ULI 2008 Fortune Telling: A Shortlist of Cool Moves Including Going Green

“Two years from now, a Class A non-green building will not be considered Class A.”

- George Denise, General Manager for Cushman Wakefield /Adobe Systems San Jose Campus. Overheard during a panel session on green building.

Like a lot of finance professionals, I was hopeful about attending the ULI Emerging Trends 2008 conference here in San Francisco — welcoming any port in the credit market storm. Added to that was the promise of a big discussion on green real estate for the first time by one of the mainstream real estate economists.

So let’s cut to the chase: now the message is that there will be an overall slowing of the economy (sigh…duh), investors are crossing their fingers in hope that consumer demand will remain at acceptable levels, and that interest rates do not become too much of a wild card. In short, Joe or Jane Q. Investor will have to surf choppy waters for awhile but in the end, should come out in good shape.

And they stress that current conditions seem right for making a few cool moves. Here is the ULI shortlist:

• Have Dry Powder (Or Go Get Some): Investors with strong relationships and liquidity are going to score now that there may be more motivated, overleveraged sellers in the market needing a lifeline.
• Buy Distressed Loans: Investors are looking at B and mezz loans, figuring that they can get their hands on a quality asset for a 10%-20% discount from its original value if the borrower is unable to repay the obligation.
• Focus on Global Pathway Markets: Traditional 24-hour megacities enjoy more buyer demand and upside potential, especially when capital gets nervous.
• Buy Public REITS: A panelist from BRE Properties, Inc., a top multifamily player, gave a great analysis of the value. Their high quality multifamily portfolio is valued at an implied cap rate of 6.8%, yet multifamily is expected to outperform other asset classes. Cap rates for Class A multifamily shouldn’t get too far above 6%! In the case of multifamily, many stock analysts lump them together with other residential stocks, like homebuilders, so they’ve been taking a harder beating than is really justified by their asset quality and performance.
• Use Demographic Strategies: Old school dirt investors like myself love this category, because it plays to our strength of intimately knowing communities and their potential. Seniors housing, second homes, medical office buildings, and even student housing play on baby boomer wealth accumulation and long lifespans. Also think about urban plays that penetrate markets with high immigrant inflows.

The Green Competition Factor

Green real estate was woven into the conference as a prominent economic factor affecting the direction of investment real estate in many ways. The economists explicitly cautioned that owners of non-green buildings in high development markets should start understanding the impact of new green developments being built around their properties. In short, the presence of green developments around brown real estate may decrease the competitiveness of brown real estate. The lead in quote to this post, from George Denise, of Cushman Wakefield, is his point of view. I would add that two years ago no one would have even understood what he was saying and now people might start to realize that his point is highly plausible.

Green Real Estate Plays for 2008

ULI’s take on busting a move with green real estate was still restricted to thinking about new development plays — so they still have a ways to go in my book. Also note that ULI didn’t delve into any discussion of defining green, which is appropriate for an economics-oriented conference. And here’s a couple of their recommended green plays for 2008:

Green equals competitive advantage: Okay, for the Green Journey crowd, this is preaching to the choir. But believe it or not, just thinking about building green at all is still pretty edgy for alot of market investors.

• Focus on Mixed Use and Infill: 24-hour residential environments with pedestrian-friendly layouts and varied living options are in. Particularly among empty nesters and career starters. Fringe subdivisions without amenities are losing appeal.

• Build Transit-Oriented Development: Condominiums, apartments and retail near lightrail or subway/train stops are becoming “increasingly attractive”.

Green Journey Takeaways

ULI did do a good job of evangelizing green from an economic point of view and started the process of translating green into an investment strategy — critical for market transformation of our industry.

I’m still waiting for one of the big firms to be a leader in discussing how we green existing buildings.

Photocredit: Flickr/Jai-to-Z

TBLI, Paris: Sustainability Heavy Hitters & Green Building Transparency

As you think about your green real estate strategy, have you defined how transparent your property’s energy performance and environmental impact will be to tenants, other investors and lenders? Do you measure and report environmental outcomes based upon internally derived or neutral third party standards? As you think about it, read on for examples of how the same questions are being approached in the European Union.

Last week I was in Paris speaking about financing green real estate at the Triple Bottom Line Investing conference hosted by Brooklyn Bridge, a powerful organization run by Robert Rubinstein out of Amsterdam. TBLI is at the cutting edge of global sustainability, allowing corporate social responsibility representatives from traditional organizations such as TIAA-CREF and Allianz Global Investors to share perspectives with socially responsible and/or mission-based groups like Calvert Investments and Environmental Defense.

The green building session was packed with a savvy, enthusiastic international audience of developers, venture capitalists, NGO’s and financial institutions. Turns out that they were all busy chiseling out their green real estate strategies or updating their intelligence on how green building’s emergence may be affecting some other key area of their business.

