Cliffhanger: Which of these investors will earn a green value premium?

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Do you believe that achieving a value premium on green properties is possible? Even in the currently tough market?

Well, Jamestown and the State of California have both recently been in the press talking about how they expect to realize extra value from their commercial real estate via green and energy efficiency strategies.

Check out the articles and tell us if you think their projects should earn them greater returns than non-green market peers.

Jamestown: $3-$10 Million Portfolio-wide Retrofit Commitment

Jamestown has committed to greening its entire $4 billion commercial real estate portfolio. In the recent New York Times article about their efforts, they point to their European sensibilities as being the reason why they moved ahead with a portfolio-wide commitment to greening existing buildings.

When  you read through the savings and quick paybacks that they report achieving, it seems clear that their focus is on low-hanging fruit. After all, $3mm-$10mm in retrofit costs are peanuts on a $4 billion portfolio. The good news is that they report realizing immediate savings — meaning permanent increases to property net operating income.

Nonetheless, or perhaps because of that, they focus on the green/energy efficient building’s ability to attract the right kinds of tenants and assure the asset’s sale to a broader pool of buyers. The article showcases several recent efforts, including 999 Peachtree Street in Atlanta, GA, which recently earned LEED-Gold status.

We actively follow how German and other European investors are moving quickly to incorporate comprehensive acquisition and portfolio management sustainability programs. You can read previous posts about these investors’ enhanced criteria and due diligence here. More good stuff –> If you receive Pacesetter, our newsletter, you recently read and downloaded the new EECE study ranking global property funds according to reported and implemented energy efficiency practices.

State of California: Will Green Buildings Net Higher Sales Prices?

The State of California recently put a portfolio of 11 properties, totaling 7.3 million square feet, on the market for sale-leaseback transactions. The State is reporting that these properties, most of them being, in their words, “some of California’s most energy efficient and environmentally friendly properties” could sell for $2 billion, and would be “attractive to a market that is seeking sustainable, green designs.”

What makes this an item worth tracking is that the state official making that quote is also reported as saying that the sale will allow the State of California to “lock-in the lowest rental rates seen in years“.  Bids on the sale are due 14 April. It will be interesting to see the extent to which a green premium can be realized when market or transaction conditions stipulate particularly low rents.  The beauty of real estate is that it is not rocket science — there is no free lunch, and all trade offs come with their price. We are seeing and hearing that, in tough markets, green strategies help to hold back some amount of value deterioration, but are not necessarily rewarded with immediate upside.

That being said, there are multiple angles to watch here.  For instance, the concerns expressed recently by some investors about the mixed-use Boston property that attracted 27 bidders and might close at a “crazy” 6% cap rate.

Why the concern? That cap rate, indicating a valuation far higher than typical for the current point in the real estate cycle (even for Boston), reflects the current shortage of high quality properties combined with a lot of capital on the sidelines. This kind of activity raises fears of a liquidity bubble, even in these tough times, as investors pay up to win what few good deals are available.

That could be a strategy that helps Schwarzenegger shrink the state’s debt woes by more than they would typically recover from the assets.

Yes, the excitement continues!

What I Learned at the Competitive Edge Workshop #1

“Teaching is half learning.”

That’s a Japanese proverb, originally from the Chinese Book of Documents.  After teaching the first Competitive Edge workshop last week, we definitely believe that’s true — teaching involves a great deal of learning.

In addition to a personally amazing experience with a fantastic group of high-caliber professionals, we found ourselves reflecting deeply on how much we learned from them.

If you’ve been following previous posts on this blog or getting Pacesetter, Investment Analysis of Green Buildings, sponsored by the US Green Building Council - Northern California Chapter and law firm Hanson Bridgett was held last week, we taught to a nearly sold out room.  On top of that, the course was granted CEU-status by USGBC national, a first for the Northern California Chapter — and for green finance anywhere, to the best of our knowledge.

Here is what we learned from listening to and working with the workshop attendees:

#1: Green finance is important to a much larger group of professionals than you might think.

