Green Mortgages 2.0: Less Carbon & More Money

Is your mortgage rewarding you for being an environmentally conscious homeowner?

Not many can say ‘yes’, so read on. I was at West Coast Green over the weekend and learned that green home mortgages have undergone a radical revamp, and now help you to fight carbon emissions, boost your wallet and enable you to direct your investment to a complete supply chain of green investors.

The Prototype: Energy Efficient Mortgages
Energy Efficient Mortgages (EEMs) came about in the 1970’s when former President Jimmy Carter challenged government agencies to create home loans that counted energy and water savings as additional income for use in paying debt service. In the past ten years, EEMs from Fannie Mae, Freddie Mac, the Veterans Administration and the Federal Housing Administration have all offered homeowners the opportunity to stretch their debt-to-income ratios by slight amounts, so long as the loan was used to purchase a new energy efficient home or helped to install energy-saving improvements. Unfortunately, the structure of EEM programs ignored the basic realities of homebuying, so they’ve never been a hit. For starters, they do not pay sufficient loan proceeds – for example, the maximum loan amount you can receive under the Fannie Mae EEM is $417,000, rendering the product irrelevant for most of us in high cost markets such as California. Additionally, features such as loan docs and closing costs were not streamlined with today’s market standards, making them seem more cumbersome and less competitive.

The Upgrade: Green AND Competitive
Now private investment banking firms such as Oakland-based Sustainable Capital, are coming to market with a redesigned green mortgages enhanced with best practices in residential rating systems, realtime energy monitoring, reduced interest rates as well as a true green capital supply chain. Here’s how to distinguish the newer green mortgages from their predecessors:

• A smaller carbon footprint. Reducing the home’s carbon footprint is now the goal, as opposed to only water conservation and energy use reduction. The outcome of you having additional income from energy and water savings is still a main goal but the new green mortgages go steps further. Using best practice independent rating systems such as Build-It-Green’s Greenpoint system, a more in depth assessment of the home includes indoor air quality, construction materials, paints and carpets as opposed to merely better appliances, light bulbs and plumbing. Additionally, specialist vendors supply cutting edge monitoring technology, which provides you and the lender with continuous verification of the reduced energy usage and water conservation over the life of the loan.

• Higher loan proceeds and lower interest rate. The loan qualification process and proceeds are comparable to what is on the market today from most banks, fixing a basic problem of the EEMs. Your rate of interest is reduced from comparable current market rates, based in part upon post-financing audits verifying the success of the green renovations and the results of ongoing energy monitoring.

• Integration of incentive financing. The new green mortgages manage to integrate the diverse financial incentives offered to you from other sources such as local utility companies, state and federal governments. So you get additional help in the complicated search for the necessary funds to green your home.

• True green supply chain. The new green lenders source loans using certified Eco-brokers, who are trained to sell green homes and can provide additional support and tips on going through the process of greening the house. Finally, the funded loans are packaged and sold off to socially-responsible funds, concluding a supply chain of totally aligned consumers, contractors, intermediaries, lenders and secondary market sources.

So now you do not have to put up with substandard financing alternatives in order to live (and invest) according to your values. Definitely much better than a few bucks off the closing costs and a new toaster!

Climate Change Legal Risks: Energy Companies Feel the Heat

“Selective disclosure of favorable or omission of unfavorable

information concerning climate change is misleading.”

- New York Attorney General Andrew M. Cuomo to Energy Companies

Check out OneAtlantic.net’s excellent post on the creative use of existing law to sensitize corporate investment practices to climate change risks. Following predecessor Eliot Spitzer’s example, New York Attorney General Andrew M. Cuomo is using an almost forgotten law to investigate five energy companies, which intend to build coal-fired power plants.  The Attorney General’s correspondence advises the energy companies that they should have made their investors aware “of the growing potential that they may be taking on big financial risks by building coal-fired plants.”  The Attorney General’s overarching thesis is that publicly-traded companies are legally liable for taking undisclosed risks that could diminish their value to shareholders. The goal appears to be one of forcing polluting companies to proactively reduce their carbon emissions.

My synopsis: this investigation, if successful, will propel commercial real estate’s risk management practices and corporate social responsibility into a new millennium — at warp speed.

In commercial real estate finance and investment, hard money liability, regulatory and reputation risk directly affect bank and investor decision making. Such amounts flow through to net cash flow or funds from operations, meaning the potential for deterioration of net asset values and with it, market capitalization and shareholder value.

