Housing Developers: Preparing for Opportunities During the Downturn?

So I heard Bob Gardner, of RCLCO, give a presentation about the state of the multifamily market and trends at the ULI Multifamily Trends conference today. Turnout was good, albeit with a somewhat subdued mood overall.

One of my friends summed it up this way, ” there’s a lot of folks in this room who are hurtin’ right now”. The more positive statements by the groups who reported that their business and portfolios were still performing well went something like, “we’re building out product that we’ve committed to; beyond that we’re staying on the sidelines”.

All that being said, a couple of mezz guys said that they were getting steady calls to assist with recapitalizations that couldn’t be accomplished through the senior debt channels.

The Sunny Side of the Housing Downturn

The bright side offered by Bob and several of the other speakers was that many real estate fortunes have been made during a downturn. Bob’s example: low land prices in the early 1990’s set up master developers for many years thereafter. Hmm… good point; so I started taking notes.

He pointed to Gen Y as one of the largest opportunities out there right now and that real estate developers and investors would be wise to study up on this group and prepare for the significant impact they might have on how and where real estate will be built in the very near future.

Basic Gen Y 101–> Here is a presentation that will give you the GenY download.

Here are a few notes on Gen Y’s demographic characteristics, which strongly favor green and sustainable real estate investing:

• This group of consumers is willing to pay for walkability and transit. They really value their time, so they are not big on paying for a big house and commuting. These types of issues receive great attention when siting sustainable investments.

• They are very into working from home. Having an office in a corporation is not as much of a big deal for them. (Cuts into their “me-time”.)  This also seems to add support to the low carbon information, communications and technology opportunities, talked about in my telecommuting post yesterday.

• They start becoming homebuyers in 2012 (!!). The green angle here is the “other green”. (Excuse the pun, I couldn’t resist)

Yesterday I wondered aloud about whether developers would start creating more live/work units that cater to home workers and families all in one. If so, make sure they’re sited in a walkable, transit-oriented location.

Based on what I learned today about Gen Y, it appears that this type of product is not some far off fantasy, but could present a mid-term opportunity. In any event, an economic downturn is a good time to study the opportunity and spend time positioning your firm to deal with this emerging demographic trend.

Energy Efficiency German-style & LEED Grows Legs

Last week, I moderated an energy efficiency symposium that brought together German and American building and energy experts. The Germans were here to sell us a few building energy products and services. The Americans were there to look and buy. After a few great presentations and some hefty debate from an engaged audience, I started synthesizing clear differences between how Germans and Americans approach high performance buildings.

So here’s a few statistics and slides from the presentations, to give you a picture of the current state of energy consumption, how its being reduced in Germany as well as some thoughts on why Germany and the US are achieving different results. Go here to the German American Chamber of Commerce Website to see all the presentations in full.

Germany & Japan Use less Energy to Create the Same Economic Value as the US Fred Pollack, an architect with Van Meter Williams Pollack helped frame the current state of energy consumption in the US with the following statistics from the International Energy Agency:

Energy Consumption, in $/Gross Domestic Product as of 2006:

• USA = 3.2 kwh/ $GDP
  
• Germany=2.4 kwh $GDP (25% less than the USA)
  
• Japan=1.5 kwh / $GDP (53% less than the USA, 37.5% less than Germany)

So Germany and Japan can create the same unit of economic value as the US for 25%-53% less energy than the US. When you add to that, the current fact that the dollar’s value has weakened sharply against both the Euro and the Yen over the past year, then the idea of the US economy’s exposure to energy price risk becomes even more concerning.

When it comes to energy security, Germans have been walking another road, at a faster pace, for decades. Historical context frames these ideas and you’re probably familiar with the American version. Both Germany and the US experienced severe energy price shocks during the 1970’s. This experience kick-started Germany’s national policies that mandated decreases in building energy usage. That success has supported a steady walk to some of the cornerstones of Germany’s great track record in lowering its fossil fuel dependency: the wildly successful feed-in tariff, the creation of the low-energy and Passivhaus standards as well as the Plus-energy House.

Dr. Manfred Hegger, Professor with the Technical University of Darmstadt put up a slide summarizing how residential energy consumption in Germany has decreased as new legislation was enforced and innovative construction methods developed. Click directly on image to see an enlarged version.

Reduced energy consumption in Germany is more closely associated with investment value preservation. The German presenters kept stressing how their ideas and products contributed to “investment security”.  Americans currently talk about greening buildings in terms of lowering operating expenses, but the idea of investment security isn’t spoken about so widely. So I could see that German owners have developed the thinking that, to the extent a building is energy inefficient, the owner is exposed to energy price risk from the open market — a very bad deal. Bear in mind that Germany has 1) MUCH higher energy prices (gasoline in Germany now = ~$8/gallon) 2) a slower rate of economic growth than the US generally and 3) correspondingly lower interest and cap rates. So value appreciation through opportunistic rental rate increases like we can do here in the US (sometimes) is less likely.

