Leslie Christian’s Sharp Focus on Risk and Flawed Asset Allocation

Leslie Christian’s Essay Series:

Originally published in Reimagine Money -

» Social Finance from an Investor’s Perspective

» Getting Serious about Long Term Investing

» Allocate your Risk Response

So many of us in sustainable finance talk about the need to “finance differently”. However, not many are underwriting or, more importantly here, understanding the green finance problem any differently than before.

As Scott Muldavin points out in his recent work, your intended decision drives the content of and the manner in which you underwrite green real estate investments.  Underwriting green does not have to be done in any “special” way. Your common, hardworking DCF analysis will do the job just fine.

Many governments and NGO’s understand the green finance “problem” as one of raising awareness and delivery logistics. Make consumers aware that a new behavior (like turning off the lights) will save them money and then pay them a few bucks (as an incentive or rebate) to adopt the desired behavior.

For investors perceive the “problem” as one of risk versus reward. They want to earn an appropriate risk-adjusted return for the sustainable property they are purchasing (or lending on). You get the picture.

We’re all in favor of green real estate, just as long as we don’t have to do (too much of) anything differently.

But does any of this address the real problem, or is it all just surface noise?

“It’s the global economy, stupid…”

I imagine that’s what James Carville might say if he read Leslie Christian’s recent essay series that been published in the Reimagining Money blog, over the past few months.

Instead of providing her take on the next couple of short term moves, Christian introduces the idea that we’re all playing the wrong game entirely.

She asks us to consider whether current day approaches are driven by basically faulty assumptions. Her point: limits on ecological resources mean that there are limits to economic growth. Ignoring the role that ecological limits play within our global economy opens us up to other risks (negative and positive) the financial community has never thought about. Risks that are already playing out every day throughout our markets and the world.

Rather than trying to measure the riskiness of a particular asset within the framework of a growth economy that looks a lot like the past century but with more players, perhaps we need to consider the riskiness of the global growth economy itself.

In her first essay, she lays out why “global growth thinking,” as reflected by Modern Portfolio Theory (MPT) and pretty much all of modern finance, is no longer a workable framework (if it ever was). The unquestioned expectation of perpetual growth leads many to analyze a particular asset or risk within a perpetually growing global economy. But they never question if the global growth economy itself is a problem.

Christian does — challenging MPT, then proposing a new risk framework for the 21st century, which positions social investing as a risk mitigant. And all that happens in just the first act.

In the two subsequent essays, she takes it to the next level. By the third essay, she calls you out, naming ostriches and other non-responsive market participants in denial.

The issues she raises are getting attention in financial circles. Pacesetter Vince Siciliano, CEO of New Resource Bank, commented on the second essay:

I welcome the discussion on limits to growth and the very real impact it should have on our lifestyle and investing decisions today. When we define the word “sustainability” we express a concern about future generations without acknowledging the inherent paradox of everyone around the world trying to live an lifestyle. The blunt question is whether we are willing to freeze (or shrink) our current standard of living to make room for others both now and in the future.

On the other hand, Leslie states that we crossed the tipping point on global resource use in the mid-1960s; I wonder how we prove that fact? The use of cradle to cradle thinking and sustainable technologies will enable us collectively to live much better on a global basis and that needs to be figured into the overall calculus.

Are we protecting ourselves with an umbrella in a hurricane?

Vince points out the need for more proof on the connection between ecological and economic limits. Actually, while I think the need for proof is prudent, it is quite plausible that Christian is at least half right. And that spells big trouble because modern finance can’t even address a part of the risks that she point to. So even if she’s partly wrong, there’s still a need for sustainable finance to redefine “financing and underwriting differently”.

So if you thought that any of Christian’s writing could be true, what would you do differently?

If you even partly accept the notion of ecological limits to growth that make the entire global economy riskier than we know:

• how much have you reduced your ‘risk’ by financing and investing in green real estate?
• what is the cost of waiting to implement your strategy?
• how much benefit will you gain by focusing only on “low hanging fruit” during your energy efficiency retrofit?
• are energy efficiency finance programs, such as PACE, really effective or are they too little too late?

Or do you think, as Vince Siciliano comments, that some of today’s new sustainability thinking — like cradle to cradle — can play such a significant role that you’ll be able to to avert the horrible future Christian suggests is waiting not only for the status quo but current day green investing, too?

Take a look at Leslie Christian’s essays, risk framework and recommendations.

Think about some of the markets where you currently seek investments.  Think about your underwriting.  Your network and clients. See any signs of ecological limits taking shape?

