1. Introduction
The world’s population is estimated to increase by one-third in the next 30 years, to 9.7 billion in 2050. By then, an estimated 6.7 billion people will live in urban areas [
1]. This predicted rapid urbanization could be considered as an opportunity, but it also presents a challenge to making cities resilient and sustainable in line with the United Nations’ sustainable development goals [
2]. Furthermore, such rapid socio-economic development will significantly affect the long-term outlook of energy, as the demand for space heating and cooling, for instance, will rise [
3]. Therefore, it is vital to make buildings, both directly and indirectly, less energy- and carbon-intensive in the future [
4].
The greatest challenges to achieving a decarbonized energy system and, indirectly, for the building stock are the efficient deployment of renewable energy sources (RES) and the use of the most efficient generation technologies [
5,
6]. The most promising solution for the sector appears to be the integration of the electricity network into buildings’ energy systems [
7,
8]. The integration of information and communication technologies (ICT) in the energy system may be the key to achieving a decarbonized building stock and accelerating the energy system transformation [
3]. The adoption of ICT will enable a faster energy market operation that is more responsive to the balancing needs of a power system with less inertia and faster rates of change [
9,
10].
To support the energy system transformation, and to enhance the uptake of RES, the European Commission has strongly directed European Union (EU) members to engage in activities that promote the adoption of digital solutions in the built environment. One such activity is the development of a smart readiness indicator (SRI) [
11]. The objective of the indicator is to provide an equal rating system for EU members and raise awareness of the benefits of grid flexibility enabled by distributed and fast-responding electricity and thermal storages, electric vehicles (EVs), and demand response. In alignment with the scope of the proposed framework, the SRI aims to evaluate a building’s potential to optimize the overall energy consumption, provide occupants with more accurate information about their consumption, and enable the central system operators to manage the grid more effectively based on demand [
12]. The SRI for buildings is not, naturally, an indicator of the maximum level of smartness in a building system. Nevertheless, it aims to provide a way to support the cross-sectorial integration of the building sector into (future) smart energy systems by enhancing the role of the building, the user, and the grid.
One of the key goals behind the development work of the SRI is to make the added value of building smartness more tangible for property owners. So far, however, evaluations of holistic smart energy investments, that support real estate investment valuations, are still lacking in the literature. Previous studies, such as [
13,
14,
15], have mainly concentrated on measuring economic aspects of various stand-alone smart energy systems. In these studies, the financial profitability of the investment in a smart system has been estimated from a technology project perspective by using traditional economic analysis methods, including internal rate of return (IRR), return on investment (ROI), and payback period. However, even though the investments as such have appeared appealing, these frequently applied valuation methods do not consider the possible impact of such investments on property value.
From the real estate investment point-of-view, the property is evaluated as an entity with the focus on its total value [
16]. The value of professionally managed investment properties is often evaluated using a discounted cash flow (DCF) analysis. In a DCF analysis, the present value of a property is based on the estimated cash flows and exit value, which are discounted to the present with a suitable discount rate [
17]. The most important parameters forming the cash flow of a property are rental income, rental growth, vacancy rate, operating expenses, capital expenditure, depreciation, and a discount rate that reflects the relevant risks [
17]. Depreciation includes both physical deterioration and obsolescence [
18]. Thus, to understand the real estate investors’ perspective and capture the value of smart building investments for them, DCF analysis should be applied in evaluating the economic profitability of such investments.
In the current literature, there is only a limited number of studies, if any, that consider the property value aspect of a smart (energy) system investment in a building. On the other hand, existing research that considers the property value aspect focuses purely on energy efficiency improvements (i.e., does not consider the system smartness). However, these studies mainly apply statistical analysis [
19,
20,
21], which does not explain the value influencing mechanism of such investments in detail. Christersson et al. [
16] and Leskinen et al. [
22] seem to be the only practitioners who have considered the value-influencing mechanism of energy efficiency improvement investments of on-site energy production in a DCF framework. Additionally, Vimpari et al. [
23,
24] and Kontu et al. [
25] considered the potential property value increase in their profitability analysis of rooftop solar and ground source heat pump investments. Interestingly, hardly any studies have estimated the financial feasibility of the technological shift towards smart energy systems at the property level.
