Boiler And/Or Burner Conversions: A Potential Financial Boon - Joseph Bohm

There is a strong case to be made that converting a boiler from oil to gas could be the single best investment available to owners of multifamily properties. Not only is there huge opportunity for savings, but there is opportunity to increase revenue as well. The property also becomes more attractive to buyers.

The following scene has played out numerous times across the industry. A potential buyer wants to pay $5.5 million for a multifamily rental property and the owner is staying firm at his asking price of $6 million. Neither wishes to budge; both are confident in their valuation of the asset. So how to break this stalemate? How to bring both parties back to the table? Throw in a gas conversion.

Realized fuel savings of 40%-50% are no secret and are reason enough to invest the money in converting. Increased operational efficiency from natural gas lowers a boiler's maintenance costs. Additionally, removal of a boiler's side-arm pre-heater will create electricity related consumption savings. However, the true economic benefits of these conversion projects can be even greater.

On a simple level, the value of any asset is determined by measuring expenditures against revenues. The savings listed above are in fact just that, savings. They decrease the operational costs of running the asset. But certain types of gas conversion projects (specifically when a boiler and/or burner is being replaced) can actually increase the revenue side of the equation if the project is eligible for a major capital improvement (MCI) increase. MCI increases have long provided owners of buildings containing rent-stabilized and rent-controlled apartments with an incentive to upgrade their building's infrastructure. The Division of Housing and Community Renewal (DHCR), upon application by the owner, has the authority to grant permission to an owner who performed an MCI to increase the legal rents on rent-stabilized or controlled units by a specific formula.

In a straight-forward explanation, the amount of the MCI increase is calculated by dividing the cost of the project by 84 and further dividing it by the total number of rooms in the building. The result is the permitted monthly increase in legal rent per room (a caveat being that a tenant's rent cannot increase more than 6% annually).

For example, if a gas conversion project that includes installing a new boiler and/or burner costs $58,000, and there are 50 apartments in the building with a total of 200 rooms, the permitted monthly increase per room can be calculated as follows: $58,000 x 84 x 200 = $3.45.

It is important to note, however, that not all gas conversions are created equal in the eyes of the DHCR. There are specific requirements for a project to be eligible for an MCI increase, as well as discretionary authority of the DHCR to overcome. The DHCR requires that a new boiler and/or burner be installed as part of the gas conversion project in order for accompanying and related work, such as a chimney lining and gas piping, to be eligible as part of the MCI increase. If the conversion project consists only of installing piping and a gas train to an existing boiler and/ or burner it will not be eligible for an MCI increase. Even if a new chimney liner is installed in conjunction with the gas train and piping, the project will not be eligible for an MCI increase.

Also, not only must a new boiler and/or burner be installed during the conversion for the project to qualify for an MCI increase, but the boiler and/or burner being replaced must have reached the end of its useful life. Owners who wish to undertake a gas conversion project where the current boiler and/or burner needs to be replaced but has not reached the end of its useful life can apply to the DHCR for a waiver of the useful life requirement. The owner must apply for such a waiver prior to the commencement of the work.

Because benefits of a gas conversion can be substantial, buyers seeking opportunities in today's higher priced environment should consider properties that consume heating oil whose boiler and/or burner are beyond their useful life as defined by DHCR. At those properties, a gas conversion can make an immediate and meaningful impact on the asset's underlying valuation.