied unit by the entire expected amount of utility savings may not be possible. These factors make capturing the benefits from energy-efficiency improvements an uncertain proposition, which in turn makes investment in retrofits less attractive.

Creative solutions to the split incentives problem are currently being tested. A recent guide from Enterprise Green Communities describes how public housing authorities can use energy-efficiency utility allowances to incentivize owners to invest in energy-efficiency retrofits in their low-income properties. Utility allowances are used to calculate the rents for HUD-subsidized tenants, ensuring that they are paying only 30 percent of their adjusted monthly income toward gross rent, which includes contract rent and estimated utilities.1 An energy-efficiency utility allowance gives property owners who make energy-efficiency improvements the opportunity to reduce their tenants’ utility allowance, resulting in an increase in contract rent by the same amount.

An innovative strategy for overcoming split incentives in market rentals is to incorporate a cost-sharing agreement for energy-efficiency improvements directly into the lease. In the residential sector this technique, known as “green leasing,” is still in its infancy. A green lease specifies the amount that rent has been increased to help cover the owner’s investment in energy efficiency as well as the tenant utility savings that will offset that rent increase. For recent investments that have not yet generated sufficient energy usage data, a green lease can stipulate that a rent increase will occur when enough usage data exists to predict energy savings. Cambridge Energy Alliance, a nonprofit sponsored by NSTAR (a natural gas and electricity provider) and the city of Cambridge, Massachusetts, will soon be piloting a model green residential lease in a small number of units. They believe that their model lease will be disseminated widely once the pilot has been completed.

1. Heschong Mahone Group, Inc. May 2011. “Utility Allowance Options for Investments in Energy Efficiency: Resource Guide,” 7.