It should come as no surprise that cities and states are rethinking their approach to green building. Not only do buildings consume more than 40% of the energy in this country and more than two-thirds of the generated electric power, but in cities where effective transit systems take cars off the road, building energy use also accounts for the vast majority of greenhouse gas emissions. (According to a recent press release from New York City Mayor Michael Bloomberg’s office, “Buildings account for 75% of all greenhouse gas emissions in New York City.”)

So cities like New York and Philadelphia are moving beyond business as usual in standards and practices. While the LEED (Leadership in Energy and Environmental Design) certification system has been the most significant measure of green building achievement in the U.S. for some time, when New York City recently launched PlaNYC, a groundbreaking approach to green buildings and energy efficiency, it decided against using LEED standards, opting instead to develop its own measures of performance.

Other cities and states are also taking a fresh look at how energy is actually consumed in buildings, and developing new policies and approaches designed to foster energy efficiency in both residential and commercial structures.

Challenge #1: Bridging the Energy-efficiency Gap

Any new approach confronts two major challenges, the first of which seems to defy both logic and the very premise of capitalism. When it comes to saving energy, people often don’t act in their own best interests. One problem, points out Christina Simeone, director of PennFuture’s Energy Center for Enterprise and the Environment, is that people “tend to discount consumption in the future.” It’s hard for most of us, she explains, “to give up dollars spent now to save more dollars in the future.”

But according to Eric W. Orts, director of the Initiative for Global Environmental Leadership (IGEL) and a professor of legal studies and business ethics at Wharton, the vast majority of us (well informed university professors included) never even get around to taking energy-saving steps that are “financial no-brainers in the short term.”

This failure of decision makers to take cost-effective energy-saving steps is an important element in what has become know as the energy-efficiency gap. While many different groups have estimated the size of the gap, its enormity is not in question. According to a 2012 working paper by the Congressional Budget Office, energy consumption by residential and commercial buildings could be reduced by 10% to 20% globally in a little more than a decade if people would simply make smarter decisions.

One cause of the gap is the opportunity cost of information:The fact that people are not acting in their own self-interest, says Arthur van Benthem, a professor of business economics and public policy at Wharton, is a clear signal that among other things “there must be a huge informational cost to doing so for some people.”

The informational cost can be thought of as opportunity cost. According to van Benthem, it’s hard for some people to translate kilowatt-hour savings into terms that will help them decide if a $300 investment upfront will save them money over the long term. And for many, the scale of any possible gain simply doesn’t justify the amount of time and energy they would have to invest in figuring out the payback.

Even for owners of larger single buildings or groups of them, opportunity costs can remain an issue because the challenge of deciding whether or not to make improvements grows increasingly complex as structures themselves increase in size and complexity.

Understanding all the inter-related systems and dynamics involved in major structures “is not rocket science — it’s more complicated than that,” says Mark Allan Hughes, distinguished senior fellow at PennDesign at the University of Pennsylvania and lead investigator at the U.S. Department of Energy’s Energy Efficient Buildings Hub (EEB Hub) at the Philadelphia Navy Yard. Hughes doubts that asking even major building owners and investors to spend the large sums currently needed to evaluate their buildings’ energy performance is going to work.

A growing number of cities are using benchmarking to encourage energy efficiency: One way to lower the opportunity cost of information is to simplify the task of deciding whether energy-efficiency steps are warranted. Government incentives do this effectively by reducing decision making to a simple choice about whether or not to participate and by decreasing the upfront cost of taking action.

But money for incentives is hard to come by and even successful programs tend to have limited life spans. One new policy that is gaining some traction in the field is benchmarking and disclosure. In 2007, California became the first state to require benchmarking. Since then, Hughes told, “Five U.S. cities [including Philadelphia and New York] and two states have passed laws that mandate benchmarking energy use in some form. Connecticut, Vermont and Massachusetts are considering similar policies now.”

Benchmarking obligates and empowers owners to rate their buildings’ energy performance, using common metrics, and then report their findings to the city or state. The Department of Energy (DOE) and the Environmental Protection Agency (EPA) jointly developed the Energy Star “Portfolio Manager” software that is provided free to building owners, who can complete the necessary inputs in an hour or two — even faster when utilities make the raw data available for easy downloading.

The end result of the process is a measure of how much power a building is using per square foot. Portfolio Manager also includes a set of standards by building type, so owners get quick access to vital information about how well their building is performing relative to similar structures. And because each building’s score is made public in some way, owners and tenants can compare the relative performance of buildings in the area.