My main TBLI takeaway can be summed up in one quote from an SRI professional, overheard during another session on carbon offsets:

“Transparency makes a market”

This reminded me of the recent Costar Green Report, which listed the latest green building initiatives by heavy hitters such as CBRE, Simon Property Group (SPG), Glimcher (GRT) and Jones Lang LaSalle. It’s great that US real estate is going green in a big way, but I still see lots of subjective picking and choosing of green initiatives with only vague mentions of concrete, meaningful energy performance improvement and environmental impact. This essentially relegates the green real estate investment proposition to being a cat in a sack – so long as a property owner does not have to disclose the true energy and environmental impacts of their green initiatives, buyers can not objectively value (i.e. pay for) the green benefits they expect to receive. So, in the spirit of Carnegie Mellon professor Randy Pausch, I’d like to introduce you to The Elephant in the Room:

“Which, if any of these companies are executing initiatives that deliver the real value and impact expected by their investors and communities? And if they are, how can we compare and judge their initiatives relevance and success for ourselves against what objective standards?”

Examples of Transparency from the European Union

The European Union has already passed the ‘Energy Performance of Buildings Directive’, requiring member countries to implement laws regulating building energy efficiency.

Generally, the regulations:

• define what areas of a building’s energy performance and environmental impact will be measured,
• compel building owners to obtain the evaluation at certain junctures in the building’s lifespan and
• require the property owner to make the official certification of the most recent evaluation to occupants and prospective buyers.

I talked with green building professionals from Germany and Britain about how these regulations have already caused investors within their countries to tie a portion of a property’s value to its objectively certified energy performance and environmental impact.

In Britain, the Energy Performance Certificate, is the official document verifying a buildings energy performance and environmental impact. The evaluation results are plotted on an A-G scale, where A is very efficient and G is highly inefficient. The EPC is required any time a property is built, bought or sold. It is required to be displayed near the building entrance at all times, to inform all occupants of the building’s actual performance (!). I talked to a London-based property professional who reported of the quick action by investors to begin retrofitting buildings once they learned that their tenants and buyers would know of their building’s potential lower grade – and possible devaluation. Predictably, the retrofitting of buildings has become a very lucrative market by itself. Representatives from British engineering firms also reported that they were already scouting out the North American markets for potential expansion.

Germany implements the EU directive through an Energieausweis (‘energy certificate’) — see a sample certificate above — similarly certifying to occupants and potential buyers a building’s performance level on the same dimensions. The Energieausweis must be created/updated at the time of construction, rental, leasing or sale. Public buildings have to display their certificates as in Britain, but private building owners simply have to make their certificates available upon request by tenants and property purchasers. Interestingly, the energy evaluation for commercial buildings can be made based upon either the property’s actual energy consumption or its calculated requirement, based upon its construction and use. Again, the energy audit and building retrofit business in Germany has been big business for years and now will probably grow in relevance for the industry.

Since the implementation of the EU directive is still in its early stages, there is not any data on the actual environmental impact of this directive nor on exactly how property values have changed as a result. Both the colleagues that I spoke with however, said that the energy certificate results are utilized by investors to assess a property’s operating efficiency and sales price by transparently comparing a certain result with national standards and those outcomes achieved at similar properties in the market trade area. So the laws have brought some amount of transparency to these aspects of the investment property market.

And what about the USA?

It is a good time for us to begin an industry level conversation about objective standards of measurement and disclosure as the basis of investor perceptions and action on energy preformance and environmental impact – in order to better promote green building, protect its integrity and allow the real stewards of best practice to be properly rewarded for their efforts.

At the present time, many of our cities and states have begun to enact laws and regulations, which implement green building and LEED ratings criteria into code. This is great for new construction, however it still does not address the greening of existing buildings nor do investors have a relevant, comparative benchmark for environmental performance when they are evaluating a potential acquisition. Also bear in mind that, while LEED-certified buildings generally have a lower energy usage and environmental impact, no particular LEED rating assures that a property has actually achieved a certain level of energy performance or environmental impact.

Here in the US, we are keen fans of transparency. This time, American green real estate can benefit from learning how our colleagues across the Atlantic have been approaching the same issues.

Green Journey Reading Recommendation: Check out Germany’s GreenBuilding program. This is not a green building program like the USGBC LEED rating system, rather a special program , administered by the German Energy Agency (’dena’), designed to inform and help German property owners to green their buildings. The program’s overall setup, content and implementation is ‘high protein’ information for industry professionals who are participating in similar programs here in the US. Both sites contain English translations of all information.

GE Real Estate Announces Green Initiative

Go big or go home!

That has got to be GE Real Estate’s motto concerning their green real estate initiative, announced at Greenbuild 2007 in Chicago earlier this week and covered in this week’s CoStar Green Report.

Under the new program, GE intends to imbed sustainability into its entire investment and asset management process. They are doing this through a partnership with the Clinton Climate Initiative. That alliance allows GE to “tap into CCI’s resources to improve the environmental performance of properties”.

