Mandatory NY green retrofits R.I.P, but does it really matter?

Blowback from NY building owners forces Bloomberg to drop mandatory retrofit proposals.

But, does this really matter for green building?

Mayor Bloomberg had to scale back his announced plans to require New York building owners to obtain energy audits and, based upon the results, require the owners to perform the upgrades suggested in those reports.

(Note: This particular item has been sent to me from several sources, so I’m compiling and can’t link back to any specific source).

Fact pattern:

• Mayor’s plan would have affected some 22,000 buildings in the city; reportedly creating 19,000 construction jobs
• Above statistic vigorously disputed –> “I’d be shocked if 5,000 of those jobs were created” from Louis Coletti, president and chief executive of the Building Trades Employers’ Association
• Funding the bills that would have created the program really stirred the pot –NY only has $16 million stimulus funding for loans to building owners for this type of work, but the estimated total investment required for the retrofits was calculated to be nearly $2.5 billion

So now the debate rages over what this all might mean for green building. Is the Bloomberg retreat damaging for the advancement of green building?

In general no, but it did highlight the plight of an often overlooked group of property owners.

New York’s pullback from requiring the retrofitting of existing buildings doesn’t mean much, in the sense that so much industry level data and momentum has been generated about the positive economics associated with the energy efficiency of buildings, that larger, quality landlords will retrofit it anyway (albeit according to their own schedules). They’ll do it because they fear devaluation of their assets within the global investor circles they travel.

More importantly, they are more likely to be capitalized in a way that allows them to implement retrofits along a decent timeline. I’m saying here that real estate cycles will force them to pony up the cash just to “keep up with the Jones” and maintain property values as real estate markets recover and investors expect rents and values to grow.

Mid-sized landlords have a different reality. Many cities are just now waking up to this. Their smaller property sizes and smaller portfolio’s make them more cash constrained. The industry owes it to these landlords to come up with existing building retrofit solutions that fit their wallets. Many mid-sized landlords own buildings larger than Bloomberg’s suggested 50,000 square foot threshold, but the costs and fees associated with implementing the retrofit are still expensive for them.  They would have been very hurt by this legislation.

The lesson I see in this is about how much of successful green building and energy efficiency retrofits (and their finance!) is about growing  partnerships within markets over time. Exuberant public officials who only propose requirements, but haven’t created the deep, lasting partnerships with the real estate community necessary to support these kinds of efforts find themselves in Bloomberg’s situation — announcing pullbacks even as experts have clearly demonstrated the excellent economics that building owners can enjoy if they retrofitted their assets.

More clearly for me, is that other cities should take a closer look at making sure that their engagement of real estate owners is differentiated between larger and smaller property owners. Larger owners often deal with different kinds of shareholders and the size of their assets gives them more cash flow on hand to consider retrofits.  Plus they are getting pressured by even larger shareholders.

Smaller property owners need special attention, and services tailored to their specific needs. They are much more cash constrained. Yes, in California and some parts of the Northeast, PACE loans are helpful for these types of building owners, but PACE is still a new phenomenon and not available everywhere.

In the meantime, let’s hope that officials in other towns are involved in more relationship building within their own markets, so that they are able to come up with green building plans that make better sense and therefore, might be more palatable to the local real estate community.

Tax credits for green investing by insurers — we’ll pass

The availability of appropriate insurance coverage is a key risk issue that affects the overall value of green buildings and their financing.  Without proper coverage tailored to a green building’s technical features, green building owners might be exposed to losses on sustainability-related systems that can’t be recouped via an insurance claim.

At the end of the day, that leaves lenders and investors exposed to losses on those features, which inherently reduces their value and presents a barrier to advancing green building.  So appropriate “green” insurance coverage is key to assuring the proper financing and valuation of green buildings.

Skip Rawstron of InterWest Insurance Services of Sacramento, sent around an article detailing efforts to require the California insurance commission to study various sustainability risk issues tied to insurance coverages. The article (request it from us here) shares a laundry list of hearings that the insurance commissioner would be required to hold if the legislation passes.

The following snippets from the proposed legislation reveal the lawmakers focus on trying to attach advantages to green finance and investing as well as levy costs on those insurers continuing business as usual. Specifically the law, if passed, would:

• Require the insurance commissioner to hold hearings on the risk, costs and claims associated with green buildings.
• Require the insurance commissioner to conduct hearings regarding the health impacts on workers in green buildings, and use the information in establishing the Workers’ Compensation Claims Cost Benchmark. [our note: wow!]
  
• Offer state tax credits to insurance companies that invest in financial institutions that provide products designed to protect the environment and support renewable energy.

Now here’s the rub:

The concept of encouraging insurer investments in banks offering green products is a novel pass at trying to influence market forces in favor of both ecologically-friendly insurance and green banking products. Lots of folks have been talking about similar moves.