Conversely, slow rental rate growth combined with volatile, already high energy costs greatly exposes a property to quicker value erosion. So Germans are combating real value deterioration via lowering building energy consumption. Energy has been relatively cheap in the US and American owners, while cost conscious, have focused on growing the top line and reducing first costs, but only now are thinking about risks to the building value from escalating energy costs.

Germans use an energy budget to drive the design and construction process, not just “optimization”. An energy budget is the maximum amount of energy a building is permitted to consume. Period. For example, in Germany, the low energy residential house standard basically restricts maximum heating usage to 30-20 kwh/sqm/yr (USA:8,000-6,000 kBtu/sf/yr). In the commercial property market, the concept has evolved to the point where an owner simply will not pay for a building that exceeds its agreed energy budget. It is the architect’s job to make sure that every building part and system works together to achieve the energy budget in addition to creating the building’s aesthetics. Over the years the energy budget of German commercial buildings has been reduced as innovations in building science were introduced. Architects and engineers distinguish themselves by the smaller scale of the systems that they
install into a building, not how much.

The Germans pointed out that the building is also usually cheaper, when it is dependent on smaller systems. They also had the strong opinion that American design and construction professionals still focus on “optimizing” using established building codes as benchmarks as opposed to obtaining the greatest absolute reductions in energy usage. And this optimizing mindset leaves too much room for tolerating more energy consumption out of buildings than is truly necessary. Their experience is that current building science and technology can deliver buildings that operate with greatly reduced energy consumption and systems at reasonable costs, if we Americans were to utilize an ‘energy budget’ mindset.

Measure Actual Energy Performance, Not Just Energy Modeled. One of the strengths of the discussions was that the German speakers had a great deal of actual data comparing the energy efficiency regulations implemented over the years with the actual energy decreases achieved. This supported the advice of Dr. Norbert Fish, Professor at the Technical University at Braunschweig, that one really can’t know a building’s actual energy consumption until its been tested during the first 1-2 years of operation. His slide below shows how widely the actual energy consumption of high performance buildings can vary.

LEED Gets Lots of Praise and is Growing Legs Andrea Traber, President of the USGBC Northern California Chapter, gave an update on the upcoming changes to LEED. I posted about this before and you can also find info about upcoming changes on the USGBC national website here.

The German participants were complementary about the LEED system as a way to provide a cohesive language to discuss the green building domain and its components. They also noted that they were seeing international investors, particularly Americans, approaching them in Germany and trying to relate green building performance there in terms of equivalent LEED ratings. So there was lots of interest in LEED generally, since it is starting to move through the investment market. After the event, I talked to a few German product manufacturers who said that they realized that in order to better market their products to US property owners, they were going to have to translate their products contribution to energy reduction into LEED-relevant performance data, since this has become the official language of the green building community in the US.

Photo Credit: Flickr/Popaver - Passivhaus.

Warning: Common Sense Lurks Behind Integrated Design

Have you ever been on a project team with or for a commercial real estate owner who had high expectations of their new green building project? Or maybe the better question is, who hasn’t?

Timothy Corbett, President of SmartRisk, recently cautioned an audience at the AIA’s conference on public space and design to carefully manage an owner’s heightened expectations of green buildings. If the finished product doesn’t meet their expectations, ‘then lawsuits and claims could follow”.

No duh.

When I read through Corbett’s examples of green building lawsuits and claims, I began to think that someone on those project teams also drove their car around with hot coffee between their knees.

Corbett is quoted as saying that the best way to manage the exposure to such claims is “direct contact with the client”.

Another duh.

All of the green building professionals that I know continually stress that an integrated design process from the very beginning helps to reduce the risk of misunderstandings about what the green building can and cannot deliver.  They contrast that with the tendency of some owners to think of green as an added feature than can be plugged into the project at some later point, creating more costs and the potential for miscommunication.

The article’s title, indicating that ‘risks lurk’ in green building, as well as its appearing on GlobeSt.com, a website targeting real estate investors, unfortunately makes me think that GlobeSt was more interested in getting a few more clicks on their website by playing on investors fears about green building, instead of helping to educate them.

Click here to read the article and decide for yourself.

Photo credit: Flickr/Everydaylifemodern

LEED: Avoid Underwriting Misconceptions

Do you prepare your non-green project budget and then add your “green costs” on top of it? At which LEED-rating do you think you own a distinctive higher value green asset? Think that ‘integrated design’ is only interesting for the architects and engineers? Read on.