Hughes says the policy puts “information into the marketplace that everyone assumes will reward people who have invested in improving their buildings’ energy performance. And it incentivizes people whose buildings are energy hogs to make some of these improvements.” The expectation, adds Hughes, is that third parties will “translate this information into buyer-sensitive information.” A leasing agent or real estate broker, for instance, might tell a client that since he or she will be spending less on energy, he or she can afford to spend a little more on a lease or mortgage.

In New York City, which last September became the first city in the country to make benchmarking information public, the data certainly got people’s attention. The New York Times quickly pointed out that 7 World Trade Center, a modern 52-story office tower with a LEED Gold rating, scored just below the minimum for high-efficiency buildings set by the EPA, while buildings from the 1930s, such as the Chrysler Building and the Empire State Building, scored far better (thanks to thick walls, fewer windows and extensive upgrades).

And the public rankings sparked just the kind of competition Hughes described. As Simeone notes, in New York, “some of the people who owned buildings that were at the top of the list started competing for the top positions, asking themselves what they could do to get even better. And the people with buildings at the bottom of the list really did not like being at the bottom, which prompted them to take action.”

Simplified modeling tools can also help lower the opportunity cost of information: While most privately owned buildings are individually metered, others are not. The buildings on the University of Pennsylvania campus, for instance, are just now being set up to measure their own electricity usage. But when University President Amy Gutmann became the first Ivy League president to sign the American College and University Presidents’ Climate Commitment (ACUPCC) in 2007, “Nobody at that point had any clue which buildings on campus … should be using more energy or less energy or for what,” says William W. Braham, a professor of architecture at the University of Pennsylvania and director of the university’s Master of Environmental Building Design program.

So Braham and others spent two years doing what he calls walk-around audits of each building on campus; then analyzed the data using a predictive simulation model developed by Penn’s T.C. Chan Center. The Building Performance Assessment Tool (BPAT) provided detailed, if simplified evaluations of how each building would be expected to perform given its design. With a margin of error of plus or minus 10%, BPAT yielded a good deal of actionable analysis. It was found, for example, and much to everyone’s surprise, that laboratory equipment was the second-biggest consumer of building energy on campus. As a result, the university is now focusing on ways to reduce laboratories’ energy consumption.

Because it lacks the actual performance data provided by utility bills, however, BPAT can only make predictions based on design. A rat stuck in a duct or a malfunctioning valve can cause major differences between what is predicted and what actually happens. When in-depth audits were conducted in half a dozen of the previously audited UPenn buildings, Braham says that the process showed everyone “just how different a building could perform from how it was designed to perform.”

But as long as people understand this limitation, the value of simplified simulation tools like BPAT is clear; they provide valuable information at very low cost. BPAT can be completed by a couple of graduate students in two or three days, making it far less expensive than more sophisticated models that require teams of experts and weeks or even months to complete. It also offers advantages that benchmarking’s Portfolio Manager does not: It does not require that buildings be metered and it provides detailed information about which steps should be taken first. (Portfolio Manager gives only a single score; additional work must be done to prioritize corrective measures.)

A new financial model does away with the opportunity cost entirely: According to Hughes,”One of the things that the market is moving toward is a new financial model,” one that relieves building owners of having to acquire any energy-efficiency information at all. The owner simply hires a third party provider to create the kind of environment he or she wants in the building (temperature, humidity, daylight, etc.) and gives that firm access to the building. The provider in turn guarantees to deliver the desired environment for a given price. Behind the scenes, the provider conducts any analyses it needs, brings in vendors to make needed improvements and tinkers with the building until the desired outcome is achieved.

Since the provider has guaranteed the owner price for performance, it is clearly in the provider’s interest to keep energy costs as low as possible. But the owner doesn’t have to pay any attention to energy information or bear any opportunity cost for acquiring it.

Challenge #2: Realigning Costs and Benefits

Green leases can help heal split incentives:The energy-efficiency gap is one major obstacle to energy efficiency. The other is misalignment of costs and benefits. The classic example, known as “split incentive,” arises when the people who pay for the energy are not the ones who control its use. “There’s a huge disconnect between who gets the benefit, who’s responsible for managing and measuring those expenses, and who is actually consuming them through their behavior,” notes Joseph Stettinius, CEO of commercial real estate services company Cassidy Turley.

Tenants who do not pay their own utilities have no financial incentive to help their landlord pay for energy-saving improvements that will lower only the landlord’s costs. Conversely, when tenants do pay their own utilities, the owner of the building has no incentive to invest in efficiency since the tenants are the ones who will reap the benefits.

An innovative solution to this problem is the creation of “green leases,” which align the financial and energy incentives of building owners and tenants. This is not a simple undertaking. In New York City, a group that included some of the city’s largest building owners, tenants, management companies and engineers worked for six months to develop a prototype of such a lease. And in Philadelphia, the EEB Hub has joined with others to create the Green Lease Library, an online resource that provides guidance, case studies and tool kits to help cities create green leases of their own.