But despite being a big fan of incentives and novel financial mechanisms, I don’t think that using already strapped state funding sources to effectively pay insurance companies with tax credits to make those investments in banks is the way to go. Actually its surprisingly cheap.

Insurance companies are not hurting for cash in any respect, so there is no need to bribe them into green investing with tax credits. Everyone knows that tax credits are really a short-term play and we’re at a place where longer term financial mechanisms are needed to advance sustainability. And banks are not reluctant to offer green credit products due to lack of investment by insurers. They haven’t made that leap for other reasons that we’ve covered in other posts.

On top of all of that, the increasing availability of insurance products, well ahead of the banking industry, only convinces me that the insurance industry already sees green insurance products as  being both necessary and profitable.

Please email us to request the article, since Skip sent it to me personally.

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Will the Economic Slowdown Grow or Slow Green Real Estate?

No doubt these are challenging times for the US commercial real estate market. It’s been a tough go since the start of the real estate credit crunch during the summer of 2007, and it’s not likely to improve in 2009.

But what does this slow down mean for sustainable real estate?  Will conventional and green commercial real estate come under the same pressures? Will the growth of green be derailed as investors, developers, and even tenants, quickly transition into survival mode?

Recently, several industry practitioners have prognosticated on how green will weather the storm. The verdict? It’s mixed.

In an article from Costar, titled “Amidst Deepening Recession, Green Fights Back“, industry experts argue that the tremendous growth in buildings registered with green building rating systems in 2008 are a testament to the continued growth of green during the slowdown (GEC note: The 2009 numbers will be more relevant). But an across the board decrease in construction starts will slow down green new construction, shifting the focus to existing assets.

In a tenant’s market with rising vacancy rates, portfolio managers would be smart to green their existing assets in order to keep tenants from leaving for greener pastures. According to David Pogue, sustainability director at  industry pacesetter CB Richard Ellis:

“If you’re going to compete today at the upper end in most of these markets against new product, that requires existing buildings to also be more sustainable.”

The National Real Estate Investor sees both challenges and opportunities for green in 2009. In the article “Green Building Industry Wrestles with Recession”, industry sources see lenders coming back online and considering deals again in 2009.

Unfortunately, while lenders may loosen up their purse strings, deflating energy prices may prolong expected payback periods for renewable energy systems and for green capital improvements in existing assets, lowering the returns from such investments.

The GEC Take

We don’t have a crystal ball, but we do see several things for green real estate during the downturn:

• Green will gain ground versus conventional real estate: We can only guess as to how long the deterioration in the commercial real estate markets will last, but we are confident that sustainable real estate will continue to gain market share. Any equity capital available for new construction is pretty much earmarked for green buildings.

• (Green) Cash is King: We see lots of players working very hard on a compelling LEED-EBOM investment strategy  for their portfolios.  Face it, most of the money that is active these days is chasing cash flow as opposed to taking the risk of a long development cycle. As one fund investor told us, “we need to see a real meatball (his private slang for real cash returns) on any deal we’re lookin’ at”. So creating additional cash flow through greening existing buildings satisfies the fundamental needs of investors active in today’s real estate markets. Meaning: there’s a tangible reward for becoming good at existing building retrofits and certification.

• Green incentives will grow: These programs will expand and bring more capital to the sector. At the federal level, the Obama administration has recently indicated that energy efficiency will be a big part of a stimulus package in early 2009. The October renewal of federal tax credits from the Energy Policy Act of 2005, set to expire at the end of the year, was a good first step.

• Green regulatory risk will grow: At the state and local level, sustainable building and higher energy efficiency are becoming mandates. While the real estate downturn means that reluctant developers and investors will have a stronger case to argue against new green building regulations, they will ultimately not prevail.  The governments that we’ve worked with have aggressive timelines for green regulation, and intend to move forward quickly.

• Green will rebound faster from the downturn: There is an established preference within the marketplace for green space. When demand increases, green space will go first. This is an advantage to the first-movers who can build green with minimal to no cost premium.

For more insight on future trends in sustainable real estate, be sure to look out for our 2009 prediction post at the end of this month.

What’s different about underwriting sustainable real estate?

Do you see the unique value that green brings to your real estate investments reflected within their appraisals? No? Well, join the big crowd and read on: this is a special post for you.

Not everybody in commercial real estate is immersed in gloom and doom. Some folks, like the Appraisal Institute, are using the downtime coming from fewer transactions to get themselves fit for the sustainable real estate future. In case you missed the announcements, the AI is in the midst of a series of classes for their members, to introduce them to sustainability principles and the basic considerations for appraising green buildings.

