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.

Download report: Net-metering winners and losers

As you head off to Thanksgiving, you can take stock of how your state has progressed on renewable energy (and based on what we’re showing here today, you can hopefully be thankful).

We follow renewable energy trends because one of the central challenges of district or regionally-focused green finance strategies involves having a base of renewable energy policy that the jurisdiction authority can build from.

Renewable energy policies which reward systems owners for electricity generation can go a long way to support sustainable finance funding mechanisms. These mechanisms, depending on their structure, can allow for a transparent flow-through of renewable energy benefits, and the creation of lower carbon districts as well as achieving regional greenhouse gas emissions.

Net metering update

Net-metering is a critical influence on the uptake of renewable energy, since it allows the solar power system owner to earn money by selling electricity back to the grid. So… is your state a pacesetter on net metering? What’s its grade?

Network for New Energy has put out some new figures, detailing how different states make the grade on renewable energy. You can download a copy of the slide deck on this page as well.

Winners

In terms of net metering policies, Network for New Energy names the following states as being top:

1. Colorado
2. Delaware
3. Maryland
4. New Jersey
5. California, Oregon and Pennsylvania (tied)

Losers

According to Network for New Energy, the following states have no policy on net-metering, which resulted in them receiving a failing grade:

1. Alabama
2. Alaska
3. Mississippi
4. South Carolina
5. South Dakota, Tennessee and Texas

3 ways monitoring building performance can help you innovate

While some property owners may look upon increasing building energy performance requirements as a burden, we think that early adaptation of your portfolio to these new regulations opens up opportunities to innovate within your platform.

As reported by The Real Estate Development Law Blog, Washington State’s SB 5854,  following the “lead” of USGBC’s Building Performance Initiative and California’s AB 1103, will (when passed) require the use of Energy Star Portfolio Manager as its benchmarking tool for calculation and reporting of building energy performance data to be provided to a prospective buyer, lessee or lender.

The promised benefit is more effective market transformation via reporting transparency on existing buildings. However, we also know about lots of frustration from owners, who find additional regulations for existing buildings to be burdensome.

But it doesn’t have to be that way.

In fact, early compliance with these new regulations might open up unique opportunities for property owners to get ahead of the pack in achieving competitive advantage for their firms.

How to create opportunities from compliance…

The September 2009 Harvard Business Review focuses on sustainability and innovation. In it, authors Nimudolu, Rangaswami and Prahalad lay out the typical phases companies go through to build a sustainability platform.  Interestingly, that process begins at the place where many portfolio owners are at now today – compliance with new regulation.

They argue that early adaptation of a property portfolio to comply with anticipated sustainability regulation opens up the potential for innovation in several ways:

1.    First mover advantage: First movers on compliance gain knowledge and time to experiment. Adopting emerging energy reporting compliance standards (whether binding or not) provides property owners critical time to develop solutions best suited to their portfolios and fosters genuine best practices.

2.    Lower overall costs of compliance: Conforming to the highest compliance standards allows for scale benefits across markets and better insulates diversified portfolios from changing legal regimes. Attempting to  create and manage different compliance approaches based on lowest local thresholds is costly and inefficient.

3.    Critical stakeholder development: Early adoption of the tougher building performance reporting standards sets the stage for better relationship building with city officials in the markets where the company operates. Property owners with building performance data in hand will become preferred partners of city officials because they are able to prove that they are the better partner than their competitors. This creates meaningful advantages in terms of future permitting and entitlement actions, as well as allowing those owners preferred status in helping the city adopt other emerging standards.

Embracing building energy reporting early across your portfolio can be a catalyst for innovation that spurs market leadership, enhancing asset value sooner and better than your competitors. Early adopters to emerging building performance measurement requirements will position their businesses to outpace the competition and secure deeper relationships with capital sources and policy makers.

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• Photo credit: istockphoto.com: Dave Bolton/”Blue Glass”.

Avoid the threat behind lower emissions

You might hear that 2009 carbon emissions are down over 2008 and think that means you have more time to get started with your portfolio’s sustainability initiatives.

In reality, you should do just the opposite– because there is a real estate story buried here that isn’t as benign.

