Get the Best Valuation for Your Green Real Estate Project

The appraisal industry is just starting to incorporate sustainable design considerations into the valuation practice. So how can you navigate your green project towards its maximum appraised value?

We recently heard Wells Fargo’s appraiser James Finlay’s personal perspectives on how the appraisal industry is working to adapt valuation standards to sustainable real estate.  Here’s a short summary of his comments:

Green Project Valuation Road Bumps

• On-site distributed energy systems: The real estate appraisal might overlook the value of these components. A lot of these systems would best be appraised by an M&E (mechanical and electrical) appraiser. Additionally, systems like geothermal heat pumps may also require the services of an M&E appraiser.
• Appraisers can’t base their operating expense assumptions on your energy savings projections alone. Claiming that your asset is designed to use 30% less energy than conventional product is not evidence enough- what happens when the performance is suboptimal? If you don’t support your case for the lower operating expense projections, don’t expect the appraiser to go out on a limb for you- it’s their job to be conservative.
• Appraisers are unlikely to value incentives. Simply stated, banks won’t lend on property tax credits or any other green incentives that would flow through the asset’s revenue stream, so don’t expect your appraiser to value them.  Expect them to be reversed out so that the appraisal is based upon the assets true economic performance. (Our note: we’ve seen cases of owners negotiating large incentive packages –and their lenders ignoring the fact that some of these incentive benefits could also be additional collateral that secures loan repayment).

Preparing for a Good Appraisal

Finlay provided the audience with key suggestions on how to manage the appraisal process in order to maximize the appraised value of high-performance assets:

• Hire an appraiser with green experience. Look for a local appraisal expert with some green experience, who is eager to learn more about green building systems. If a perspective lender has a go-to appraiser, find out in advance of agreeing to terms whether they have any green experience. If not, offer up an experienced, alternative appraiser.
• Proactively provide your appraiser with as much relevant and organized information as you possibly can. Don’t just assume that an appraiser will be able to value your advanced building systems- provide them with the data and evidence they need to do so. It’s your responsibility to build the case for higher than market value.

Most importantly:

• If you are not monitoring and tracking the performance of your green buildings, you are not maximizing appraisal value. Want an appraisal to accurately reflect the superior energy performance of your asset? You need to track your data. Additionally, utilizing building management systems and commissioning (or retrocommisioning) are great ways to show an appraiser that the asset will continue to outperform market assumptions.

By the way, there will be great case studies and valuation discussions at the upcoming Green Building Finance and Investment Forum, which will be held here in San Francisco next week on March 2-4, 2009.

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Part 6: Starting A Green Real Estate Fund?

If commercial real estate has truly embraced going green, why bother with green real estate funds?

In Part 6 of our Special Series on the Green Building Finance & Investment Forum - New York, co-sponsored by Galley Eco Capital, we talked shop with established and emerging green real estate fund managers. We wanted to learn why investors and development partners want these funds, and the do’s and don’ts for building a green fund.

The panel, moderated by our own Lisa Michelle Galley, featured the perspectives of  industry pacesetters Deborah La Franchi of Strategic Development Solutions, John Hirschfeld of Class Green Capital Partners, Raymond McGaugh of Kiwanja Capital Partners, and Leanne Tobias of Malachite LLC.

Does commercial real estate need pure green real estate funds?

The panelists highlighted the following advantages of a green-specific fund strategy:

• Green real estate funds align capital more clearly with mission. Increasing numbers of  of institutional investors, especially pension funds, are adopting a double and/or triple bottom line (TBL) focus - meaning they measure economic, ecological and social returns on their investments. Green real estate funds allow them to allocate capital to sustainable investments at their targeted market rate of return. For Raymond McGaugh and Kiwanja Capital, a green, urban redevelopment investment strategy resonates better with their investor audience.

• JV development partners are seeking a green fund’s concentrated expertise. It’s not just investors that are looking for green real estate, potential JV partners are looking toward green capital sources. Strategic Development Solutions recently surveyed over 400 developers to gauge whether a green-specific fund would satisfy their equity needs. The response was very positive, even among the groups that had never worked with green before. The results make sense: there are many experienced, smart development groups that need to gain the organizational capacity to develop green properties cost effectively, or risk becoming obsolete. Partnering with capital sources committed to sustainability, that can also educate them is a cost-effective method of gaining this capacity.

“Developers would love to have a capital source to help them up the green learning curve.“-Debbie La Franchi, Strategic Development Solutions

• Green funds benefit from the superior financial performance of green assets. Green real estate assets benefit from lower operating costs and reduced performance risk. A “mixed” fund that invests in both green and conventional real estate assets dilutes the positive green impact on returns. For Leanne Tobias of Malachite LLC, this is the most important reason for an all-green fund: “If you are going to spend the time to create a new investment platform, why would you not build a vehicle that will maximize the benefit from green-specific performance enhancements?”

Best practices for building a green real estate fund

Already raising your own green fund or planning on contributing capital to one? Here’s first hand advice from the panelists:

• Your team must have sustainability expertise. The fund absolutely must have in-house staff that is knowledgeable of green construction and design, and is experienced working with both LEED and Energy Star rating systems. For John Hirschfeld of Class Green Capital Partners, this means staff that understands sustainable construction and can “get through the green clutter“, identifying the financial implications of green components for a potential investment, and bring these figures into the financial engineering of both the asset and the fund.

• Pay attention to both the leasing team and lease structure. Work with your JV partners to ensure that the leasing team for your investments understand the marketing benefits of green assets, and can adequately convey these benefits to the marketplace. (Our note: also make sure that their asset managers know and understand the value of green). It’s also crucial that your partners are using the right lease structure, so that the financial benefits of going green are accruing to the investors, not just the tenants.

• Establish the right partnerships. Seek partners that can help you maximize the returns from your green fund. As an example, Strategic Development Solutions has a partnership with Johnson Controls, who evaluates the green construction and design for each fund investment. Strategic partners look at the fund’s activities from a different lens, ensuring that no important details have been overlooked and that potential returns are not left on the table.

• Proper reporting is crucial. Reporting obligations are critical components of a successful green fund. Your triple-bottom line investors will require reports that show the environmental impacts of your investments- how much energy and carbon emissions is your investment portfolio actually saving? Your JV partners and their vendors will have to accurately track energy and water usage. In addition,  don’t forget about appraisers: there aren’t many green comps out there yet, and if you want to maximize the value of your assets, you need accurate and robust reporting of energy performance and green-leasing advantages to build the case for higher valuation.

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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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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.

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.

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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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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