Initiative Highlights

• Energy audits and retrofits of properties “where profitable”.
• Tracking of environmental and energy metrics alongside financial performance.
• Incorporation of LEED rating system and international equivalents into their ongoing property assessments.
• Sharing best practices with customers.

GE’s $30 billion a year operation is large enough to influence the actions of of their owners and partners throughout the property financial system.

Pay attention to the fact that they limit their commitment to retrofit to situations where it would be profitable. That is one of the biggest questions investors wrestle with these days. As I’ve written before, greening existing investment properties seems to be harder for investors to achieve than building brand new green buildings. It also raises questions about how they will judge the post-retrofit profitability of the property and what environmentally beneficial retrofit work might be avoided on a property because the benefits are not profitable enough in their view.

GE’s integrating energy and environmental metrics alongside financial indicators is a needed best practice. They have the financial strength and platform to cause these types of metrics to proliferate throughout the real estate industry. Of course, we will have to see what exactly those metrics are and hope that they result in transparent, verifiable reductions in their portfolio’s carbon footprint.

The Green Journey Synopsis: The content of GE’s key real estate initiatives is excellent intel on where investors should focus their efforts as they build environmentally responsible investment platforms.

We will not know any of these answers until we see GE’s performance over the coming years, but one thing’s for sure — they have got everyone’s attention.

Industry Pacesetter: Digital Realty’s LEED-Gold Datacenter

Hurray! Digital Realty Trust (NYSE: DLR) recently announced that its datacenter at 350 East Cermak Road in Chicago has earned the first LEED-Gold certification in the US for a datacenter from the USGBC.

Click here to see more details on the property.

Note that none of the information available reports on the targeted performance improvements that are expected because the building has undergone a green renovation.

Digital Realty also reports that they are currently greening several other buildings in Chicago, Northern Virginia and Santa Clara with the goal of either LEED Silver or Gold for all of them.

Green Datacenters are a Great Leap Forward for Green Building

While all green real estate is good, a green datacenter gets special attention due to its deep impact on energy savings over conventional buildings and the great expansion of green building best practices for existing buildings.

Dave Ohara, who writes for Microsoft’s TechNet magazine, reported that “datacenters consume nearly forty times more energy than conventional office buildings”. He went on to say:

A typical US datacenter can account for up to 15%-20% of that company’s operating costs. Several studies report that datacenters in the US are responsible for between 1.2%-2.0% of the nation’s entire energy consumption. That means, if you analyze datacenters together as a single industry, their aggregate level of energy consumption would put them in the top five US industries with the greatest energy consumption.

350 East Cermak’s LEED-Gold certification was earned for greening an existing property – currently a tougher challenge in the industry. I know several investors who have become adept at developing green buildings from scratch, but still struggle with retraining their organizations, collaborating with tenants and raising the capital to green their existing portfolios in a way that generates decent returns. Digital Realty’s announcement of getting this done can provide a positive example of how market driven investors are using the green challenge to their, their shareholders and the planet’s advantage.

Get the Green Datacenter Video

Interested in best practices for greening a datacenter? Digital Realty’s Vice President of Engineering talked with InfoWorld about his company’s initiatives in greening datacenters a few months back and provided lots of specifics that help to better understand the decision process involved with greening this asset type. For practitioners serious about greening their assets, this video is definitely worth the time spent.

Now I can’t help but look ahead to the next question:

How will greening an existing investment portfolio affect a publicly-traded REIT’s stock price?

It will be interesting to see how that develops.

Photo credit: 350 Cermak - Digital Realty Trust

Extinct Debt Terms & Agency Muscle in Multifamily

Here’s a quick update on the pulse of the debt market:

Earlier this week, I had the great pleasure of spending time with colleagues at the Counselors of Real Estate at their annual convention here in San Francisco. During a Capital Markets forum, the panel was asked their views about the types of deals lenders are willing to do these days, in light of the currently constrained credit markets. That discussion humorously morphed into “what kinds of debt terms are extinct these days”.

So here are a couple of the debt market’s newest extinct species:

• Full Term I/O: Lots of nods on this one — wide agreement that lenders are back to old school underwriting, requiring at least 25 to 30 year amortization for most loan terms over three years. On a 5+ year loan, the borrower may be able to get up to two years I/O.
• Cashout Refi: In light of rates, spreads and cap rates having moved up, creating the risk of lowered valuations, lenders are particularly hard-pressed to finance profit-taking anymore.

Plus a Snippet on Apartment Financing

There was a strong consensus that the agencies (Fannie Mae, Freddie Mac) are emerging as true winners in financing apartments during the debt market’s latest gyrations. They are putting out large levels of debt for apartments, using their own underwriting criteria and benefitting from less competition. The audience felt that the strong presence of the agencies makes the multifamily market the strongest asset class out there for now.

While this blog is heavily focused on green real estate, I like to bring in capital markets commentary since green real estate, after all, is still real estate.