114 million ways the AI is helping green building

“What’s the use of investing in a green building if you won’t get the benefit of any added value from the green features?”

That question presumes two things: 1) that green features always cost more, which is not true and a topic for another day, and 2) that the market does not accurately differentiate the financial benefits that green buildings add to the owner’s bottom line. At the present time, this is very true.

I don’t know anyone who hasn’t pointed out how hard it is for investments in green building and energy efficiency retrofits to scale up without the appraisal community providing that crucial feedback loop — property valuations that consider green strategies in place. Without this, banks and other capital providers have a hard time deciding how (much) to lend on and invest in sustainably built real estate.  That perpetuates the status quo — wasting resources, capital not flowing towards green real estate and continued community decline.

Here’s a first step towards addressing that problem on the residential side with potentially huge impact. The Appraisal Institute has just released a Residential Green and Energy Efficient Addendum, to help structure the way that appraisers can consider many typical green and energy efficiency features within their valuation of residential properties. While this is probably a first step in the AI addressing green residential valuation issues, when you think about the fact that we have 114 million residential structures in the US, this “little” form can help the trillions of dollars of US housing and mortgage market investors actually see the impact of their decisions (or non-decisions) about energy efficiency and green design features.

I know that similar efforts have been underway for commercial real estate valuation, too, for quite some time. We’ll keep sharing the word on that, but in the meantime, let’s appreciate the progress the AI has made with this closely linked milestone.

P.S.–> Go to the EIA’s Residential Energy Use Explained (the source for today’s image) for good download on energy use in the residential sector. 114 M residential structure estimate taken from 2009 RECS data tables.

What’s the right way to grow energy efficiency finance?

In the last issue of Pacesetter, I talked about how we need to identify the right underwriting behaviors that need to accompany our evaluation of green properties.  Pacesetter Nancy Anderson, Executive Director of the Sallan Foundation, replied with a link to a panel session she’d moderated that focused on the same issue, but from a variety of perspectives.

Called Reimagining the Metropolis — No Joke, the session featured three panelists with different areas of energy efficiency finance expertise sharing their perspective on the approaches they saw as being critical for growing a liquid market for energy efficiency financial products and services.

Which idea will have the most impact?

The three big ideas boiled down to:

More data and best practices for lenders - Sam Marks, from Deutsche Bank Americas Foundation, talked about how their Living Cities project was in the process of studying and aggregating  benchmarking data on housing energy efficiency performance. That benchmarking data, should cover 12,000 multifamily units. It will eventually identify best practices for lenders.

More data, particularly for the multifamily market is desperately needed. I have to add, though, that any such project should ultimately focus on satisfying the needs of appraisers, since any regulated financial institution ultimately relies on an appraisal in order to estimate how much they will lend on the property.

Teach lenders how to incorporate energy efficiency within underwriting - The Community Preservation Corporation’s Sadie McKeown showed how underwriting for energy efficiency finance is not as hard as it seems, plus pointed how how scarce incentives really are. Their approach included training their own staff in the benchmarking process.

Both of these comments are very close to what we cover in our Competitive Edge Green Finance Workshops, where we teach how to develop a green building business case. I also think that, given the level of  inefficiency “trapped” in so many of our buildings, the upside in energy efficiency is actually in retrofitting the building and obtaining better performance and higher value, as opposed to cashing in incentives.

Tougher regulations - Attorney Lawrence Schnapf talked about a pathway of tougher policy and regulation, such as tougher building codes and ordinances, which will simply force investors and financiers to deal with lower energy assets, “like it or not”.

This scenario has already been presumed by so many green building advocates, that you might be tempted to skip it, but don’t. It’s still significant because you cannot simply assume one particular market action in isolation. My investment and lending experience has shown me that most surprises come in two’s or three’s. That is, you have to be able to think about the impact of tougher building energy regulations happening at the same time as other tough scenarios, such as a long-term lack of credit and/or even greater water shortages.

Or, all of the above

Actually, the above approaches should not be viewed as an “either / or” type of choice. Based upon our view of the market, all of the above will have to be interacting together for a sufficient duration, in order for us to see a liquid, fairly-priced market for energy efficiency financial products supporting U.S. real estate.

Your thoughts?

Can private real estate make a bigger impact on housing affordability? Share your views.

Today I’ll be speaking at the NeighborWorks Symposium: Investing for Impact in Sustainable Communities and that provides a great opportunity for you to send in questions and thoughts on the topics they are covering.