While we deeply believe that green finance can change the world, we had still oriented much of this course’s material to real estate finance and investment professionals. And, we had a full house of folks from some of investment real estate’s household names, which was flattering.  In addition, however, there were also professionals from the building technology,  construction, corporate real estate, affordable housing and legal sectors. In our conversations, we asked attendees about why they attended the course. The answer we received repeatedly was that professionals were finding it critical to understand the perspective of the property owners that they worked with and they believed that updating their knowledge of financing sustainable properties would be a good way to do that.

Real estate professionals in the room were leading change within their firms or they saw the workshop as a good way to help themselves transition within real estate by upping their knowledge and skill of financing green  real estate.

#2: Attendees most liked learning a simple, cohesive underwriting approach, how to apply LEED to finance decisionmaking, metrics and taking away a rich set of resources

We had definitely focused on creating actionable content, and when we reviewed the feedback, the following  topics were voted as being most significant time and time again:

• the GAPS approach simplified underwriting: We had really focused on reducing the complexity associated with underwriting and received strong, positive feedback on this. The participants gave high marks to our own system for green real estate underwriting, which we use to help decisionmakers quickly to define, evaluate and communicate the value-add of green real estate. It was interesting that folks from many non-finance sectors found this approach quite useful, too, in their structuring of their own work with property owners. (Don’t know about GAPS, yet? You should check it out at the next Competitive Edge, Financial Considerations of Energy Efficiency Retrofits, on 7 April; sign up here.)

• Learning how to connect LEED credits with the project operating cash flow: This particular need, a core requirement of our work here, got high marks as well. Most of the feedback was along the lines of participants feeling much more comfortable in conversations at work and with clients, now that they could point to very concrete areas within the LEED-NC system, which were prioritized according to cash flow impact.
  

• More metrics, please!: Green Journey readers know of our papers and posts about metrics for responsible property investing. This topic came at the end of the day, when people are typically a little tired. However, the participant feedback revealed that the topic of metrics was considered very important, telling us that professionals assign a value to incorporating both double and triple bottom line metrics within their practice.

• In-depth resources for self-study: Getting a packet of distilled, vetted sources of the latest green finance research plus tools and tips for further learning and takeaway was voted as very valuable by the attendees. While we taught course materials from  powerpoint slides and handouts, we had originally thought it would be helpful if people received an extra resource book compiling the research, tools and tips on real estate underwriting and sustainable finance that we’ve come to rely on here. So we prepared an 87-page resource book, to support the underwriting of new green construction, which expanded upon the information being taught in the course. We really focused on the green building, finance data and information that we most like to geek-out on. We were pleasantly surprised at how many attendees stated that this information was very valuable. Just this evening, I received a note from a participant saying, “I wanted to thank you for your great insight and the wealth of information that you shared”.

It was really gratifying to be able to share our knowledge and passion with a sharp group of professionals. Their feedback about the topics and resources that were most valuable to them opened our eyes also . This will definitely help us in the upcoming Competitive Edge events.

P.S. → The next Competitive Edge workshop, Financial Considerations for Existing Building Retrofits, takes place on 7 April 2010. We are excited about the fact that the City of San Francisco and PG&E will also be taking part with great information that will help properties to better finance existing building retrofits. Sign up and join us in an exciting day! Seating is limited and several of Workshop #1 attendees have indicated that they’ll be attending again, so register sooner than later. On top of that, early bird pricing runs through 24 March 2010.

Powerful leasing stats for green buildings — on two continents

Strong evidence continues to build showing that green buildings can deliver better investment value, both now and later.

Moreover, the strength of this assertion is underscored when you see confirmation of leasing performance from unrelated international markets with different green building rating standards.

The below leasing stats are from local brokers and property managers in San Francisco and Paris. We hope that they can give you more ammunition for those green building value conversations you may have with clients and other stakeholders.