We do.

If you work with institutional investors, send the essays along and ask them what they think.

Then, share your experience and their reactions with the rest of us. We’d love to know if and how these ideas cause your conversations and more importantly, your investing, to differ.

Access all three of the essays here:

» Social Finance from an Investor’s Perspective

» Getting Serious about Long Term Investing

» Allocate your Risk Response

Why colleagues are attending our Competitive Edge 3 workshop

I regularly talk with colleagues about how and why they are using green finance, to make sure our course content is at least meeting, if not exceeding, their needs.

Here are the perspectives of Jon Gibson and Rowan Edwards, who’ve already signed up for the upcoming Competitive Edge 3 workshop, Communicating the Value of Green Building Using Principles of Real Estate Finance.

The workshop is happening on June 24, 2010, here in San Francisco (download the course flyer here↓).

Why Jon and Rowan will attend this class

Jon Gibson, Hedge Fund Accountant, San Francisco

My background is in accounting for hedge fund portfolios, but I am transitioning into a green real estate finance position. I found the green finance series extremely valuable in helping me find my way; I have learned about the green real estate value proposition (the basic financial underpinnings), met many industry contacts-from architects and engineers to financiers, lawyers, and investors-who now serve as a network of resources, and developed a sense of the market. The guest speakers, drawn from a host of high-level public and private organizations, were exceptional.

The extensive (and high quality) handouts have allowed me to continue to learn and enrich myself long after the course was over. Lisa, George and the rest of the team (including USGBC-NCC) do a great job organizing, presenting and making sure each participant has several great takeaways.

Rowan Edwards, Sustainable Developer, San Francisco

My interest in Galley Eco Capital seminars is to find new ideas. As a sustainable business developer I am looking for new opportunities that may exist, not only in light of the current economic situation, but because innovative methods always seem to flourish and gain traction in times like these.

We have seen that other methods of financing exist like micro-financing (Grameen), and on the horizon, B-to-B micro lending. It is exactly this type of out -of-the-box thinking that creates new opportunities. It is this new way of thinking that would be the primary reason for taking the green real estate financing seminar.

With LEED and The Living Building Challenge gaining momentum, fostering a new language, and offering long-term value for all stakeholders, the time is at hand to capitalize on new innovative methods. I look to Galley Eco Capital to be the thought leader in this direction.

More About → Competitive Edge 3: Communicating the Value of Green Building Using Principles of Real Estate Finance

» Click here to find out more about the workshop and register today for early bird pricing!

» Click here to download the flyer↓

Please pass this on to a friend

Feel forward this post or the course flyer↓ to anyone in your firm or network who you feel would benefit from this course.

Questions about this course? Can’t make the date and want to buy the materials for self-study? Write and let us know!

Mini-workshop: Five tools and tips for relevant green finance programs that don’t lead to green gridlock

We’ve said before that green finance programs that are more meaningful to customers are actually safer investments.  Here are five tools for increasing your program’s relevance to customers.

Problem →Most green finance programs drive green gridlock

No one wakes up planning to create ineffective incentives, yet it happens. Despite the mega-billions of taxpayer dollars sunk into incentives, rebates and other tools designed to stimulate green building and energy efficiency, most green finance programs aren’t getting the kind of traction needed to stimulate private investment and bring about real energy security and sustainability.

Green finance failure is evident in the thousands of redundant, fragmented monetary incentives littering the market, even as building owners complain about insufficient green funding options.  You see it every time an owner retrofits only enough to qualify for a couple of incentives and ignores other energy-saving opportunities.  He lacks the organizational bandwith to access more programs scattered throughout the market.

It’s also apparent in the choking bureaucracy investors experience in trying to access grants and loan guarantees.

Missed signals → fragmented, uncoordinated policies and incentives → green gridlock → frustration

Even more insidious are the ways in which distorted signals about funding lead to even more fragmented, ineffective incentives, adding to the confusion. Click on the graphic to enlarge it and see how that happens.

So an already clogged, murky vat of regulations, policies and confusion continues to calcify, blocking green capital flows to the very initiatives needing funding - gridlock.

The point here is not that “incentives are bad.” It’s that there needs to be more thinking about the customers these programs serve and the kind of job they’re supposed to accomplish.

This requires you to adopt a different mindset about designing and delivering green financial services for your customers.

1→ Reality check: Traditional real estate financial services is an old Buick

Commercial real estate financial services, in general, are like a gas-guzzling old Buick, and putting together commercial real estate transactions is an expensive and time-consuming endeavor.

