Pension Funds Green Agendas Continue — You Prepared?
Are you on top of your institutional investors’ green agenda?
Today’s post focuses on a “state of SRI” article sent over by Green Journey reader and blogger, Ari Frankel.
It hints rather loudly to American real estate investors and developers that they need to step up their green investment and development programs — or else find themselves less competitive with funding from the ‘Big Money’ institutional investors.
Seems that an increasing number of pension funds worldwide are pushing for a more explicit environmental agenda within their investment holdings, according to the New York Times earlier this week. Nothing new there, for the deep green crowd, but great to know, in any event. And the Times gets kudos for being GPC — geopolitically correct — by citing the leadership of several European and one American pension fund in green investing (such factoids hammer at the “reinvent the green wheel” bias we have here in the US). It points to the United Nation’s Principle’s of Responsible Investment (to which we are a happy signatory) as now representing 381 members and $14 trillion in assets.
The Times also asks the necessary question of whether Big Money is really creating positive environmental and social change. For example, they point out that no one really knows if the pension funds’ efforts are really creating the impact they profess to seek. Or if all of the funds with a green agenda as committed as they claim (gasp!) .
HOWEVER, it was pretty surprising that the usually sharp, pro-SRI NY Times failed to dedicate one pixel of ink to the corporate watchdogs like CERES or BSR — THE acknowledged leaders in pushing corporations and institutional investors to adopt ESG (environmental, social, governance) principles within their business and investing activities. CERES has an extensive list of tools and publications documenting their efforts to educate the investment community on the value a green agenda brings. And you can take a lookat our previous coverage of CERES’ video on their engagement work as well.
Nonetheless, good takeaways and a not-so-subtle warning are there between the lines for commercial real estate. The point? Simply, most of these Big Money investors have some amount of their funds allocated to real estate. If they haven’t tailored their real estate investment criteria towards green real estate, yet, then they are bound to do it soon.
Sooner or later, you are going to call on your pension fund investors for your normal performance meetings and, in addition to the regular good dialogue, you are going to be handed more requests – possibly in the form of more compliance reporting, audit checklists, risk assessments, engagement meetings, what have you.
Will you be ready?
What if Facebook Hired Green Finance Professionals?
When you are pondering your green investment strategy, is there a silent voice asking, “how am I going to get all of these employees to actually buy-in to this? How am I going to prevent failure of the plan?”
A human capital bugaboo is quietly freeloading on nearly every one of our engagements with investors. Some clients have already figured out that the organizational learning and people challenges attached to green real estate investing might be more daunting than the physical assets themselves.
Change is a distinct skill that many businesses focus intense energies on avoiding. So they aren’t any good at it. Just google “US auto industry”. Human capital problems are nothing new, but lately we’ve been asking ourselves,
“How has sustainability changed the job of real estate finance and investment professionals? Are investors thinking correctly about the required skill sets?”
The problem’s complexity is amplified by the dimensions of networks needed to be a successful green investor. If you are a fund with operating partners and developers in many different regions, your success rests upon their ability to adopt green building practices and align their colleagues around your business direction, too. Yes, their problems become your (additional) problems. We know some investors who complain about green “cost premiums” as a thin cover for murkier issues — large, amorphous “shadow human capital / supply chain” challenges.
But, subscribers know this blog’s favorite question: “What CAN you do” to address these problems?
Look at Facebook. The social networking universe completely reinvents itself nearly every six months. They have the fortunate challenge of massive growth complicated by turbulent organizational change – and they make it all up as they go along. The volatility of their business makes green real estate sound, well… tame. Like green real estate, there’s a big vision within social networking, but no one has all the answers. So how do they address and scale up their model around people?
We’re including some snippets from an interview with a Facebook hiring manager. His insights might apply to hiring/training green finance and investment professionals, too. You decide. To speed things up for those who need to go microwave a second helping or move on to another football game, we start with our takeaways first. [Note: the underlining is our own enthusiastic emphasis.]
