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.

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.

Be a tenant and investment hero with these Empire State Building retrofit tips

Heard at ULI Fall 2009 session: “Green Retrofits: What is making this the wave of the future?”

I went in to this session thinking that I’d already heard all there was to know on the well-publicized Empire State Building (ESB) retrofit. I’m pleased to report that my assumption turned out to be wrong … this session was a thriller; a high-protein download with lots of how-to’s that practitioners can use to be a tenant hero and  improve value with a comprehensive energy efficiency retrofit strategy. A thorough reporting of all the great tips would be too long for this post, but I think you’ll be able to put these highlights to good use:

The Set-up: A Great Business Case

Anthony Malkin, of Malkin Holdings spoke on behalf of the ESB ownership. The other speakers were representatives of New York City, the Rocky Mountain Institute and Johnson Controls.

The Empire State Building was already going through a $550 million repositioning, managed by Jones Lang LaSalle, before the ownership began to consider an energy efficiency retrofit. Since capital was already available for retrofit, no outside financing was needed to pay for the retrofit investment.

The team reported that the retrofit added nearly $13 million in upfront costs, with calculated savings worth $4 million per annum, so, the overall retrofit metrics are great, with the team reporting strong economics:

• Building annual energy costs were $11 million p.a., or 88 kBtu/sf/yr.
• 38% annual reduction in energy usage is projected; almost double the industry average.
• 3.1 year payback vs average 10-20 years.

Top Energy Tip: Reduce Load and Use

The evaluation of an aging chiller showed that the retrofit team can’t only focus on ‘easy’ measures such as changing light bulbs to achieve energy savings. The better business case comes from investing opportunities to reduce the building’s energy load, in addition to use. In the case of the ESB,  $40mm was slated for new chillers in a cooling plant, but load reduction measures elsewhere eliminated need for new chillers (!)  Result: Existing chillers were retrofitted for $5mm.

Tenant Relations Hat-trick

Investment real estate is only as valuable as the bundle of leases that generate rental income. So, many owners are motivated to green and/or retrofit their buildings when they know that it will help them to keep existing and/or attract new tenants. The trick is to get tenants on board with doing their share to keep energy costs down. When discussing retrofit costs/benefits with tenants, the ESB team focuses on the three drivers of tenant occupancy costs: payroll, utilities and rent.

In the case of the ESB, tenant buy-in on retrofit measures was crucial, since analysis revealed that more than half of the energy conservation measures would take place in the tenant’s space.  The team discussed three interconnected programs they use to assist tenants with reducing energy within their suites. The bonus they discovered is that word of these programs has attracted the attention of brokers and prospective tenants that typically would not include the ESB within their search for new space, so now the building has become competitive with a larger universe of possible tenants than prior to the retrofit.

Here are the three key tenant-related programs:

1. Pre-built space: Vacant suites were pre-fitted to turn-key status for prospective tenants, containing many features which would aid tenants with maintaining energy reduction upon move-in.
2. Tenant design guidelines: For tenants that build out their own suites, the landlord’s design guidelines incorporate energy efficiency measures
3. Tenant energy management program:  The ESB team developed a special energy management guide to help tenants understand how they use energy; they also give the tenants reports about their energy usage within their space, telling them how their energy use compares with the building average.

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Use these metrics to measure your portfolio’s triple bottom line performance

Get this new research on metrics that helps you measure property triple bottom line performance.

We are pleased to share a new report titled, Metrics for Responsible Property Investing: Developing and Maintaining a High-Performance Portfolio.

You can download the report here.

This research was co-authored by Jean Rogers of Arup, David Wood of the Responsible Property Investing Center and myself. This is a working draft for comment that was presented today (4 November 2009) to a joint session of ULI’s Responsible Property Investing and Sustainable Development Councils.

Why do we need metrics for triple bottom line investing?

