Bankers Call for More Green Banks

Even with all the excitement about the greening of commercial real estate, investors often ask

“why aren’t the big banks offering financial products tailored to the specific needs of sustainable investment property?”

In our workshops, we put it this way: there are effectively “two kinds of green debt” — banks that offer green loans and others that offer loans on green property. Most banks fit the latter description.

I have also met with bankers to understand how their firms’ well-publicized commitments to sustainability excludes products for greening commercial real estate. Usually, they explain that they cannot allow discounted loan pricing on green buildings, because  they don’t have sufficient data available to quantify the risk differential. Although that point makes sense to me, it’s an incomplete answer.

They never talk about how their institution is addressing energy price and operating risk within its existing collateral portfolio of conventional property. Or how they’re dealing with the market risk from their collateral properties falling out of favor with tenants.  Finally, bankers could pay closer attention to the Appraisal Institute’s new education classes for appraisers on valuing green features on real estate. Think about it: wouldn’t they benefit from funding the greening of existing buildings, if only to mitigate energy price and appraisal risk within their conventionally built collateral?

Is the conventional mortgage lending model really the best way to finance green buildings?

Others within the financial community are speaking out on the same question.  Joel Freehling, of industry pacesetter ShoreBank, back from an international confab on green finance, wrote a post calling for commercial lending pure play — new banks, which would be dedicated to green financing. Think lots more, larger New Resource Banks. He points to ShoreBank’s pioneering lending within low income communities as proof that similar forces could organize and grow the green real estate finance space.

I know that among the Green Journey subscribers, there are a couple of groups working on such projects. But today’s capital markets make it tough to establish any kind of bank, pure green or otherwise:

• Banking is contracting, with an estimated 70,000 jobs lost on Wall Street alone .  There are fewer institutions alive with money to lend.  When you shake your head about less capital, don’t overlook the loss of bright minds within these institutions who could have catalyzed capital markets innovations we need to create intentional, large scale capital flows to green real estate.
• Most major commercial real estate banks and insurance companies have already announced that they expect to originate significantly less new business in 2009 than 2008. This is mainly because of continued weakness in many real estate markets and sponsors.
• Valuation upside comes from strong real estate markets, which depend on healthy employment trends. Unemployment is helping to soften market fundamentals, which is bad for any kind of real estate, green or not.
• In the workout of prior real estate downturns, banks were subjected to more regulation. I expect to see our real estate capital markets undergo heavier regulation this time around, too. Regulation, even when it is desperately justified, is generally not the friend of innovation.

Hang on, it’s not all bad. My other, related perspective is that the above circumstances actually create one of the best opportunities for private market platforms, which could be better positioned to finance sustainable real estate, in the right way and at the right price:

• There is no shortage of capital in the market. It’s just sitting on the sidelines, waiting for the markets to calm down. We’re tracking several new debt funds that are currently raising equity to address the current bridge loan and gap funding needs of investors, taking advantage of the pullback in other sources of capital.
• Real estate assets are being repriced downward, so time to think like Warren Buffet — its a buying/funding opportunity for those who know how to underwrite. Any platform getting into the market now could be acquiring and greening assets at the bottom of the market. And green real estate is expected to outperform conventional real estate as the market rises again.  So I see great upside for those debt players who are smart enough to figure out how to incorporate underwriting green within the overall platform.
• There are also expectations of significant federal financial stimulus, which would promote energy efficiency of existing buildings.  Capital markets investors (both debt and equity)  who have done their homework on green buildings practices, are best positioned to create an advantage for themselves by incorporating those funds within an overall investment strategy.

Equistone’s Simple Green Investment Tool

Our work has shown us that any firm’s success with green investing is based  (in part) on how effectively  it communicates with its stakeholders — employees, building staff and tenants — over time, as opposed to at any given moment.

Unfortunately, we regularly run into landlords who treat communication as a one-sided imperative.  Their tenants receive bland emails written by the Borg about a green initiative only when there’s a specific request, without any thinking about how that message fits into the overall relationship that’s been built up over time.

But we found an example of a landlord who is taking a more positive approach, and getting their stakeholders to rally around their sustainability efforts. The lesson here: a green investment strategy often includes simple, thoughtful moves focused on long term relationship building.

Case in point –> Benjamin Osgood, a partner at Equistone Partners, sends out Five Simple Things, a newsletter about sustainability to all of Equistone’s tenants, vendors and associates. Five Simple Things features concise how-to lessons about resource efficiency. The newsletter is a hit with their tenants, because the simple hints help make sustainability achievable at any level.

Particularly clever is that the newsletter combines hints for going green at the home and office. That way, tenants and vendors can identify personally with going green, a key to getting their buy-in on more formal project related initiatives.