I’ve had the chance to talk with the seminar’s co-developer,  Theddi Wright Chappell, Cushman Wakefield’s new National Practice Leader for Green Buildings & Sustainable Real Estate. The overall course is framed around the question “how is a sustainable building different?” than conventionally built property.

With good questions focused around understanding the differences, appraisers will be more likely to surface up more relevant facts that help them to better distinguish the risk profile of the green vs the non-green building.

As for the potential differences, any of these may be present within the green transaction:

• lower exposure to energy and consumables costs increases
• potential for greater construction and delivery risks, depending on factors such as availability of trained professionals
• different pattern of lease-up and absorption risks
• different pattern of tenant retention and turn-over risks
• different pattern of periodic capital improvements
• lower exposure to obsolescence.
  

The Green Journey Take

This is just a tidbit of the considerable body of knowledge that Theddi and her AI colleagues have packed into this very timely course for those just getting into the green real estate game.

Within our own practice, we typically receive detailed investment cases from clients for green buildings, which completely overlook any type of enhancement that sustainability brings to the assets. Nearly 100% of the time, some portion of our investment client work involves working with the the investor to “connect the dots” between the green building’s design and construction budget and the operating pro forma assumptions during the holding period. The clients rightfully want to know how appraisers might handle these same issues, under the logical (but incorrect) assumption of if the appraiser won’t count it, why should we do change our underwriting? So, from our point of view, it is good to see that the AI is helping to address this question with their new course.

What can you do? Talk with your appraisal colleagues about how they might evaluate sustainable real estate and urge them to take this new course, if they have lots of questions.

Jean’s Question: Anybody Actually Getting Carbon Credits for Green Buildings?

Gotta love the creative local church marketing campaign! Photo credit: Mykl Roventine

In any situation, you always wanna hang with the folks that ask the tough questions — they’re usually closer to the real answers. Like Green Journey reader Jean Shia, of Avant Housing, a CalPERS fund based here in San Francisco.

She asks,

“We are interested to see if anyone has been able to figure out a way to get carbon credits on their green buildings. Is there anyone pioneering this area?”

Fascinating! We were pretty sure that lots of people would be curious about this one. And a big thanks to my colleague, George Vavaroutsos, for putting in some research time, talking with a several carbon traders to get the real story on what’s happening. Here’s the deal:

You’ve Missed Nothing So Far, And Now’s the Time to Stay Alert
Turn’s out that there is limited information in the marketplace about sustainable real estate and the carbon markets. No wonder, since there are significant challenges to property owners and developers who want to receive credits for greenhouse gas (GHG) reductions. Carbon trading experts we spoke with cannot identify a single sustainable real estate project in the US that received credits for GHG reductions.

So what’s the holdup? There are a few issues:

Measuring and Verifying GHG reductions: Measuring reductions, and the ownership of these reductions, is one of the biggest challenges. Quantification is an involved and difficult task, and there is no guarantee that auditors will accept reductions. In addition to verification being prohibitively expensive, current methodologies and standards for measuring GHG reductions do not cater to real estate.

If a developer wants GHG credits for sourcing, production, and transport related GHG reductions, it may be a challenge to quantify and satisfy ownership requirements for these reductions. Additionally, the GHG reductions may not be enough to justify the cost of verification. Note: Talk directly to a third party verifier about your GHG reduction objectives. Here is a link to the California Climate Action Registry Verifiers list.

The “Additionality” Clause: Another major limitation to developers is the “additionality” clause, which requires that in order to receive GHG credits, a carbon-reducing measure would not be implemented if not for the credits that would fund such a measure.

Therefore, if you have a project that will reduce your property’s energy usage, but you will recapture your additional capital outlay with increased operating efficiency over X years and improve your ROI, then the project will not pass the additionality test, and you will not receive the credits. Yep, its pretty technical, we know.

Future Legislation: A US cap and trade system is considered likely by the carbon trading market. I posted a couple of days ago about California already forging ahead. Buyers of GHG credits will not consider many voluntary emission reduction (VER) credits, given the uncertainty created by these expectations. Experts do not expect a sustainable real estate GHG credit mechanism to develop until after a national cap and trade mechanism is implemented.

Industry Pacesetters on the Carbon Trading Front

There are several developers who are pioneering in the field of GHG reductions and credits. ProLogis and Liberty Property Trust, both REITS, are registered entities on the Chicago Climate Exchange, a voluntary cap and trade market.

Both REITS are working to create ownership over the GHG reduction credits their properties are helping to create. ProLogis leases rooftop space on some of their industrial properties in California to Southern California Edison. This renewable power helps satisfy the renewable energy credits (REC) requirements for California utility providers. This arrangement is creating GHG credits, but they are accruing to the power company, not ProLogis.

Stay tuned for more updates — as I’ve already posted, we’re expecting lots to happen on the cap-and-trade front!

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