The Green Journey Takeways
- Real estate investors might need to re-think their assumptions on the skill sets of successful sustainable real estate professionals within their organizations. Look at Facebook’s “atheletes-people” as an example.
- Do you need more ‘clever’ people on your green team or ’smart’ ones, per Facebook’s definition?
- Are you clear on what your firm is trying to accomplish with sustainability in order to get people who ‘fit’ the best in their roles? Facebook has set Apple as its customer service standard. Look at how they challenge interviewees with related questions that make them choke.
- Are you focused on organizational excellence in green finance and investing or just copying what you see some other firms doing at the moment?
The Snippets
“You are on a crash hiring spree. How do you avoid making mistakes when you have to move so quickly?
Everyone makes mistakes. No matter how hard you try, there will be some percentage of hiring mistakes you make. Where the management test hits metal is not just in hiring employees, but in retaining and motivating them, and in fostering some collaboration and innovation inside the company.
What qualities do you seek in candidates for those jobs?
We need to find people who can “turn the big ship on a dime.” The ship keeps getting bigger because there are more lines of code, more people using the product, more features in the product, etc.
When it comes to a type of person, I am a big believer in hiring team players, but really hiring athletes-people who can play multiple positions and who have varied skills. That means you end up hiring a mix of inexperienced but bright people. I look for people who are clever. There is an adage that says “a smart person solves the problem, but a clever person prevents it from being a problem in the first place.”
Are there certain candidates who just aren’t a good fit with Facebook?
The lowest “hit rate” through interviewing are people who come out of large IT organizations because their mindset tends to be very reactive and process driven rather than figuring how to deliver excellence.
For example, we are interviewing for a help desk manager-someone who is going to run our global help desk that services all of our employees. We have interviewed a number of people who have fantastic résumés and come out of extremely high-pedigree companies.
When they interview, they say the help desk can only be run so well, that it is impossible to run a help desk 24/7 at a low cost or that it is impossible to have users satisfied with the help desk and meet these other cost objectives or time objectives.
When you try to test their assumptions by asking them how they would scale a help desk to support 1,000 or 2,000 people while providing better service than the Apple Store that’s across the street from our office (which is our standard for excellent customer service), people choke on that question.
They cannot wrap their head around why you would want to do that or how to approach solving that problem. The people we hire have to be reasonably comfortable with the unknown and be willing to put some amount of structure around it.
Happy Thanksgiving from Our Green Journey!
The Negawatt: Simple Concept, Major Implications
Nope, that’s not a typo in the title. Negawatt is a term you should get to know. You’ll probably hear it, and maybe even use it yourself, in the near future.
So, what is a negawatt?
\né-gə-wät\ n: A measure of the avoided use or the conservation of a unit of energy.
Coined by author and scientist Amory Lovins, the term has been around for quite a long time. When energy efficiency measures are implemented in existing structures, energy consumption is reduced. This reduction can be measured in negawatts. Get it? negative watts.
So why is it important, you ask?
1) Negawatts = cost savings. When your assets consume less energy, you pay for less energy. Depending on how your leases are structured, energy-use reductions can greatly improve your property’s net operating income and building value. Moreover, in any existing asset, there are always energy efficiency measures that can be implemented at near zero cost. The savings in energy costs represents cash flow to your bottom line.
2) Negawatts hedge energy price and investment risks. Energy prices can be volatile. When your assets require fewer units of energy to operate, you reduce your exposure to energy price risk. If prices increase substantially, you have a competitive advantage in the marketplace, which should help minimize the negative impact on your NOI.
3) Negawatts can limit your climate legislation liability. From our perspective, a national carbon policy or cap and trade mechanism is now just a question of time. Several green finance and investment experts expect a national carbon policy by 2012.
While we can only speculate about the details of climate change legislation and how it will impact commercial real estate, we expect to see resource efficiency rewarded, and resource waste penalized. Energy efficiency measures that produce negawatts should limit existing asset liability under climate change legislation.
The negawatt is a great tool to use when promoting and discussing the importance of energy efficiency. It’s a tangible concept that will resonate with your audience, whether it be your employees, tenants or other financial stakeholders.