The present study was designed as a novel case study that examines the economic viability and impact on the property value of a real-life smart building system investment. The implemented energy system generated not only traditional energy savings but also new income for the property through the participation in the frequency containment reserve (power) markets. This is the first study known that has used empirical cash flow data and utilized property investment analysis to reveal the added property value of such a smart energy system in buildings.
The present study provides insight into a smart energy system investment in a case building through a technology description, investor interviews, and an investment’s profitability analysis. First, the case building’s smartness, i.e., its technological readiness to support the energy system transition, was assessed using the EU-driven SRI rating system. Second, the economic and strategic motives of the investment were identified through interviews with representatives of the case building’s owner. Third, investment analysis with case-specific data was performed. To the best of the authors’ knowledge, this is the first study to apply a property investment analysis to a real-life smart energy system investment.
The study found that the building system was highly advanced in terms of its energy smartness, signified by a near-maximum score on the smartness rating scheme (SRI). The core technologies for achieving a high score was the system’s microgrid functionality, on-site energy capacity, and advanced demand management capabilities. In the interviews, representatives of the building’s owner implied that the investment was justified mainly by decreased operating costs and income related to participating in the frequency containment reserve market, which improved the net cash flow of the property. However, the improved net cash flow and the lucrative internal rate of return (IRR) were not enough to make the investment appealing. Besides, the smart energy system supplier’s, i.e., service supplier’s, active, and service-oriented attitude appeared essential in investment decision-making. Finally, a government subsidy made the investment even more lucrative. The additional strategic value of “being smart and environmentally excellent” was also considered an important factor in executing the investment. The explicit reasoning of the more sophisticated drivers, such as branding and image benefits, were recognized, but their influence on investment’s profitability was difficult to evaluate in financial terms.
The present paper is structured as follows:
Section 2 describes the research design of the study, including the case description and empirical data collection methods.
Section 3 reviews the empirical research results comprising the energy smartness assessment, semi-structured interviews, and investment’s profitability analysis.
Section 4 further discusses the results, and
Section 5 presents the conclusion.
4. Discussion
This study was designed as a descriptive case study to examine the viability of a progressive smart building solution that supports the cross-sectorial integration of the building sector into smart energy systems. The solution, including energy storage, software development, and energy conservation technologies, was considered as a real-life smart energy system. The viability of the investment was observed from the real estate market perspective, as evaluations of holistic investments in smart building solutions are still lacking in the literature. The study aimed to show the technological implementations, investor motives, and investment profitability of a smart energy system, using a market-driven case example with real-life data. The study found that investment in progressive smart building systems is already an economically viable option for contributing to the transition towards future smart and renewable energy systems. However, it was also found that the investment’s profitability alone was not enough to justify such an investment.
In this study, the case building system’s level of energy smartness was verified using the EU-driven SRI framework. Based on the energy assessment results, the case building was considered to be a real-life example of a viable smart energy system. The building’s final score, over 90% of the maximum on the SRI scale, implied that sophisticated TBS appliances and technologies—which positively affect the building, the occupant, and the grid—have been implemented in the building [
12]. Other smart technologies, including the PV system, active LED lighting, and EV charging were found to support the high SRI score significantly. Nevertheless, the power storage with the smart building’s advanced demand management capabilities was considered to be at the core of the high scoring, as the relevance of grid flexibility has been strongly emphasized in the SRI development work [
27,
40]. Namely, the SRI rating scheme appears to increasingly favor demand response related features in buildings [
40]. As has been shown, an integrated demand management system enables the efficient utilization of available resources within the building system; it also integrates the building into the national energy system by acting as a reserve power system for the grid [
41,
42,
43].