Benjamin says that they’ve been happily surprised at how the the subscriber list has grown far beyond their existing tenants. Take a look for yourself — subscribe to Five Simple Things here.

We want to hear from you:

How are you engaging stakeholders on your green initiatives?

Write us and tell us your best stories. We’d love to share your story with the Green Journey crowd.

Part 5: Green Building Drives Triple Bottom Line Advantages

How do you achieve environmental and social progress within your real estate investment platform while delivering market rates of returns?

In Part 5 of our Special Series on the Green Building Finance & Investment Forum – New York, co-sponsored by Galley Eco Capital, triple bottom line investors discuss how and why their environmental and socially-driven investment vehicles meet and sometimes exceed market rates of return, and their investor’s expectations.

The panel consisted of Lisa Lafave of HOOPP (Hospitals of Ontario Pension Plan), Brandon Mitchell of Full Spectrum NY, Nicholas Stolatis of TIAA-CREF Global Real Estate, and Stephanie Wiggins of the AFL-CIO Housing Investment Trust. The panel was moderated by Lisa Hagerman, Ph.D., of the Institute for Responsible Investment at the Boston College Center for Corporate Citizenship.

Green building is a key ingredient within triple bottom line investing

Pension funds invest according to input from a broad universe of stakeholders. Everyone from their pensioners, to employees and major investors has a particular reason to request that the fund focus on all three bottom lines simultaneously. And absolutely no one gives an inch on returns. At the conference, these investors reported that there is a lot a variation in how triple bottom line investing can look in different companies and different regions. However, green building was a key ingredient within nearly every type of triple bottom line initiative that they reported.

At the AFL-CIO Housing Investment Trust, which has financed more than 80,000 affordable and moderately priced housing units, major investors require the trust to meet CSR criteria, ensuring that investments are handled in a socially optimal manner.

For TIAA-CREF, which has a direct real estate portfolio of over $30 billion, the focus is on connecting environmental responsibility with asset competitiveness. Major tenants want LEED certified space, and they are not willing to pay a premium for it. Failing to address these tenant requirements will decrease TIAA-CREF’s asset competitiveness and decrease portfolio performance.

“Those that don’t operate green will be obvious, and they will go the way of the dodo bird” - Nicholas Stolatis, TIAA-CREF Global Real Estate

In order to limit future downward exposure and protect portfolio value, HOOPP portfolio manager Lisa Lafave calculates risk-adjusted returns, accounting for social and environmental risk. For HOOPP, environmental risk equals the risk of not being green, and losing asset competitiveness. By accounting for this risk and greening their portfolio, HOOPP expects to see higher occupancy, better tenant retention, shorter lease-up periods, and in certain markets, higher rents.

Experienced developers deliver great results with triple bottom line investing

Many investors and lenders have preconceived notions that socially-responsible investment initiatives automatically deliver below market returns. However, there are a number of firms that are redefining socially-responsible investment vehicles, while at the same time exceeding investor expectations.

Brandon Mitchell, Director of Development at Full Spectrum of NY, explains how his firm is doing well by doing good. Full Spectrum is a mission-driven organization, that seeks to reduce the housing burden in low-income communities, while also creating opportunities for local businesses to create jobs and wealth. They work with institutional-grade debt and equity investors, and focus on sustainable development because its good for the environment, the community, and their pocket book.

Full Spectrum of NY creates a product that few other development firms consider- they create environmentally and socially sustainable mixed-use, mixed-income developments in low-income and emerging communities. They have developed several successful projects in Harlem, including the Kalihari, a 249-unit condominium building with 50% affordable and 50% market rate units, designed to use 50% less energy than a conventionally-built structure.

Key features of the Kalahari include:

• A panelized wall system to reduce construction costs and shorten the development timeline
• A tight building envelope and energy star appliances for high energy efficiency, and renewable energy from building-integrated solar panels
• A green roof for storm water retention, tenant green space, and urban heat island mitigation
• Submicron air filters to improve indoor air quality
• After school programming for children, supporting working parents
• A creative art center, with a focus on African and Latino art

By creating mixed-income housing, Full Spectrum of NY can access incentives and grants accounting for more than 25% of their project capital needs. In addition, the firm is able to secure a low cost of capital for the remaining capital requirements. By utilizing sustainable building strategies, they lower operating costs and hedge against future energy and water price risk, a great selling point for residential buyers and commercial tenants.

This development strategy has worked well- on a recently completed development, Full Spectrum achieved a per square foot selling price for the market-rate residential units that was $125 to $350 higher than anticipated. This significantly exceeded the expectations of project investors, supporting Full Spectrum’s investment thesis:

“Integrating social and environmental factors into our projects has not only meant that the communities we build in benefit, but our investors benefit, and the homeowners benefit- we are creating a platform that allows us to redefine how we think about real estate and sustainability” - Brandon Mitchell, Full Spectrum NY

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Will the Economic Slowdown Grow or Slow Green Real Estate?