Real estate investment trusts (REITS), being publicly-traded, should immediately begin to incorporate climate change risk into their corporate and portfolio risk management processes. Their client investors (pension funds, etc.), are probably following this carefully, too, and will start requiring similar reporting disclosures.  It goes even further: other investment real estate developers and operators who want to do business with REITS (practically everyone else in the industry) will have to be similarly compliant. After all, no one will take an asset into their portfolio until they are sure that they can understand and economically manage that building’s carbon footprint in compliance with the law and market expectations.

And here’s the competitive advantage angle for Green Real Estate Investors.

In the course of meetings yesterday with a couple of investor clients who already develop green apartments and retail, I asked about their motivations to focus on building green real estate. Besides the fact that they felt it is the right thing to do, they honed in on their perceived risks of not going green. Both developers indicated that they see the potential of the federal or state government passing some form of carbon tax on commercial property as being imminent. They, too, perceived any type of carbon tax as being a direct hit to their bottom lines and, therefore, a valuation risk to their properties. Already being green puts them at a competitive advantage in such an environment.

“Wash me… but don’t get me wet”

Any German will immediately recognize the above saying about people who are less committed to something than they publicly profess. Environmentalists call it ‘greenwashing’.  And here’s my devil’s advocate question:

What if we are confusing a company’s incremental progress on a complex long-range strategy with hypocrisy?

The Wall Street Journal has just updated us on General Electric’s (NYSE: GE) progress on its attention-grabbing Ecomagination strategy. It seems that there is resistance to Ecomagination’s promise and products from both customers and the ranks within and more limited C-level support than was widely assumed.

To its credit, GE leads the pack in establishing top-level leadership on going green. And its stated approach, to bring innovative environmentally-friendly products to market without sacrificing profits, raised our expectations of the bottom line benefits of corporate social responsibility. Yet, GE’s current business reality is that it backs proposals to cap industrial carbon-dioxide emissions even as it continues to sell coal-fired steam turbines.

And it is particularly troubling that some GE employees still question whether climate change is even for real. Huh? (Hint: Ron Nielson’s The Little Green Handbook is a number cruncher’s dream).  Also, CEO Jeff Immelt’s statement about limiting GE’s sustainability initiatives to only those things that made ‘economic sense’ sounds reasonable on the surface, but also leaves the loud silent question of whether sustainability initiatives are being shouldered with a heavier burden of proof (and performance) than status quo business practices.

With green building now emerging in our industry, this article provides deep insights about the realities of leading organizational and industry transformation and leads to a more concrete question:

What would they write about you?

If a Wall Street Journal reporter googled your company on its green building progress, perhaps even called you and your peers to find out more on what you’re doing, what do you think would be written about you and your firm?

• Can you compartmentalize the business of green building away from your personal beliefs about sustainability?
• Do you embed sustainability into your personal lifestyle?
• Do any of your peers and employees?
• Is favoring green building a moral or business choice, or a political necessity?
• What are the economic and political realities of embedding sustainability in your company?
• What business tradeoffs are you prepared to make?
• What tradeoffs will you absolutely NOT make to go green?
• How are you engaging your employees, customers and other important stakeholders about your efforts to go green?
• Are you retaining any other business practices alongside your green building efforts which may be in conflict?
• How do you explain that?
  

It is very difficult to make the necessary business decisions about green building without spelling out your level of personal and organizational commitment. I hope these questions help us to engage each other more constructively and authentically.

Is Subprime Lending Good for Green Real Estate?

One of my friends, a sustainability consultant, called me up and what she actually asked was,  “What is the connection between subprime lending and green?” She went on to explain that her firm had an internal pow wow on how the credit crunch might be affecting their real estate customers.

What a great question. I immediately saw its Freakonomics potential. We talked about it at length and afterwards, I even related it to one of my institutional clients. He also reacted immediately, so I knew that I was on to something.  It is always good thing for a sustainability consultant get some independent validation by  investor.

These days, real estate investors sail choppy waters in the capital markets  Some cruise in elegant ocean liners, other in make halting headway in rugged frigates, and a few are surviving with flimsy canoes. So the current market’s impact really depends on the condition of your fleet. Bloomberg chronicled the mood of anticipatory doom that is swirling about institutional real estate, projecting a possible 15 percent drop in real estate sales prices and values in the coming year. I think they should have inserted one of those instant polls where people can vote on whether they were going to renew their antidepressant prescriptions.

And as for the connection:

• What goes down, must go up. The current events in the credit markets represent a reversion to the mean. For months, there have been mumblings in and out of real estate that the prior-go years of mega deals, and value increases have been fueled by cheap, “covenant light” debt. So from this perspective, interest rates were long overdue for increases back to historical averages. Subprime lending was a natural, timely trigger for for an observable market process that is critical to economic cycles.
  