I’ll add your questions to others I already have and will get the answers from speakers during the day — sharing them back on Twitter or via a blog post about the event later.

NeighborWorks has put together a unique event, with an agenda that sports quite a few sharp teeth.

Starting off with a keynote from Angela Blackwell, Founder and CEO of PolicyLink, the symposium dives deep into several interconnected aspects of housing affordability, with the goal of generating actionable ideas on next steps to improve the impact of investing in housing affordability and sustainable communities.

Symposium topics include:

• the proposition that greater investment in housing organizations is needed to assist the cause of affordability.
• the role of sustainable design in housing affordability.
• a look at our understanding of social returns from affordable housing and how can that knowledge stimulate greater private capital investment in the sector.

I am speaking on the last topic above, as part of a panel moderated by Nancy Andrews, of Low Income Investment Fund.  Since we are speaking in an open Q&A format, the specifics of our discussion on social returns will evolve from the input of all the speakers.

Tomorrow, I’ll speak about the tools from Galley Eco Capital’s work that non-profit housing groups can use to better engage private real estate investors on investing in rental housing and sustainable communities.

The graphic for today’s post is the title page of my talk, which will contain a good dose of material on triple bottom line metrics as well as the role of innovation within the discussion.

After the event, I’ll post a short except from the presentation, to continue the conversation on the role of  social returns within private real estate investment decision and if it is truly possible improve the way we invest in housing affordability and communities within the US.

Got any questions that you’d like answered on the above topics? If you send them to me, I’ll ask panelists and speakers during the day as time permits.

In any event, I look forward to hearing about your views on the topic.

I can post the answers either on Twitter or on a blog post for everyone later when the conference is over.

Stay tuned!

Put Fortune 500 Product Innovations to Work for Your Green Initiatives

Now that the economy appears to be improving, we expect billions of dollars of fresh capital to flow into green development and energy efficiency retrofits over the coming years.

However, we also know that many firms are still hesitant to proactively green their portfolios and financial offerings. We think we know why and have new tools to boost their confidence.

These practitioners are saying something that the green building crowd simply can’t ignore. They feel they’re in a Catch-22: they know their companies are at risk if they don’t go green, but they don’t have a clear view of the possible results of committing their capital to green investments at a meaningful level.

Even though researchers have published studies indicating that green properties earn an average 3% higher valuation, or 16% higher net operating income, that still doesn’t mean that you are going to make that on your properties. It doesn’t mean that your particular tenants are going to pay you more rent on a given date. Nor does it mean that you will absolutely realize these results upon sale of your particular green assets.

The truth that leaves these firms skittish is that realizing the value-add of green depends on many variables for which no data exists. Not only must you do the right things, but the sub-market around your asset has to do (enough of) the right things, too, in order for you to be properly rewarded for your sustainability initiatives.

That’s a very hard disclaimer for many investors, lenders and governments to tell their shareholders and voting taxpayers.

So we’re stuck, right?

No, we’re not. There is a much better way.

What Real Estate Can Learn from the Fortune 500

We noticed that leading global players – players like VeriSign, SAP, Genesys, etc. – face similar issues as commercial real estate investors.

They also have the predicament of committing billions of dollars each year to create new or revamp existing products and services in an unclear business environment. The B2B product development gurus who work for these companies told us about the secret sauce of their success – what has made the difference between so-so and blockbuster products, even when the economy is tough.

It turns out that Fortune 500 companies reduce their investment risks within new/revamped product and service initiatives by using sophisticated “voice of the customer research” (VOCR) tools very early in the design process. These tools gather how customers perceive and experience their products and services, which is perhaps the most difficult information to obtain. It is also the most valuable for developing new products and services – particularly the kinds of products and services that are very new to an industry, like green building and energy efficiency.

The B2B product development gurus stressed that these techniques minimize capital at risk because the company obtains key insights up front on what might enhance their product’s success with their customers. Products and services can then be further developed to fit customers’ needs as closely as possible. Often times, these methods reveal data about unspoken or hidden needs customers have never clearly expressed, leading to innovative product breakthroughs.

Galley Eco Capital has carefully adapted VOCR tools to work specifically for the real estate finance and investment sector as well as municipalities engaged in energy efficiency and green building programs. They are available within a branch of special services called Real Estate Innovation Advisory®. REIA now offers special collaborative forums that power green initiatives by enabling investors, lenders and governments to collaborate with their customers on their green space, investments, and service offerings.