No doubt these are challenging times for the US commercial real estate market. It’s been a tough go since the start of the real estate credit crunch during the summer of 2007, and it’s not likely to improve in 2009.

But what does this slow down mean for sustainable real estate?  Will conventional and green commercial real estate come under the same pressures? Will the growth of green be derailed as investors, developers, and even tenants, quickly transition into survival mode?

Recently, several industry practitioners have prognosticated on how green will weather the storm. The verdict? It’s mixed.

In an article from Costar, titled “Amidst Deepening Recession, Green Fights Back“, industry experts argue that the tremendous growth in buildings registered with green building rating systems in 2008 are a testament to the continued growth of green during the slowdown (GEC note: The 2009 numbers will be more relevant). But an across the board decrease in construction starts will slow down green new construction, shifting the focus to existing assets.

In a tenant’s market with rising vacancy rates, portfolio managers would be smart to green their existing assets in order to keep tenants from leaving for greener pastures. According to David Pogue, sustainability director at  industry pacesetter CB Richard Ellis:

“If you’re going to compete today at the upper end in most of these markets against new product, that requires existing buildings to also be more sustainable.”

The National Real Estate Investor sees both challenges and opportunities for green in 2009. In the article “Green Building Industry Wrestles with Recession”, industry sources see lenders coming back online and considering deals again in 2009.

Unfortunately, while lenders may loosen up their purse strings, deflating energy prices may prolong expected payback periods for renewable energy systems and for green capital improvements in existing assets, lowering the returns from such investments.

The GEC Take

We don’t have a crystal ball, but we do see several things for green real estate during the downturn:

• Green will gain ground versus conventional real estate: We can only guess as to how long the deterioration in the commercial real estate markets will last, but we are confident that sustainable real estate will continue to gain market share. Any equity capital available for new construction is pretty much earmarked for green buildings.

• (Green) Cash is King: We see lots of players working very hard on a compelling LEED-EBOM investment strategy  for their portfolios.  Face it, most of the money that is active these days is chasing cash flow as opposed to taking the risk of a long development cycle. As one fund investor told us, “we need to see a real meatball (his private slang for real cash returns) on any deal we’re lookin’ at”. So creating additional cash flow through greening existing buildings satisfies the fundamental needs of investors active in today’s real estate markets. Meaning: there’s a tangible reward for becoming good at existing building retrofits and certification.

• Green incentives will grow: These programs will expand and bring more capital to the sector. At the federal level, the Obama administration has recently indicated that energy efficiency will be a big part of a stimulus package in early 2009. The October renewal of federal tax credits from the Energy Policy Act of 2005, set to expire at the end of the year, was a good first step.

• Green regulatory risk will grow: At the state and local level, sustainable building and higher energy efficiency are becoming mandates. While the real estate downturn means that reluctant developers and investors will have a stronger case to argue against new green building regulations, they will ultimately not prevail.  The governments that we’ve worked with have aggressive timelines for green regulation, and intend to move forward quickly.

• Green will rebound faster from the downturn: There is an established preference within the marketplace for green space. When demand increases, green space will go first. This is an advantage to the first-movers who can build green with minimal to no cost premium.

For more insight on future trends in sustainable real estate, be sure to look out for our 2009 prediction post at the end of this month.

Part 4: Portfolio Owners’ Top Advice on Greening Existing Buildings

How do you get at the benefits of portfolio-wide energy efficiency within a large real estate organization, with multiple management layers and a number of subsidiaries?

In an existing portfolio, how do you prioritize properties for green retrofit? Most importantly, how do you minimize execution risk, and ensure that this transition is profitable?

In Part 4 of our Special Series on the Green Building Finance & Investment Forum – New York, co-sponsored by Galley Eco Capital, portfolio owners discuss the challenges and opportunities of greening their portfolios.

The panel featured Tatiana Eck of AIG Investments, Edward Glickman, of Pennsylviania Real Estate Investment Trust (PREIT), Kevin Kampschroer of the US General Service Administration (GSA), Paul Morris of Cherokee and Stanley Roualdes of Shorenstein Realty Services. The panel was moderated by Paul D’Arelli of Greenberg Traurig LLP.

You need green champions at multiple levels of your organization

Getting to green means structural changes to many aspects of the investment platform, something we’ve discussed before. During this transition, you need strong, committed leadership. If your c-suite isn’t sending out the message that a shift to green is vital to the firm’s success, the effort may not be successful.

