Aligning Incentives: Financial Models for Promoting Energy Efficiency Renovations in American Apartment Buildings

Abstract: Buildings account for a significant portion of energy consumption and carbon dioxide production in the United States. Renovations could improve the energy efficiency of these buildings. However, a number of market barriers, e.g. high upfront costs, are resulting in a low adoption rate of energy efficiency (EE) technologies in the building sector. Apartment buildings face an additional challenge of overcoming the split incentive, or landlord-tenant dilemma. This study assesses public and private financial models that could address the split incentive in EE renovations in public and/or private apartment buildings. This thesis uses principal-agent (P-A) theory as a framework for understanding the contractual relationships in which a principal pays an agent to act on the principal’s behalf or to provide a service to the principal. The objective of this thesis is three-fold. Firstly, financial models that address split incentives in apartment buildings were identified through a literature search. Analysis showed that most of the financial models do not suffiently address the problematic principal-agent relationship. Secondly, two models that did address the split incentive—green leases and on-bill programs—were examined further to explore how they alter the principal-agent relationship and to investigate the effects of these models. Data was collected primarily via literature analysis and supplemented with interviews. While both address the split incentive, only on-bill programs showed promise in contributing significantly to increasing energy efficiency renovation rates in American apartments. High transaction costs are preventing green leases from adoption in the residential market. Thirdly, a case study was conducted on How$mart, an on-bill program based in Kansas. This program has successfully overcome the split incentive barrier. The How$mart program packages EE renovations as a utility service that is financially attractive to landlords, tenants, contractors, and the utility company. This thesis concludes with a compilation of aspects that are key to a financial models success at addressing the split incentive and achieving a high participation rate. The thesis also found that, despite the success and promise of on-bill programs, EE financing programs tend to underserve non-low-income tenants in medium- and large-scale apartment buildings. Suggestions are provided on how to close this gap. Furthermore, developing on-bill programs in coordination with complementary policies would strengthen efforts to address EE renovation needs in American apartment buildings. Suggestions include minimum energy standards as a part of rental licensing, energy efficiency disclosures for apartments, and removing fossil fuel subsidies.