Innovative financing aligns owners’ short-term interests with long-term investments: Another common misalignment of incentives concerns time horizons. A given improvement may eventually prove profitable, but the building owner may not want — or be able — to wait long enough to enjoy the net gain. Companies with impatient stockholders may have trouble justifying major improvements that will not pay off for many years, and individual building owners may not own the property long enough to reap the benefits of their investment.

One answer policymakers have developed for this problem is a new kind of financing that ties the capital cost of the improvement to the property instead of to the owner. PACE, or Property Assessed Clean Energy, says Simeone, provides “a great way to allow the private sector to come in and make really safe investments.” Banks, which are less enamored of the mortgage market than they have been in the past, are attracted to these investments, Simeone notes, because they are “collateralized to the property, with a first lien on the property, which even the mortgage is subordinate to, and because the energy savings that will be realized by the property is very easy to prove…. Performance is almost guaranteed.”

And the PACE program is just as attractive to building owners, who benefit from reduced energy costs right from the start, without onerous down payments or high short-term repayment costs. Instead, the cost of the loan typically adds a relatively small charge to the property tax bill. And because the loan is tied to property taxes, it stays with the building if the owner decides to sell.

Connecticut launched the nation’s first statewide commercial PACE program in June 2012, and Riverside County, Calif., created the first, and one of the very few, residential PACE programs in 2011. Today, nearly 30 states have passed legislation enabling PACE programs.

Decoupling aligns energy generators with energy conservation: Since utilities are in the business of selling energy, it may appear unreasonable to expect them to actively support the state’s goal of reducing energy consumption (although many do). For the utilities, lower consumption has always meant lower profits. Yet as Hughes notes, “Utilities are a crucially important part of energy conservation all over the country. The places where you see the most progress are where you’ve got the most engaged utilities.” So finding a way to align the power of utilities with energy conservation is an important policy goal.

The approach a number of states are taking to achieve this goal is “decoupling,” which detaches how much a utility is paid from how much energy it sells. The fundamental idea is that state regulators adjust utility rates to compensate utilities for any revenue they lose as a result of their own efforts to reduce energy consumption among their customers, whether through incentives, subsidies or educational programs. And the gradually increasing utility rates further motivate consumers to consume less energy.

Those familiar with the politics of decoupling note that some utilities have been wary of any change to the traditional system, which offers them and their stockholders a guaranteed rate of return. But as the Natural Resources Defense Council (NRDC) notes, “Half the states in the nation now have policies to break the link between recovery of fixed costs and sales for natural gas and electric utilities.”

Ultimately, building codes have to be aligned with all of the other initiatives: At Philadelphia’s EEB Hub, the Policy, Markets and Behavior Task Force has a motto: Make it hipper, make it cheaper and then make it mandatory. That last part is key. While policies try to incentivize and reward the best energy efficiency behavior, building codes ultimately establish the worst behavior that will be tolerated.

For years, energy efficiency was not even part of most building codes, which addressed issues of health, safety and accessibility. But this has been changing. The International Code Council (ICC), which establishes new model codes every three years, has been steadily sharpening its focus on energy issues — so much so that Hughes describes the last two rounds of model codes, in 2009 and 2012, as “major improvements” in terms of energy efficiency.

But Christina Simeone points to the weakness of these model codes: While most U.S. communities and many global markets choose to adopt the new, stronger codes every three years, the decision to do so is voluntary. For a time, states were motivated to accept the new codes because federal stimulus funds required that they do so. But now that those funds have dried up, Pennsylvania, for instance, has decided against adopting the 2012 code. And some other states, says Hughes, are actually thinking about rolling back their building codes to even earlier versions.

At the other end of the spectrum, New York City and others are demonstrating how building codes can be aligned with other initiatives. The city has opted to go beyond its legal obligation to enact building codes that are as stringent as the state’s energy code. Instead, New York has enacted its own tough municipal energy approach, the New York City Energy Conservation Code (NYCECC), which guarantees alignment of city building codes with all the other New York City policies and programs to reduce energy consumption in buildings.

Each of these policy initiatives advances the overall goal of reducing energy consumption in buildings. But ‘in the end,” says Hughes, “it’s about connecting the dots.” That’s what the EEB Hub in Philadelphia is hoping to do: “serve as a broker across all of these different things, making sure everyone is on the same page, making sure everyone is moving in the same direction and making sure that there is follow-up.” It’s this kind of coordination that will ultimately make all the new policies that are developed truly effective.