San Francisco: LEED vacancy = 9.7% vs non-LEED of 15%

Dave Klein, of NAIBT’S San Francisco office, maintains the RealGreen Index. It tracks the availability of office space in green buildings here in San Francisco, where he’s estimating a 9.6 million sf market of LEED buildings as of 9/09. That green space is overwhelmingly LEED-EB certified.

In our experience with underwriting markets, there is a very different point of view about 9.7% vacant submarket vs a 15% one, even in a historically strong market like San Francisco. That 530bp gap in vacancy shows that the non-LEED buildings will eventually be forced to offer either lower rents and/or larger lease concessions, resulting in lower effective rents to attract tenants.

If those non-LEED Landlords decide to tough it out and not offer greater concessions to compete, they’ll still be paying for that higher vacancy by being the last buildings to fill up, as the local market recovers and the LEED-certified buildings fill up first. It’s really just a question of time, as tenants seem to have already voted with their feet and checkbooks.

On the flip side, calling out these non-LEED buildings like this seems to be a nice circling of a fat EE-retrofit market, in my view.

» Download LEED vs Non-LEED vacancy (NAIBT) (112)

» Download NAIBT Green Index (158)

Paris = Green vs non-green pre-leasing –> 57% vs 11%

Recent story out showing that the French HQE (Haute Qualité Environnementale) green building certification is strongly preferred by tenants in the Ile-de-France submarket of Paris (largely corporate Class A office submarket).

Keep in mind that this is a 2 million sqm submarket — about 21,527,821 sf, meaning no small shakes for the fortunes of those investors. Per GlobeSt:

Around three-quarters of total office space above 5,000 square meters planned for delivery in 2012 and beyond will carry the standard, most of them in the periphery in the south of the French capital. It also concluded that HQE certification is accelerating leasing processes, with 57% of certified space deliverable next year already let, against 11% which is not certified.

In the case of this market, if you are the owner of a non-green building in development here (not even in operation, yet), and your investors see a pre-leasing variance of this magnitude, what kind of conversation are you having with them about creating value with their money?

Not a fun one, I think.

» Read the full story on French green building certification and leasing stats here.

While I realize that the real estate industry requires greater empirical support for the value contribution of environmental certification, these stats already point to huge implications for building owners in each of their submarkets as well as all others where green building penetration is growing. All other things being equal, lower vacancy and/or faster absorption  accrues directly to the bottom line and deliver a great pop to returns.

In my opinion, even though the industry hasn’t reached consensus on a final approach to valuing green buildings, asset underwriting methodology in each of these sub-markets must consider a particular asset’s environmental performance vs that of its peer set, since tenants have demonstrated a clear preference.

The little clause that killed a green building sale

Here’s a live action green building underwriting story.

Basically, it underscores the need for property owners and lenders to make sure their underwriting processes are tailored to certified green and/or Energy Star qualified buildings.

Tonight I received a note from a rather overworked, but sharp-eyed investment analyst, under the gun to underwrite his firm’s purchase of an office building under a very tough deadline.

He was not only frazzled, but also frustrated — prompting his note. You see, earlier in the deal, he had been excited about helping his firm to buy a LEED-certified building. Working on this acquisition gave him the hands-on chance to participate in directing more environmentally responsible investment choices — what he really wants to do more of in his career.

The excitement turned to frustration, however, as he came across the following phrase in the anchor tenant’s lease:

“Landlord shall not be required to impose on Tenant or any other tenant of the Building, requirements for Tenant or other tenants to comply with any certification requirements under the USGBC’s Green Building Rating System or other green or sustainable design elements.”

Long story short: his firm interprets this clause to mean that the landlord is blocked from employing any O&M practices, which would help the building to perform to the level expected from it’s LEED certification. To them, the language allows the tenant to object to any measures employed by the landlord that can potentially affect their costs in any way, no matter if those measures even benefit them down the road.

The building is LEED-NC certified and now the property buyer is faced with the reality that — if they wanted to get a LEED-EBOM certification or even just an Energy Star qualification — which, in their view, helps preserve value over the holding period, absolutely every tenant in the building is explicitly not obligated to cooperate with any measures the Landlord would introduce to achieve those certifications.