Part 3: JP Morgan Chase Talks Green Real Estate Investing
When JP Morgan Chase says that sustainability is creating fundamental changes to how they invest in real estate, you pay attention. Part 3 of our special series on the Green Building Finance and Investment Forum - New York, co-sponsored by Galley Eco Capital, continues with the perspectives of keynote speaker, Doug Lawrence, Managing Director at JP Morgan Chase Asset Management.
“Achieving sustainability can be an uphill battle-but it’s crucial that you get there. Your future customers will demand it, and your ROI will depend on it.” - Doug Lawrence, JP Morgan Chase
Doug set the stage by reminding everyone about the basic objectives of investment banking: 1) preserve and grow clients’ capital and 2) make money for themselves in the process. In JP Morgan Chase’s case, sustainability has become a profitable strategy for them that also preserves and grows client capital, which in turn ensures their competitiveness in the ever-changing financial marketplace.
Case in point: Doug manages the Urban Renaissance Fund, JP Morgan Chase’s newest vehicle, which focuses on cities and their first suburbs — where population density is high and the payback on energy efficiency is substantial. The Fund sees investing in sustainable real estate as a way to improve returns and reduce investment risk. However, “getting there” with green real estate is not without it’s challenges.
Green real estate is a different animal than conventional real estate. Successfully investing green means re-calibrating underwriting metrics and changing many of the fund’s business procedures. It costs money to do this and it can take quite a bit of time to change hearts and minds about what constitutes a great sustainable real estate investment. On top of that, you have to manage organizational inertia, which can often be the worst enemy of change.
“Green means changing our procedures, our underwriting, our vendors, the way we put our products together.” -Douglas Lawrence, JP Morgan Chase
So how did Doug and his team help the powers that be at JP Morgan Chase embrace green real estate? Well, first of all - it took them two years, plus some organizational change, but the repeated message to leadership was clear: if we don’t do this, we will lose our edge, and our financial products for real estate will be obsolete.
Doug drove home his point about obsolescence in real estate with the example of the emergence of building air conditioning back in 1950/1960s. The technology was rapidly implemented, and buildings that did not incorporate air conditioning became obsolete. They faced appraisal risk, and their valuations decreased quickly. For owners, their failure to upgrade their properties increased their investment risk and devalued their real estate holdings.
Wanted: Experienced and Knowledgeable Green Developers and Investors
So now that your fund is focused on sustainable real estate, what’s next? Well, your next challenge is identifying experienced and qualified developers/operators who can reliably build your project in a way that gets you the great green benefits you (and your investors) seek.
In today’s market, a successful track record is key to investor confidence; and Doug made it clear that, while they are supporters of green real estate, they are not interested in any developer learning about it on their dime. However, since green real estate is still in its infancy, they realize that they have to be flexible in how they evaluate their partners, otherwise they will have a difficult time generating a sufficient level of investments.
“If you have a great idea, tell us how you are going to mitigate risk.”
So what do you do if you’ve got a great development track record, but are new to sustainability and want to attract green equity capital? From Doug’s perspective, if you want their money, you need to reduce the execution risk within the investment. And creating strategic alliances between the experienced developer and firms with proven sustainability expertise is a smart way to mitigate those types of concerns.
And with that great team in place, what aspects about green real estate are driving JP Morgan Chase’s involvement in the sector?
- Green retrofits to existing buildings can be done profitably: JP Morgan Chase estimates that existing buildings which have been retrofitted green enjoy a 3% higher occupancy, a 7.5% higher valuation and use 25%-30% less energy than their non-retrofitted counterparts.
- There is no cost question about building green real estate: Despite the fact that many in the industry still talk (incorrectly) about hefty cost premiums to build green, JP Morgan Chase sees that an experienced developer of green property can deliver LEED-certified and LEED-Silver product to market at absolutely no cost premium whatsoever.
- Integrated design is the key: Engineer value at the beginning instead of value engineering at the end of a project. Also, integrated design optimizes both first and life-cycle costs.