I’ve blogged before about Davis Langdon’s update study on LEED-rated project costs and recently saw a talk by one of their architects, Lisa Fay Matthiessen, that went substantially beyond just concluding that LEED projects do not necessarily cost more than non-green buildings. She spoke in depth about the source of misconceptions about LEED project costs and shared a surprise that challenges our current knowledge of LEED-ratings and the associated project costs.

Recap of Davis Langdon’s Findings
In case the study is still sitting on your “weekend reading” stack, here are the Cliff Notes takeaways:

• Many projects are achieving certification within their budgets and in the same cost range as non-LEED projects.
• Construction costs have risen dramatically but projects are still achieving LEED certification.
• The idea of green as an added feature continues to be a problem.

The study conclusions were essentially preaching to the choir. Nothing new for the audience of mainly architects, designers and engineers – many of whom were LEED accredited. But when they drilled down into the ‘why?’ behind these findings, things got pretty interesting.

Why Add Green Components When You Can Integrate Them?

Matthiessen says that the false notion of being able to design and build a green project by adding the desired green components to an already planned non-green project is a deep-seated misconception. Moreover, this sets up the project team for another incorrect evalation approach: comparing the building to itself. When this happens, the project team compares the budgeted construction costs of the building without any green elements to the same budget with estimated costs to achieve the determined level of LEED certification. Naturally, the latter budget is often greater then the former, and individual green components get put on the fiscal “chopping block” instead of the team focusing more on better design and engineering solutions to optimize budget constraints. Matthiessen stressed the need for an evaluation based upon benchmarking costs from a pool of comparable projects, as was done in the study, meaning that the project costs of green buildings were compared with normalized costs for a larger array of similar projects with similar elements and criteria. Also, a heightened awareness about the potential economic benefits, or savings from an integrated design approach will help project teams to achieve their intended goal of the best LEED-rating for their budget.

LEED-Gold Sometimes Costs Less Than LEED-Silver
This was a surprise that was not discussed within the study text and that not many people know about. Davis Langdon’s data included several instances of LEED-Gold projects costing less than LEED-Silver projects, which the audience focused on quite intensely. While Davis Langdon did not study this observation individually, Matthiessen said that the study team concluded that the project teams for those less expensive Gold properties had met the challenge of attaining the required higher level of LEED points by having green elements perform several more functions for the project than normally expected. For example, the roof and building skin might provide more ventilation, heating and cooling assistance than would typically be required of such components. These multi-functional integrated elements not only help the project to qualify for the greater number of points needed for the higher LEED rating, Davis Langdon thinks that the bundling of so many functions within certain components actually saved money.  This is good evidence that extending integrated design principles into the project budgeting process can deliver a financially competitive advantage: a project owner could come out with higher performing assets with higher LEED-ratings for less than assumed.

And achieving that level of financial optimization has implications for financiers and capital markets investors. A standard investment underwriting process involves the preparation of linear spreadsheets, so that investors can evaluate project costs and revenue generation potential against their desired payback and return hurdles. Standard operating procedure involves judging specific line items against specific intended paybacks.

But this type of process assumes that every single line item in can be tied to one measurable benefit. And that assumption is at odds with the premise and approach of integrative design. Optimizing your project to the point where you deliver LEED-Gold assets for less than the cost of LEED-Silver will take your financial underwriting to a whole new level. The capital markets are not that familiar with multi-tasking line items that simultaneously deliver multiple and overlapping quantitative benefits.  In order to make the best assessment of such a project’s potential investment value , investors – and their lenders – need to implement a holistic financial analysis based upon utilizing these cutting-edge green building best practices.

When is a Green Building Really Better?
This was an interesting side discussion, with Matthiessen relating her opinion that a LEED-certified or LEED-Silver project essentially represented a few good upgrades to a non-green building. However, the elements and engineering required to make a LEED-Gold or Platinum building greatly distinguish the building from its peers, to the point where she considers these properties to truly be several steps ahead in terms of quality and performance. A basic question for the new green investment funds and their partners is “At what point are we building or buying higher value real estate?” This opinion also points to the potential for more differentiation in asset pricing for those higher-rated properties. For example, if that opinion prevail with the current ratings system remaining in effect, speculative development of LEED Core and Shell projects would not be considered as more valuable simply because they are green.

Taken together, Matthiessen’s talk pointed to a needed paradigm shift for investment real estate analysis in order to fully assess and realize the value of green development. Project owners cannot stick with a ‘business as usual’ approach of appending green to the back end of their existing decision making process and expect to successfully compete in the market with green real estate investment strategy. Successful, high value LEED-projects will challenge professionals to employ a deeper, holistic financial evaluation much earlier in the project’s lifespan that goes beyond individual line item measurement.

I tell my friends that, in today’s green age, the deal is done in the architect’s and engineer’s offices, because environmental impact differentiation is the point of value and that’s where it occurs. That shift will continue to challenge our basic assumptions about the way we commercial real estate professionals do business.