In this study, the economic viability of the investment was analyzed both from the qualitative and quantitative perspectives. The investor interviews revealed that the financial profitability of the investment was the most important rational in decision-making, but surprisingly not enough to justify the investment. As the investment’s profitability analysis results implied, the owner of the case property would immediately gain a benefit of over EUR 4 million from the investment. Accordingly, compared to traditional investment evaluation metrics, the investment seemed to be highly appealing. Based on the interviews, the conducted analysis was seen as relevant and interesting. However, surprisingly this kind of property value increase analysis, which was performed in this paper, was not performed in the owner’s investment decision-making phase.
In alignment with the EU’s vision for future energy systems, buildings will have a crucial role as active energy prosumers in the transition to a decarbonized energy system by 2050 [
44]. Hence, to support the transition and the efficient deployment of distributed RES, it will be critical that buildings all over the world be built according to the highest energy efficiency standards [
3,
45]. Based on the results of the present study, one of the key obstacles to the transition, however, appears to be the property investors averse to take a risk in smart investments.
Overall, the new technology-related risk is generally known to be one of the barriers of smartness in buildings [
46,
47]. In the present study, the motives to implement the smart technologies and advanced demand management system were found to be rather energy- and sustainability-driven, and the smartness itself was not considered as a value driver. Despite the improved net cash flow and lucrative IRR (compared to the area’s retail property yield) generated by the investment, the most crucial part in the investment decision-making appeared to be the service supplier’s active role and commitment to the management and development of the system, as well as their willingness to share part of the risk.
In the present study, the value increase of the case property was analyzed from the perspective of decreased operating expenses and new income generated by the battery. The value-influencing mechanism of a similar investment that enhances sustainability and decreases the operating expenses of properties was confirmed by surveyors in a study by Leskinen et al. [
22]. In addition to the capitalization of operating expense savings, the value of a property can increase through other improvements in a property’s cash flow parameters. Based on earlier research, property owners can benefit from investments that enhance the sustainability of properties through increased rent levels, rental growth, and occupancy rates, as well as decreased risks [
48]. These enhancements can increase the property value even more than the capitalization of operating expense savings. However, earlier studies found that surveyors did not fully transfer these benefits into property values [
22,
49,
50].
Although in the present study the smart energy system investment appears to be very appealing from a property value perspective, investors might not be able to execute the investment based solely on the estimated increase in the value. First, the value increase is hypothetical unless the investor sells the property, or an objective surveyor confirms the value. In practice, surveyors might not be able to reflect the decrease in operating expenses fully in the value of the property. They might need actual data on the decreased operating expenses for several years to verify the justified amount of savings. Irrespective of the investment, other cash-flow parameters might change, which could diminish the value increase resulting from the decreased operating expenses.
Secondly, investors traditionally focus on managing the income side of cash flow rather than optimizing operating costs. The share of operating costs amounts to approximately 5–15% of total cash flows [
16], of which energy costs represent some 30% [
51]. Although energy costs are a significant factor in the operating expenses of a property and have huge savings potential, they represent only a small share of the overall cash flow. Hence, the value increase potential is rather small compared to the overall value forming of the property.
Third, investing in and maintaining smart technology systems require special expertise that property investors might not have. Therefore, even though in this study the reserve power system was found to generate a significant potential for value increase, the uncertainty related to the income and new technology-related risk negatively affected the investors’ expectations and willingness to invest in smartness. This should, however, create new business opportunities for technology service providers, as their relevance in maintaining and developing smart building systems can be expected to increase in the future.
In the case property, lease agreements follow a net lease structure, which means that tenants pay rent for maintenance on top of capital rent. Due to the savings in operating expenses, tenants might be able to pay higher capital rent, as it is the total amount of rent that matters from the tenants’ perspective. However, the length of time needed for the rent levels to rise in practice is unclear. In a gross lease structure, where the owner of a property is responsible for operating expenses, the owner will immediately gain the benefits of the savings in operating expenses. In the end, the owner of the property will extract the same value from the property if the difference between net and gross rents equals the difference in operating expenses [
52].
