Green Business Case Starts with Critically Questioning Your Base Case

How do you get more value from your green business case?

Real estate investors like to say that you buy most of your value in a good deal at the time of purchase. In short, buy for the right (read: low)  price.

When it comes to determining the added value that sustainability brings an asset, we’re finding that a good deal of the value is often hidden in the base case. Because there’s often more cost and downside risk trapped in there there than the typical pro forma projection indicates. And keeping that information hidden unfairly penalizes the green business case.

The base case should reflect the most accurate economics and total value creation possible by building and operating the asset as a conventional building over the holding period.

Examples

Here are a couple of basic ways that base cases often bury the true risks and costs of  doing business as usual:

One problem we frequently see is that future operating projections do not trend energy and water costs at an accurate rate of inflation. For the most part,  energy and water costs in many markets are increasing well above the rate of inflation. However, lots of practitioners still apply one static inflationary rate — usually the CPI — to all income and expenses for the asset’s entire holding period.

Fighting climate change has caused many state and regional authorities to introduce new regulatory frameworks aimed at improving land use, transportation, building codes and even cap-and-trade frameworks. Take California, for example. The AB32 legislation  has been clearly designed to have a systemic effect on where we locate, how we build and commute to buildings. Most of these regulations have announced implementation dates well within the next ten years.

Even though it might be difficult to predict exactly how these regulations will change market forces over the holding period, the base case discounted cash flow, in California particularly, should also recognize the impact of long-term systemic changes to the project’s marketability due to changes to broader market systems and demographics, such as those being introduced by AB32-related legislation.

Lots of investors haven’t yet begun to explore the effect these issues have on doing business as usual — only adjusting terminal cap rates over a ten year holding period by the typical ~50 bps, reflecting a “same old same  old” point of view about their asset’s future.

While the investors cannot predict ten years into the future exactly how much of a direct change to exit risk these actions might have, leaving these issues altogether ignored unintentionally, and unfairly penalizes the green business case.

So it’s amazing to us that — even as commercial real estate is in the midst of a great strategic disruption, due to green building as well as capital markets forces — investors still prepare pro forma operating projections as if nothing’s ever going to change.

What Kind of Market Will We Be Selling Into?

Take a look at “Connected Real Estate”, a collection of essays by subject matter experts, edited by Kevin O’Donnell and Wolfgang Wagener.

In it, the authors and Cisco Systems lays out many ways that technology and connectivity will drastically change the expectations of building construction, operation and workplace activities.

In addition to Cisco’s marketing of building internet services, the book includes some pretty sobering ways that information technology will impact the ‘business as usual’ case for conventional buildings.

One graphic called “Where Work Gets Done in 2010″, presents the following estimates of where work happens next year: corporate facilities, 40 percent, in between, 20 percent, and at home, 40 percent.

If 40 percent of work gets done at home by 2010 (basically now), what will the need for space in your property’s submarket be like over the next ten  years?

Other quotes:

We think of buildings with technology as one combined solution. Unconnected buildings are pieces of concrete and mechanical equipment, and of no use to anyone.

We believe that the move to smart buildings will be driven by the home.

These are all bold opinions, which support Cisco’s business model, but also highlight the need to critically question how much of the conventional building’s base case will really be valid throughout the coming decade.

I think not much.

Photo credit: Flickr - Kunsthaus Graz/Fatlum

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Reminder: Let’s Talk About Your Leadership

Come see my talk with Kira Gould and other Sustainability Leaders at OWA on 18 August 2009!

This is a last call to come out and join the discussion on leadership and collaboration within sustainability  tonight  (18 August). The link above includes info on the event location and registration.

I look forward to seeing you there.