Moreover, they also worry that investing in the asset marketed as LEED-certified, with the full knowledge that achieving environmental performance is effectively impossible, leaves them open to being thought of as greenwashers.

As a result, our colleague and now his superiors have adopted the opinion that the LEED certification on this building is essentially worthless. Moreover, they don’t see any way to proceed with the acquisition because they will have to wait nearly ten years until the anchor tenant’s lease expires in order to change this clause, which prevents them from working with every single tenant in the building on this matter.

The investment is fundamentally flawed, doomed to a lifetime of discounted rents and sales prices any time other tenants and future buyers figure this out — or until that lease clause is changed. It could be completely non-competitive on energy performance within its submarket by then as all the other landlords will have been able to easily write leases which assure the landlord the ability to institute O&M expected of green buildings, making this asset the market laggard and — relatively devalued at disposition.

Ironically, any appraiser would typically ignore this in their valuation of the project since absolutely none of these issues would hit their traditional underwriting radar. They would have to be sensitized to the connections between sustainable design, O&M, building performance and related contractual lease obligations to figure out the true negative impact of this clause.

So the seller, after spending so much time marketing the building as a high quality, LEED-certified asset now must move on and find a buyer, who is not as sensitized to the de facto devaluation of the building, and willing to pay his sales price.

Kudos to this investment analyst and his firm for doing the right thing, both financially and environmentally. Green buildings made brown by bad lease language shouldn’t be rewarded with top dollar purchase prices.

In the meantime, please take this as a cautionary story about actual underwriting issues that can come up with green building investments in today’s market.

Green building investment an ‘affordable truth’

Did you catch Paul Krugman’s op-ed in the NY Times this past Sunday?

Essentially, he says that going green is more affordable than certain folks would like for us to realize. Moreover, he thinks that the investment that would be required by buildings to go green would provide a great “organic” stimulus for economy (excuse the pun).

Consider, for example, the case of investment in office buildings. Right now, with vacancy rates soaring and rents plunging, there’s not much reason to start new buildings. But suppose that a corporation that already owns buildings learns that over the next few years there will be growing incentives to make those buildings more energy-efficient. Then it might well decide to start the retrofitting now, when construction workers are easy to find and material prices are low.

The same logic would apply to many parts of the economy, so that climate change legislation would probably mean more investment over all. And more investment spending is exactly what the economy needs.

Big Landlord’s: “It’s LEED or bleed”

Thanks to Greg Porter, of MP Commercial Partners, for sending along the WSJ “adver-journalism” piece featuring several large landlords and the USGBC. It contains a good lineup of industry pacesetters who build and/or retrofit green and have seen a boost to the bottom line from operating environmentally friendly buildings. Essentially, it was a “get on the bus” writeup, encouraging environmental certification of buildings.

Remember that I asked in yesterday’s post, about whether Bloomberg’s pullback on mandating green retrofit mattered for large landlord crowd? My take: the horse is out of the barn on greening buildings and they were under pressure to keep up with the Jones’.

Read what the landlords in this article have to say — even though they’ll continue to push for more incentives at every government level — since their reports of overwhelming tenant and resident preference for green and energy efficiency buildings basically mean that a LEED or Energy Star certification is just the price of entry into the big ticket game.

Then and now

A few years ago I was on a panel that was moderated by an industry icon. Cap rate compression was still the hot thing and sustainability was pretty much ignored in real estate circles.  The moderator asked me (then a lender) if I thought green buildings would ever be worth more than conventionally-built assets. I told him that conventionally-built assets would probably start trading at a discount once enough green buildings were up and running. I’ll never forget him looking at me as if I had two heads.

Today’s WSJ article contains the following quote by Dave Pogue, of CBRE:

“This is a growing movement,” he concludes. “If you don’t improve your buildings to a good standard, there will be a market penalty. We’re already at a point where sustainability gives you an edge.”

Good to see that I probably won’t have to endure panels like that one any more.

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