Selling Your Deal: Know The 7 Fears of Real Estate Equity Funds
Doug finished the presentation by educating the audience on how to best position themselves and their transactions for investment by other funds like his. He presented seven key issues (or fears) that many funds have when it comes to sustainable real estate. By understanding and addressing these concerns, investors and developers can remove many of the roadblocks to getting funding for their projects. The seven fears are:
1. Fear of being too early. Equity funds fear the failure of your concept, because there is no protection for their capital. You need to have a lot of data to support what you are doing, and develop an executable business plan that can be understood by potential investors.
2. The fear of learning new stuff. As previously mentioned, bankers are conservative. They know certain things, and they know them well. They have their favorite product types, their favorite developers, and they have their risk management down to a science. Your project may represent a major departure from their investment machine, and they might resist. It is up to you to educate them, and to be persistent.
3. Loss of power. This fear is a derivative of fear #2. Changing the game forces individuals at the top of the corporate structure to either adapt, or risk becoming obsolete. When it comes to understanding sustainability, it’s your responsibility to educate your potential partners in a way that maintains their leadership as the smartest people in the room.
4. Maintaining deal flow. Equity funds don’t want to upset their developer partners; as that might put their investment pipeline at risk. Therefore, they will tread lightly when it comes to convincing their existing partners to become more sustainable. The antidote: re-read all of the above.
5. Fear of losing return. As a green developer/investor, you can use your potential equity investor’s fear of losing returns to your advantage; help them understand how their returns will be diminished if they don’t invest in green.
6. Fear of execution. Unfortunately, there is a flip-side to fear #5. If equity investors think that your sustainable real estate investments raise the execution risk for their capital, they will be less inclined to invest. Structure your deal and your strategic partnerships to mitigate as much risk as you can. (Our note: You should be doing this for every deal anyway)
7. Fear of being too late. Whether by law or by simple economics, green real estate will become the norm. When that occurs, the incentives for green building and the learning opportunities will be gone. If equity funds don’t understand how to evaluate and fund green investment before the market transformation, they will lose their competitiveness. Make sure that you emphasize this to your potential equity partners.
Doug’s perspective was well received by the audience at the conference, and we think that green developers and investors would be wise to heed his recommendations.
* * *
If you liked this post and would like to receive more, please subscribe. Don’t forget to read the other installments of our Special Series on the Green Building Finance and Investment Forum - New York. As always, we welcome your comments.
Property Tax Appeals: Old School Finance Tactics for Existing Green Buildings
Even in the green economy, you can still go retro to maximize your project’s performance during an economic downturn.
When we deliver integrated financial services to sustainable real estate engagements, we don’t overlook the everyday financial strategies like property tax appeals because they can potentially deliver lots of value.
This type of assessment can be particularly valuable if the property has experienced increased vacancy and the owner is considering implementing a green retrofit program during the time when there are fewer tenants in the building — and is worried about whether the retrofit program will really pencil out. The reduction in property tax expense from a successful tax appeal is an additional boost to NOI over the other savings in operating expenses from going green, once the retro-commissioned building leases back up!
Here are links to two recent articles reminding landlords about the value of property tax reassessments during an economic downturn:
Item 1: Multifamily Guide has written their recommendation for landlords to obtain a property tax reassessment more regularly during an economic downturn.
Item 2: A recent Globe Street article advising landlords about obtaining a reduction in property taxes by claiming economic obsolescence.
* * *
And here’s a related issue for another day… Of course, filing a property tax appeal due to economic obsolescence is one thing these days. It doesn’t happen to that many buildings as a percentage of the total building stock in any given market. But how will the property tax appeal business look in a few years when the number of green buildings in a given market increases substantially? Could a certain increase in the volume of economic obsolescence driven property tax appeals signal a tipping point towards a more defined “green premium” (or brown penalty) that everyone’s predicting?
Here’s a parting quote for your Friday:
“You don’t pay taxes — they take taxes.”
-Comedian Chris Rock
