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.

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