The DOE Energy Information Administration (EIA) projects that 2009 U.S. carbon emissions are projected to be 6.5% lower than in 2008, due to

weak economic conditions and declines in the consumption of most fossil fuels.

The EIA also projects 2010 emissions growth at +0.9% over 2009. For reference, the EIA’s 2009 Annual Energy Outlook, projects U.S. emissions growth of 0.3% p.a. through 2030.

We became curious about the level of economic activity accompanying these projected changes in emissions, looking particularly at economic indicators most closely tied to real estate fundamentals.

So we dug in to the EIA’s super handy table of of macroeconomic indicators, where you can derive a snapshot of the “economy-buildings-sustainability-finance” trends that shape green finance:

2009 vs 2010 Macroeconomic Snippets

According to EIA projections, in 2010:

• real GDP growth will be be +1.07%
• real personal income, non-farm and commercial employment will shrink 0.31%-0.6%
• the number of housing units will remain flat with nearly no new construction
• vehicle miles traveled will increase .4%
• the change in the producer price index for petroleum reflects 20% year-over-year growth (ouch!).

Essentially, the 2010 picture picture is one of continued high unemployment and shrinking incomes, even as the economy begins to recover. And at the same time, petroleum prices are projected to grow at nearly 19 times the rate of GDP growth.

This basically lays out the risk of a continuing deterioration of real estate market fundamentals and investment portfolios even while the official news may be reporting an economic recovery.

Moreover, these projections highlight the immediate value of energy efficiency retrofit programs on property portfolios, as a real defense against escalating petroleum-driven operating expenses. It also highlights the benefits of  sustainable district-level and regional strategies for communities.

The threat of increased petroleum prices against shrinking incomes also supports the need for green finance programs, since these enable powerful, immediate responses to portfolio-wide and regional sustainability problems.

So don’t let stories of low carbon emissions slow down your firm’s energy efficiency and sustainability initiatives. Your efforts will help you to avoid some the other risks buried in the same story.

How are you moving sustainability forward in a weak economy?

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Things you might want to know:

• Do you like this post? We’d love to hear your comments and suggestions.
• You can contact us to discuss or initiate a project here.
• You can get Our Green Journey by email or via RSS.
• Sometimes you can see what we’re doing on Twitter.
• Photo credit: U.S. Department of Energy, Energy Information Agency

How misleading electricity price info can cost you

Despite electricity price trends indicating that electricity prices have been rising significantly, misleading information and a short-term perspective can still cause investors to undervalue purchasing solar power. Recent press highlights a couple of the common traps you can avoid in your own solar finance planning.

In a recent interview, a Safeway executive announced that they currently are not pursuing any more solar power purchase agreements for its stores, due to poor economics from volatile electricity prices, rising finance costs and decreasing state incentives.

The problem?

Safeway talks about currently volatile electricity prices, indicating that cheaper electricity prices extend the payback on solar projects — possibly 2 to 5 years — contributing to their view that solar financing is currently not economical.

This assessment, in my opinion, unfortunately reflects an incomplete assessment of the company’s mid-long term energy prognosis. There’s plenty of available information from respected, third-party sources that clearly show that electricity prices will continue to rise well above the rate of inflation.

Still, as Environmental Leader reports, there has been a spate of inaccurate press about lower electricity prices, causing solar power buyers to think that deferring solar financing is a better course of action.

Essentially, energy prices this October are set to be 6.5% higher than in January this year. You can review a complete set of stats on the short-term energy outlook of the Energy Information Agency here.

One solar financier confirmed in the article that PG&E electricity prices are up 10 percent over 2007, instead of the 5%-6% annual price increases they’d projected in their customers’ PPA agreements. The result? Quicker paybacks on solar for those customers.

Understanding energy price trends is essential to establishing your company’s green business case. The general message within the “real” data is that, if solar power is an option for your properties,  purchase and leasing delays caused by relying on ‘cheap electricity’ pricing misinformation will cost you. Electricity costs have been increasing and continue to rise at rates that are multiples over the current rate of inflation.

Things you might want to know:

• Do you like this post? We’d love to hear your comments and suggestions.
• You can contact us to discuss or initiate a project here.
• You can get Our Green Journey by email or via RSS.
• Sometimes you can see what we’re doing on Twitter.
• Photo credit: Alexsl on istockphoto.com

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