Deep Horizon oil spill soaks $9 billion in CMBS deals

The first factoids, attaching dollar signs to the Deep Horizon oil-related damage to commercial real estate, are washing ashore.

Realpoint, a rating agency, recently reported (in Real Estate Finance & Investment and Institutional Investor) that the Gulf of Mexico oil spill is affecting “$9 billion in commercial mortgage-backed-securities (CMBS) deals“.

The article notes:

[Realpoint] found that there are about 306 loans on 319 properties on the coasts of Louisiana, Mississippi, Alabama and Florida that are feeling a direct impact from the spill. The agency believes that the biggest threat to cash flow will be reduced tourism, particularly for properties in Florida. About 247 of the properties affected by the spill are in Florida; reports are that it could cost the state about $2.2 billion.

So will those property owners and the CMBS bondholders go marching arm-in-arm to British Petroleum, to file claims for lost income on those properties and/or debt service on those loans? How will they be compensated for the permanent loss of market value on a “marked” property, not to mention loss of access to refinancing for properties that really are or perceived to be oil-damaged?

Those factoids will roll in soon, I’m sure.

So we now have the unhappy visual of real estate investors, pants rolled up to their knees, trudging through the business, legal and insurance swamp surrounding Gulf-region CMBS, added to a somber image of the rest of the industry on its slow march to building-related sustainability.

One thing’s for sure: the proximity of these events takes the option of doing nothing about environmental and social responsibility off the table (finally).

Photo credit: DVIDSHUB / Flickr

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

Galley Eco Capital Moves to Hub SoMa, Summer Get-Together in the Works

We’ve moved — here are the details:

We’re excited to announce that we’ve moved our offices to the Hub SoMa!

Hub SoMa is the newest Hub Bay Area venture - taking their co-working, collaboration business model into the heart of downtown San Francisco.

What’s great about the new location is that we can do more of our lab work — creatively designing green finance programs and collaborating on great ideas with the other companies focusing on social and environmental change.

Add to that the great event space we’ve gained where we can hold more workshops, talks and related events for the green finance and investment community. We can’t wait to show it to you!

In fact, we’re already psyched that it is the perfect place to to host our new Real Estate Innovation Advisory® forums (see the upcoming May Pacesetter for details on that other exciting offering!).

Summer Get-Together, Anyone?

We’ll be announcing our Summer Get-Together, happening sometime in June. We’ll have a meet-up among friends new and old, for an informal, fun time. Of course, you’re always welcome to call or stop by anytime before then.

If you want to make sure you hear about our Summer Get-Together plus upcoming green finance and investment workshops and events, make sure you’re on our newsletter list — sign up for it here and we’ll make sure you get the word.

Till then, please update our contact details in your records:

Galley Eco Capital, LLC

901 Mission Street, Suite 105

San Francisco, CA 94103

(415) 305-9512

(P.S. I’m off to Germany for the next few weeks — you might see a blog post or two if I run across any interesting green finance happenings while I’m out there (volcanoes permitting).

Auf widersehen!

Heard at ULI Boston: Four Forces Shaping Green CRE

There was fresh energy among folks recently at ULI’s 2010 Spring Council Forum in Boston — market opportunities are slowly coming back, but it would be a mistake for your firm to simply repeat all your old moves from the last cycle.

I heard four comments that represent the mood and actions of investors on green real estate now:

Here’s a synopsis of the forces I see those comments representing:

“The other shoe’s dropped, but no one heard it.”

Your plan → Get going on your green portfolio strategies, you’re already behind.

Professionals finally acknowledged that a) rumors of 30%-40% loss of value in commercial real estate are, for the most part, overstated and b) there is currently too much capital in the market chasing too few deals. The latter point has been creating the paradox of deals trading at aggressive cap rates amid a recession.

In the opening session, Equity Office Chairman Sam Zell explained the paradox. When real estate markets tumbled, investors had expected banks to dump lots of deeply discounted properties into the markets, which investors would snap up at rock bottom prices.

Wrong assumption. Instead, banks have focused on working out troubled loans and strategically offloading REO assets one-at-a-time, and as a last resort. That has given the market time to gradually readjust pricing, preventing fire sales.

Reality: on-going one-off REO sales cushioned the velocity and depth of property value loss. The practice has also frustrated distressed players, forcing them to compete for REO deals against high net worth individuals and other sources with more patient capital, willing to pay more. This way has helped the banks to achieve better than predicted pricing on their sold assets and the market again saw no drastic fall in commercial real estate pricing.

In response to the question of why so many investors still talk about doing distressed deals, in the face of this very different reality, one panelist replied “the other shoe has already dropped, but no one heard it”.

Lots of investors have been delaying their investments in green initiatives, n waiting for the market to return to health. The good news is that the market is now not as bad as everyone thought. That’s also the bad news — all the players with dough have already gotten started, so you need to keep up.