Join an upcoming Mini-forum at Competitive Edge Workshop #3

If you are attending Competitive Edge Workshop #3 on June 24, you’ll participate in a mini-version of an interactive Real Estate Innovation forum titled, What Real Estate Investors Think about Your Products & Services (And How You Can Communicate Their Value).

Whether you are a real estate practitioner, investor, service provider or government employee, you will have hands-on involvement in learning how owners perceive green building products and services. You will take away insights about interactive forums as well as specific content that is immediately applicable for your own business.

Understand Your Customers, Minimize Investment Risk and Boost Investment Value

If you don’t have the voice of your tenants, borrowers, partners and customers influencing the development of your green building space, products, services and offerings, then you are missing an incredible opportunity to bring more certainty to your capital programs. You could also miss the chance to find more breakthrough ways to do smarter green initiatives.

Call me today to talk about how Real Estate Innovation Advisory® Services can help you gain clarity about enhancing your existing products and services or get customer input on new ones.

PACE inside baseball: Private-label securities to the rescue?

GSE’s bench PACE

If you follow the PACE saga — which we covered in February’s Pacesetter as well as in numerous posts before, you know that it’s attracted enough interest to keep us all hopeful about the prospects for a liquid secondary market for energy efficiency loans.

But, like any saga, there are always curveballs and intrigue to keep us wondering.

GSE’s (government-sponsored entities) Fannie Mae and Freddie Mac supplied the  action in this latest edition of PACEwatch.

They recently sent PACE financing back to the dugout, by declining the purchase of tax-lien secured energy efficiency loans on residential properties, citing concerns with repayment risk associated with the priority of the tax-lien over the senior mortgages.

No, folks,  the tax-lien-priority issue will not just get up and walk away on it’s own.  Market watchers quoted in the article point out that pricing in the theoretical risk and/or clearer underwriting to clarify the value improvements to the retrofitted properties could help the GSE’s and others buy into PACE-related debt.

IMHO, it’s going to take a solid mix of both approaches to get the secondary market comfortable with fund PACE paper.  Altering a senior mortgage’s status makes it tougher for the lender to price and re-sell their loans, even if retrofits improve property valuation. They’ll want compensation for what could be an important change to their contractual structure. It’s always been that way with modifications and I don’t think there’s anything wrong with a lender expecting to be paid a market return for agreeing to re-do a deal.

Additionally, requests to see, touch and feel (and standardize) the control of the retrofit value-creation process, beyond the theoretical math of energy savings is reasonable. Programs that dole out tax payer dollars without robust underwriting and performance measurement are setting themselves up for failure.  No matter how smart we become every economic cycle, a certain percentage of loans typically fail for the same old reasons.  “Failure to properly monitor” loans is one of the oldest, and most typical paths to default.

So, while I greatly wish to see lots more capital flowing towards PACE financing, I still think it’s prudent for any lender to request clarity on the loans they buy and to be paid the right price for the risk and underwriting.

Inside baseball: private-label securitizations to the rescue?

That being said, I suggest we keep our collective eyes on the private-label securities market as an alternative funding source.  Yeah, I know it’s been dead since the economic downturn, but that would be the alternative for PACE to build up a liquid secondary market as long as the GSE’s aren’t stepping up to buy energy loans.

And the idea’s not so far-fetched since the private-label market is now starting to show signs of life.  While the GSE’s are definitely big players in the residential mortgage secondary market, which reached $2 trillion at it’s height in 2006, private-label securities were responsible for as much as 56% of home mortgage securitizations during the same time frame.

Today’s WSJ details how Redwood Trust is taking a shot at offering ~$200 million in jumbo residential mortgages in a private-label sale. This will be the first sale of private-label mortgages in two years. Market watchers say that the timing seems good for private-label securitizations to make a comeback, now that the homeowner default surge that killed the market a couple of years ago has receded. Add to that, the currently tight underwriting guidelines in effect, which strengthens the credit quality of these loans, making them attractive to secondary market investors.

Note that this particular transaction is not a done deal yet, and Redwood may have to postpone the transaction if they can’t generate sufficient interest in the offering.

For us PACE fans, however, this is bit of side action is worth tracking. The private-label securitization market is another potential source of secondary market liquidity, if the GSE’s continue to reject energy efficiency finance.

I’m willing to bet, however, that private-label market will be just as tough on conforming documentation and tight underwriting guidelines. If investors are now able to buy into residential mortgage paper structured  with tight underwriting and and high credit quality, what will compel them to give that up for PACE-paper?

Nothing, I think.

Nonetheless, the game is not over and we’ve still got several more innings to go.

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