A strong sustainability message from leadership helps motivate business partners to follow suit. Shifting your business strategy towards sustainability affects your partners and vendors. According to Tatiana Eck of AIG Investments, if your partners know these changes are coming from the top, they are more likely to cooperate.

Buy-in from other parts of your organization is also crucial. While its necessary for commitment to come from the top, ownership in the green transition moves from the bottom up. For Paul Morris, that means a buy-in to the green strategy by Cherokee’s underwriters and asset managers- the individuals who are responsible for leveraging value and managing risk for the portfolio.

To execute a successful green portfolio strategy, this group must believe that sustainability will improve their development and investment pro-formas, including lowering vacancy rates, operating costs, and lease-up times. These are the folks who have to get the actual results. This means you have to spend the time to educate them about the financial implications of a green investment strategy.

“If underwriters don’t see sustainability as more than just a value-add attribute, if they don’t see it as essential to how they’re doing their own business, than a lot of what we are talking about today will continue to operate up in the ether” - Paul Morris, Cherokee Funds.

Use sustainability strategies to hedge risks to portfolio cash flows

Going green requires a heavy focus on risk reduction. The panel highlighted a variety of risks that their portfolios and organizations face, and how sustainability provides a hedge against them. Risks that can be mitigated by green include:

Market risk: If your tenants decide to go green, and you can’t provide them with the green space they require, they will go to other properties. Your properties will be deemed obsolete.

This is an important concern for Ed Glickman of PREIT, a retail REIT that operates 35 million square feet of retail space in 58 developments. Offering green space to the market means a reduction in tenant turnover and lease-up time, which helps PREIT preserve the net operating income of their properties and their asset values.

Energy price risk: Simply put, the higher your energy efficiency, the lower your portfolio’s exposure to energy price uncertainty.

Even if your portfolio predominantly features net leases, energy efficiency means lower operating costs and common area maintenance charges to your tenants, lowering their total cost of occupancy for your space. In a tough leasing market, this means a leg-up against competitive properties.

Environmental regulation risk: This is a big concern for portfolio owners, who have millions of SF of real estate that might be subject to environmental criteria in the near future. To ensure the future value of their portfolio, they need to get a jump on compliance now, while costs are relatively low and time is on their side. The concern of future regulation is succinctly expressed by Glickman:

“At some point you will need to be certified, you will need to meet some criteria. At that point the whole industry rushes out and wants to comply-and it becomes much more expensive.” Ed Glickman, PREIT.

Reputation risk: If your organization touts itself as a sustainable leader, but doesn’t walk the talk in all your business lines, this could significantly hurt your corporate reputation and your customer goodwill. This is an incredibly important concern for Eck and AIG, which in addition to its real estate activities, provides environmental insurance, and was a member of the Dow Jones Sustainability Index.

Talent risk: Employees want their potential employers to have an environmental agenda, and they see this agenda as part of their personal commitment to sustainability. For Kevin Kampschroer and the GSA, which has 12,000 employees, this is an incredibly important concern, and one that has grown with importance every year since the late 1990s. The GSA’s commitment to green is a great marketing tool for recruiting talent.

Put these successful strategies to work for your portfolio

Throughout the conversation, the panelists provided valuable lessons from their experience with green transitions within their own portfolios. The key take-aways:

Integrated design reduces costs and increases overall asset value: The integrated design process drives down green construction costs and maximizes reductions in energy usage for both new construction and green retrofit. If you don’t utilize it, you are leaving value on the table.

For green retrofits, target the low-hanging fruit first
In a capital-constrained environment, focus on no-cost building performance improvements first. There are a number of ways to increase building operating efficiencies without deploying capital. Educating building staff and tenants on the proper operation of building systems can improve efficiencies with virtually no payback period.

Select qualified partners: There is a perception that green construction and retrofit costs more. In reality, it’s the poor execution of green that costs more.

Make sure that your partners and vendors are educated about green construction and operating strategies. If they don’t have adequate knowledge, you need to replace them. Stanley Roualdes of Shorenstein Realty Services provides a simple method for vetting potential architects and contractors: If they tell you that green will cost more, you are talking to the wrong people. Move on.

You need third party certification AND third party performance evaluations for your assets: Certification of your properties is important- it enhances their value. But if you want to maximize the efficiency of the buildings in your portfolio, you need to conduct regular performance valuations of each building. It’s the only way to ensure that your building systems continue to operate effectively, ensuring that your operating costs are as low possible, and enhancing net operating income. In the long run, performance evaluation should also lower your capital improvement costs.

Take advantage of incentive programs: Incentive dollars are a key source of financing for both your new construction and green retrofit projects; (and an essential part of an integrated finance strategy). Make sure you use them to your advantage. Additionally, don’t take incentive programs for granted, as incentive dollars are sometimes limited and subject to change at any time.

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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.

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