“Every day, 1MM square feet of real estate is being LEED-certified.”

Your plan → The shift to green is happening much faster than you might think. You need to speed up your firm’s own shift to keep up.

Doug Gatlin, of the US Green Building Council spoke at our Responsible Property Investing Council Meeting, about the current stats on LEED. Here’s one: LEED certifications are running at 1,000,000 sf/day, even during an economic downturn. One council colleague, calculating a corresponding value of several hundred million dollars per day, said this fact would definitely influence his market conversations in favor of green building.

There’s still quite a way to go before we can say that market transformation from LEED has really happened. One main premise behind Architecture 2030 goals is that the US either renovates or builds new a net 10 billion square feet of real estate each year. The 365 million square feet annualized velocity currently being LEED-certified represents 3.65% of the estimated 10B in annual square footage built or renovated in the US — so there’s much progress to be made.

Theory: For green building to influence leasing and investment activity in a market, the “tipping point”, “competitive mix” and “OS” factors have to all be balancing and reinforcing each other in healthy levels. A sufficient concentration of LEED-certified square footage in a sector can be enough to influence investment activity in that sector towards green buildings (tipping point). Note that “sufficient” needn’t be that much in absolute numbers.

That, plus LEED maintaining its relevance and dominance as a green building rating standard (competitive mix) and regulatory support on federal, state and local levels (operating system or “OS”) are the keys to further increasing green building volume. The lack of competitive mix and OS in a market or for a real estate asset class will result in no tipping point being achieved in the area being studied.

The tipping point and OS factors are already a particular force on investment real estate in some gateway metros. For example in San Francisco, brokers have been publishing their own reports showing higher occupancies in LEED-certified buildings. There are already whole classes of global investors who publicly refuse to buy inefficient buildings. So this force is already at work, even with a small proportion of US real estate earning LEED certification to date.

“Operators need the track record to execute on both traditional real estate and sustainability strategies.”

This was a fund manager’s answer to my question about what made her choose to invest with a certain real estate operator, who had brought her a deal with an extensive energy retrofit including adding renewable energy in the business plan.

With capital markets slowly thawing and the velocity of green building certifications growing, it’s time to ask yourself if you’re company will attract capital with a mandate for sustainable real estate. Fund managers are now speaking out about needing to work with partners who can execute on a sustainability plan.

Additionally, you’ll need to assist the equity partner with understanding the value-add from green strategies being pursued, that will come from your local expertise.  The good news is that right now the market is wide open. Most of the US investment real estate firms who have achieved any progress on greening buildings have done so with a few buildings and many are still just focusing on low hanging fruit.

With the projected high increases in energy and water costs, nimble regional operators have a great chance at building a great track record on greening buildings that can get them hired over larger competitors. Plus, its a big market, anyway, with lots of room for more players. Remember what I said above, about 10B sf real estate being built and renovated in the US each year plus all the money out there chasing too few deals?

“We’re serious about being green, but we’re skipping commissioning on all our buildings.”

Your plan → Ignore free lunches. Compete via consistently delivering the best building performance possible.

This was said by an owner’s rep of an institution presenting their multi-billion dollar portfolio of institutional assets. He added:

“We are making our space LEED certifiable. We’re doing many things according to LEED for existing buildings, like green cleaning and updating the systems in our buildings, but we’re saving a couple hundred thousand dollars by skipping commissioning.”

“Pennywise and pound foolish” - even tired clichés are still true. If you attended our recent Competitive Edge workshop, Financial Considerations for Energy Efficiency Retrofits, you learned that Lawrence Berkeley National Labs (LBNL) research shows that on median costs of just $0.30/sf, commissioning alone achieved energy savings of 16%, with a 1.1 year payback and 91% ROI.

This means that our investor friend’s portfolio could probably deliver many more dollars in performance, which will literally go to waste via a) the properties remaining exposed to more energy price risk (current price plus escalations) than is warranted, b) not achieving the level of upfront energy savings that might have been possible, c) being in for longer-term, higher capital expenditures on their major systems since their performance was never audited to a commissioning standard.

Why is this unfortunate mindset a force on green building investing?  Actually — it’s pervasive to the point of being an archetype. You’ll find a similar mindset in a certain percentage of companies in every industry and at every point in the economic cycle. As the market matures, the economic downside of their inaction will become more apparent

Those of us who know better have to consistently incorporate building performance data into underwriting and valuation, and adjust prices accordingly. When a certain percentage of investors find themselves taking discounts at sale and losing enough tenants, then they’ll change their minds, improve their O&M - and even save themselves a few more bucks the process.

Energy Star, rigourous performance data shall set you free

“Talk is cheap” might be a tired cliche, but there’s always someone around who seems to forget.