To the best of the authors’ knowledge, this paper was the first study to apply a property investment analysis to a real-life smart energy system investment in a building. Hence, some limitations and uncertainties related to the results of the case study were identified. The greatest uncertainties and limitations were found to be related to the financial profitability of the smart energy investment. The annual savings were based on 10 months of actually running the system and on estimates provided by the service supplier. Actual savings can be very different from the estimate and can vary year to year. The most uncertain part of the savings is the income associated with the battery. This uncertainty was reflected in the sensitivity analysis, which contained three scenarios for the battery income. Furthermore, the electricity growth rate and inflation utilized in this study were based on the historical yearly average between 2000 and 2018. These growth rates can change over time.
Accordingly, a sensitivity analysis was added to show how the work could be improved and how a more realistic picture could be captured from the profitability analysis of the investment. In addition to growth rates, electricity prices and taxes can change over time, which might affect profitability. Besides, there were likely service charges paid by the owner to the service supplier that was not available for this study. These service charges might decrease the profitability of the investment. However, these kinds of charges might also include all the fees related to the maintenance of the technical system; therefore, this might have a minor or no impact on the results of the case study. Furthermore, this study did not consider possible enhancements in other cash flow parameters (a potential increase in rent, rental growth, and occupancy, as well as a decrease in discount rate) that could increase the value of the property even more than the decreased operating expenses.
Some limitations were found to concern also the other data collection methods. First, the SRI rating system applied to evaluate the case building’s smartness is still under development; thus, the predefined list of smart services, as well as the functionality levels and impact weightings, are expected to change in the final version of the rating scheme. Additionally, the subjective decision-making related to the selection of an applicable service may affect the reliability of the assessment, as it has been explained by Janhunen et al. [
27]. Secondly, some limitations were linked to semi-structured interviews. A majority of the interviewed investors were representatives of the primary owner, which might bias the results. However, the selected interviewees were considered to have the best understanding of the investment. To increase the validity of the results, one interview was also held with an independent secondary owner representative, who was involved both in the decision-making and management phase of the investment.
5. Conclusions
This study examined the economic viability of a real-life smart energy system investment in a building. The implemented system, including energy storage, advanced demand side management (i.e., software development), and energy conservation technologies, was considered as an exemplary smart system solution that supports the future energy system transformation. The results of this study revealed that buildings’ have the economic capability of becoming extremely smart to promote the cross-sectoral integration of the building sector into (future) energy systems.
From a real estate market perspective, there are multiple reasons to invest in smart technologies, including energy efficiency and lower operating costs with a predictable decrease in maintenance costs. However, the current study was the first in the smart building literature to evaluate the potential impact of smartness on property value through savings in operating expenses and additional income, specifically in the context of energy storage systems and new cash flows from the reserve power markets. The study found that even a progressive smart building system investment was economically profitable, and the investment generated over 10% return-on-investment along with over EUR 10 million increase in property value. However, the investment decision-making in smartness was not justifiable solely based on the appealing investment metrics, as the new cash flow opportunities were found to contain investment risks and practical challenges. For example, it is still uncertain how the property valuators approach the expected increase in the property value of such an investment.
Overall, due to the symbiotic nature of smart energy systems, the present study suggests that investment cash flows on a property level should be evaluated as one entity, instead of being broken down into subsystems based on smart technologies. Furthermore, the profitability of smart building investments should be evaluated through the impact of the savings in operating expenses and additional income (generated by the investment) on the property value to reveal the added value of smartness for property owners. However, further studies that consider the financial gains of the total smart energy system should be conducted to enhance the viability of the proposed solution as an option towards a renewable and sustainable energy system.