• Cash is King. The stronger sailers represent cashflowing assets in resilient markets with good, diversified employment fundamentals. Asset types with weaker cashflow prospects relative to lenders revised underwriting guidelines will be subject to the most volatile repricing. Lenders will not lend as much debt on these properties, the cost of any financing will be higher and investors will have to accept lower returns on their investments. Yes, even stronger cash flowing properties will be affected by lenders’ tougher underwriting standards, however, they will obtain better credit terms relative to weaker assets and, just as important, higher sales prices.

• Green is good for the Cashflow.  In their 2006 update study, “The Cost of Green Revisited“, Davis Langdon shows “no significant difference in average costs of green buildings compared to non-green buildings”.  On top of that, green buildings enjoy lower operating costs to boot.  So let’s do the math: same costs and more net operating income for a green asset. Which means, all other factors being equal, in today’s tougher credit market,  building and operating a green building is a quantifiable positive hedge of the asset’s underwritten cash flow against market driven declines in value, sales prices and returns.
  

So the existence of subprime lending, as problematic as it is these days, is highlighting a strong common interest in cashflow that aligns more investors with the sustainability community and underscores investing in green buildings. Let’s see what happens from here.

Getting Institutional Real Estate to Invest in Sustainable Buildings

In my work, the hot question from my sustainability friends is “how do we convince lenders and investors to allocate capital towards green real estate?” They are baffled about why institutional lenders and investors often nod their heads politely in meetings, but are still largely noncommittal about writing the checks for green real estate, despite all of the verified proof of its superior investment performance. You would think that such a crowd would automatically embrace the higher return and value story. So why is that not happening, yet?

A classic problem, really. The idea that people and companies will act to enlarge their own self-interest is accepted as conventional wisdom. Not true, says the Rockridge Institute’s George Lakoff, people routinely make decisions and take actions, which are not in their self-interest. In Don’t Think of an Elephant, Lakoff explains that people’s actions are driven more by how the subject fits with their view of themselves in the world as opposed to their self-interests. This could help us understand the slow adoption by institutional real estate as well as hint the way forward to greater capital flows into sustainable buildings.

The sustainability community is focusing on this disconnect. Earlier this week, Joel Makower covered the LaFarge and United Technologies study which highlighted the fact that compartmentalized expertise within the real estate value chain, incorrect perceptions about sustainable real estate costs, plus many not-so-obvious complexities of building green combine into daunting challenges to widespread capitalizing of green real estate projects.  Financiers and developers are specifically identified as the biggest barriers to more sustainable approaches in the building value chain.

Among eight recommendations on influencing decision makers about sustainable buildings, the study points to personal know how, business community acceptance, a supportive corporate environment and individual personal commitment as the four main barriers to “greater consideration and adoption” of sustainable building. Bring in Lakoff’s explanation about people acting according to their identity more than their self-interests and we have a more focused definition of the disconnect and how we can better advocate for greater investment in sustainable buildings:

• Know US institutional real estate’s identity. This industry has been experiencing a long, successful economic cycle without having to differentiate assets in the way the sustainability requires. Sustainability doesn’t exist within the investment world view. And this world functions around highly compartmentalized expertise. Integration, a basic tenet of sustainable building, does not naturally exist between participants in the institutional real estate value chain. So it is difficult for already successful real estate executives to fully appreciate how their investments will benefit from concepts and processes which do not exist in their world.

• Talk in the language they understand. These days, interest rate increases are eroding financing proceeds and are expected to result in a drop in property valuations. Did I hear someone say, “decreased net asset value”? This is a good time to start presenting sustainable building’s financial benefits as a potential hedge against eroding values from interest rate increases and lower sales prices. It is also a problem within their world  that they can understand. Lenders and investors could understand this as ‘cash flow preservation’ and/or ‘risk management due diligence’.

• Use a metaphor from their world. I like the Carrier Division’s way of borrowing tools and techniques from its aerospace division to lead real estate executives through the green building decision making process. Airplanes are a powerful metaphor to assist institutional real estate in its evaluation of risks, costs, tradeoffs and profits. Air travel is full of emotional decisionmaking. Airline travelers have a monetary, health and safety interest in the condition of a plane. Airlines must invest in updating their fleets in order to remain competitive. Most real estate executives are frequent business travelers. Their emotional stake in an airplane’s safety and their innate understanding of the relationship between a new, state of the art fleet and an airline’s reputation could be used to convey the important messages about the risks of not investing in sustainable building.