Not a week passes without another example of someone taking the easy way out on verifying green and/or energy efficient performance.   And anyone who cares about green building investing or even just making money from their buildings in the future should be vigilant about avoiding this particularly vicious delusion.

This week’s (most unfortunate) case in point is the US EPA’s EnergyStar appliance certification program, facing accusations of being vulnerable to manufacturer fraud by the General Accountability Office, as featured in the 26 March New York Times.

If you picture the emerging green real estate finance and investment ecosystem as being a giant computer, the US EPA’s EnergyStar Program is the “Intel inside” –  a powerful, branded technology within the nascent green investment “operating system” that drives the circulation of capital into and throughout the nearly $200 billion ecosystem, via providing the market standard in tools to collect and measure building energy data as well as certification regimes for the energy performance of most kinds of buildings and equipment.

EnergyStar is a big player, providing a sort of “software” that systemically links the value proposition of building energy savings throughout communities, environmentalists, investors, and citizens. Look at all the roles it plays in our green real estate finance and investment universe:

• Regulation: Building energy disclosure laws in California and Washington, D.C. are largely premised on the availability of and reliance on EnergyStar.  Regulating building energy disclosure as a part of market transformation is showing early promise in Washington, D.C. where practitioners attribute these new laws to the rise in green building certifications there.

• Green building certification: The US Green Building Council’s LEED 2009 rating systems require achieving an EnergyStar rating of 75 as a prerequisite to certification. Co-Star data (April 2009) indicates 433 million square feet of LEED-certified green building space in operation in California alone. The US Green Building Council estimated that green buildings will represent $180 billion in construction value by year-end 2009.

• Investment best practice: Within ULI’s CLUE 2009 study¹, nearly 80% of the respondents (investment funds, financial services, lenders) indicate that they perform “an explicit analysis of energy efficiency when completing a due diligence review on a project or transaction”.  Among larger property owners and managers, EnergyStar’s Portfolio Manager is as ubiquitous as Microsoft Excel for spreadsheets.

• Property Valuation: Lower exposure to energy supply and price risk is a key tenet supporting the lower operating costs, which partially drives the superior valuation of green and energy efficient (mostly defined as Energy-Star rated) homes and buildings. While we haven’t yet achieved sufficient transaction data to say with certainty the amount of valuation increase attributable to energy efficient buildings, we do know that lower operating costs are a key point of property value and value appreciation is an essential wealth creation mechanism in the United States (current economic climate aside).

• Monetary support: Closer to today’s focus, billions of dollars in taxpayer money and utility fees,  in the form of rebates and incentives, are allocated to support the purchase of EnergyStar-rated appliances and equipment within residential and commercial buildings.

With that in mind, the report about possible fraud vulnerabilities within EnergyStar’s appliance certification system should be a concern for anyone who builds, lives in or operates buildings in the United States.  It is not an understatement to say that the fortune of US green real estate finance and investment is directly linked to that of EnergyStar as a certification, data collection and reporting tool.

To be clear, I am not saying that EnergyStar Portfolio Manager, the energy data and benchmarking tool of choice commercial building owners, is faulty due to the appliance snafu. However, the residential and commercial real estate industry directly relies on EnergyStar-certified appliances and equipment, as well as the taxpayer-funded rebates attached to them. The growth of the green finance and investment industry in the United States, still very much at an early stage, also relies on faith in EnergyStar’s positive reputation, which can be compromised by false performance data on the equipment it certifies.

Add to that the weight of political capital at risk within hundreds of cities with climate action and/or energy conservation goals, based in part on residents and businesses (like property owners) switching to EnergyStar-certified appliances and equipment over the next couple of decades.

EnergyStar, rigorous performance data shall set you free

Trust is built on truth. In green real estate English that means real, vetted performance data.  Smart homeowners and investors deserve the truth about the energy performance of everything and they’ll keep their money in their pockets until you proved it. Don’t forget that the speed of the internet economy can make everybody equally smart about performance data in an instant.

Like Intel chips in computers, EnergyStar is an extremely valuable technology within our green investment “operating system”. Our reliance on it drives billions of dollars of annual growth in green and energy efficient buildings (even in a recession economy).

Nipping appliance certification concerns in the bud is not only a big deal for the EPA, it is an imperative for for the real estate finance and investment industry.

I hope that EnergyStar and the broader real estate industry will recognize what, not to mention how much, we stand to lose if we don’t take swift action to make sure that every aspect of it’s programming and reputation represent the platinum standard in energy performance data, measurement and certification.

¹Sorry to footnote a blog post, but I couldn’t find a link to the ULI 2009 CLUE report anywhere on their site, despite some intense searching. If you do want to look up this citation, and have the study handy, look at survey question #5, on page 8. I only have it in hardcopy form.

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