Over a property’s lifetime, gigabytes of redundant data will be duplicated each time there’s a transaction, generating large amounts of wasted time and expense — gas-guzzling. When a property deal “breaks down,” there are no generic spare parts that you can immediately buy to fix things. Every single repair is a painfully expensive custom job.

Still, we see most green finance programs simply cloning the same gas-guzzling models that have been around for the past few decades. It’s a boring product that’s way past its prime. No wonder investors are unimpressed.

Ask yourself: when’s the last time you were excited about buying a very complex product that forced you to spend tons of money just to acquire it, with absolutely no assurance of whether your true problem would be solved once you used it?

Tip: During your program’s design, make sure you’re not simply replicating the typical commercial real estate financial product. It’s a tired, expensive commodity.

2→ Watch your customer’s movie to solve their real problem

Just as you need to understand the setting of a movie in order to understand a character’s story, you have to get a clear view of the market context that your customer operates within in order to put together a green finance offering that is most meaningful to them. What is their end goal? They’re probably not pursuing sustainability as an end in itself. Rather, sustainability is usually a valuable tool for navigating the tough bigger picture changes happening in their world, including:

• Economic instability
• Social values
• Global markets with greater local influence
• Increased customer expectations about services and products generally
• Building standards and technology improvements

While traditional financial services products are not designed to help property owners navigate these kinds of changes, any property owner who is taking on sustainability by using your green finance program will usually be grappling with these issues.

The key is to understand the particular big picture issues affecting your customers and prioritize their impact. Last month, we talked about our Real Estate Innovation Advisory® services and how they help elicit these kinds of deep insights from customers, increasing your program’s relevance to their business.

Tip: Find out your customers’ true end goals. Build your program around supplying the key resources that help them meet those objectives.

3→ Get into their world with process visualization

The successful green finance program has to beat, not just meet, traditional financial service offerings. To do so, you must know how your green finance offering fits within the customer’s world.

A quick way to immediately improve your green finance program is to look at the range of typical activities that take place during your user’s transactions.  We use Mindjet Mindmanager 8.0 ($349 retail) to sketch mind-maps of customer activities. The example below represents the core components of a property owner’s world.

Put your client’s activities into a process map:

When we work with clients, we catalog their activities and lay them out into a process map that includes the client’s service offering within the customer’s activities.

There are many different kinds of process maps. Below is a simple mock-up of a timeline process map that we  created with Smartdraw. Click on the graphic to see the enlarged view.

This immediately helps everybody to visualize and define the issues that the green finance product addresses, using the same language. We go over the details of these processes and their impacts in our workshops, or you can find out more by contacting us directly.

Tip: Collaborate with customers to learn the typical activities that form their world. The resources below can help you to map your your green finance offering to your customer’s key processes.

Quick reads about process mapping:

• http://www.ehow.com/how_5070753_make-process-map.html
• http://en.wikipedia.org/wiki/Business_process_modeling

3 process-mapping software options:

• Flowbreeze; $39-$59: http://www.breezetree.com/buy.php
• Smartdraw; $197: http://www.smartdraw.com
• Visio 2007 Standard; $399: http://office.microsoft.com/en-us/visio/fx100487861033.aspx

4 → Three design questions for better green finance programs

Tip: To study your new process map, ask yourself the kinds of questions designers do when they create products and services. Here are three starters that you should answer:

• Does your program enhance or hinder any of these activities or events within real estate finance?
• How many ways does your green finance program touch these events?
• Which activities touch whom? When? How?

5 → The bottom line: Start with a model of good green finance

If you’re starting from scratch, of course you could just work from a better model to begin with.

We use the following model to think through the key elements of successful green finance programs, and to work with clients on pinpointing opportunities and problems. It can help you to see the kinds of problems your program will run into if you copy traditional financial services or leave out some other key component.

Summary

Green gridlock is a needless waste of money and turns the positive intention of greening buildings and saving energy into frustrating experiences and unsuccessful programs.

Many green finance initiatives would become more relevant to property investors and other customers that local governments and utilities try to influence if they a) stopped copying an already flawed finance model and b) took the world of the user, the property owner in this case, under consideration.

Use a model of successful green finance programs and a process map to visualize how your programs fit in the customer’s activities. This will make you more successful because programs that appeal to customers are definitely more successful, and therefore less risky.

What do you think?

Do you have any positive or negative stories of dealing with green finance programs that you would like to share? Let us know. We’d love to address these kinds of issues in future posts.

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