Our survey of the industry indicated that the spread of triple bottom line investing was being hampered by the fact that most currently available real estate sustainability reporting came from investors who would green a couple of showcase buildings in their portfolios.  This lack of transparency leaves the broader real estate industry and capital markets with several pressing problems:

• They cannot determine if sustainability performance on the portfolio is improving over time.
• They do not know how the portfolio’s green performance compares with the portfolio’s of other investors.
• There is no way to judge sustainability risks hidden within any portfolio.

Drafting and road-testing proposed metrics with the Bay Area Council and TIAA-CREF

After developing a set of metrics that would represent the ten RPI principles in action, we worked with the Bay Area Council Family of Funds and TIAA-CREF to road test them, to obtain real world feedback from actual investor users.

Bay Area Council Family of Funds tested the metrics on recent acquisitions to see how the metrics might be useful during the property acquisition process.

TIAA-CREF tested the metrics on a portfolio of properties they own, to determine how the metrics could possibly assist them with asset management activities.

Both investors were also at today’s ULI session and provided in depth comments on the use of the metrics and their recommendations.

Key takeaways

Here are a few of our findings based upon investor feedback about their use of the metrics:

• RPI metrics do provide a tangible link to asset and portfolio value by pointing to possible decreases in operating expenses and/or increases in rental revenue.
• The use of RPI metrics can assist with opportunity finding: a key objective of due diligence during  acquisition.
• The use of RPI metrics can help drive social responsibility within the portfolio, instead of just monitoring it after the fact.

We need your help!

This report is currently a working draft for comment. It was submitted to members of the Sustainable Development and Responsible Property Investing Councils for their review and comment. We would also appreciate hearing the comments and questions of real estate investors and practitioners within the Green Journey community.

Let us know your thoughts about these proposed metrics. Also feel free to forward this report to anyone in your network whose practice might benefit from the information.

We look forward to hearing from you and will keep you updated on this effort as it evolves.

You can download the report here.

Related reading:

• We’ve covered the emergence of responsible property investing many times before.
• You can also view a short presentation on the basics of responsible property investing here.

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German funds step up sustainability screening for decision making

If you only read about US real estate investors, you might have the opinion that the real estate community is still undecided on the topic of embracing green building.

One stack of articles will quote investors talking up their green building programs.

In an equally thick stack of quotes, they complain about green building or energy efficiency costs.

In Germany, however, investors are more outspoken — favoring increased green and energy efficiency screening and investment criteria.

According to Germany’s Handelsblatt, European real estate investors are quoted as increasing their screening procedures and criteria for green buildings and energy efficiency. Per the Handelsblatt (our translation):

German open-end real estate funds are increasingly applying social and environmental criteria to their investment decision making. These criteria are also playing a growing role in portfolio management procedures.

Five funds are quoted as discussing their use of green and energy efficient criteria within their investment decision making: Pramerica, UBS, Union Investment Real Estate, Axa Real Estate and Commerz Real.

What are the funds reported activities?

• Union Real Estate utilizes a sustainability screen at acquisition. Existing buildings which do not meet their minimum energy efficiency criteria are rejected.
• UBS uses different checklists for suppliers, tenants, project acquisition, leases and building performance to monitor and enforce sustainability standards.
• Pramerica Real Estate’s investment policy within its TMW World Funds has been adjusted so that sustainability screening is conducted for all new investments as well as on the existing portfolio. Due to the fact that there really aren’t enough green buildings in existence for investment, they also check non-green investments at acquisition to make sure that they can be greened once they are in ownership.
• Axa Real Estate had its own sustainability ratings system developed and is currently testing its portfolio.
• Commerz Real reports that sustainability criteria has an increasing influence on investment decisions, since they notice that more tenants desire renting within green buildings.

While you might encounter US investors without a firm sustainability policy, it appears that if you wish to do business with German investors, you had better have your (or their) green investment checklist ready.

This is particularly interesting because several of these funds have had successful capital raises. With US real estate (and the dollar) getting cheaper, it will be interesting to see what happens when these foreign investors start looking to the US for good deals — with their sustainability criteria in hand.

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