Part 3: JP Morgan Chase Talks Green Real Estate Investing

When JP Morgan Chase says that sustainability is creating fundamental changes to how they invest in real estate, you pay attention. Part 3 of our special series on the Green Building Finance and Investment Forum - New York, co-sponsored by Galley Eco Capital, continues with the perspectives of  keynote speaker, Doug Lawrence, Managing Director at JP Morgan Chase Asset Management.

“Achieving sustainability can be an uphill battle-but it’s crucial that you get there. Your future customers will demand it, and your ROI will depend on it.” - Doug Lawrence, JP Morgan Chase

Doug set the stage by reminding everyone about the basic objectives of investment banking:  1) preserve and grow clients’ capital and 2) make money for themselves in the process.  In JP Morgan Chase’s case, sustainability has become a profitable strategy for them that also preserves and grows client capital, which in turn ensures their competitiveness in the ever-changing financial marketplace.

Case in point: Doug manages the Urban Renaissance Fund, JP Morgan Chase’s newest vehicle, which focuses on cities and their first suburbs — where population density is high and the payback on energy efficiency is substantial.  The Fund sees investing in sustainable real estate as a way to improve returns and reduce investment risk. However, “getting there” with green real estate is not without it’s challenges.

Green real estate is a different animal than conventional real estate. Successfully investing green means re-calibrating underwriting metrics and changing many of the fund’s business procedures. It costs money to do this and it can take quite a  bit of time to change hearts and minds about what constitutes a great sustainable real estate investment. On top of that, you have to manage organizational inertia, which can often be the worst enemy of change.

“Green means changing our procedures, our underwriting, our vendors, the way we put our products together.” -Douglas Lawrence, JP Morgan Chase

So how did Doug and his team help the powers that be at JP Morgan Chase embrace green real estate? Well, first of all - it took them two years, plus some organizational change, but the repeated message to leadership was clear: if we don’t do this, we will lose our edge, and our financial products for real estate will be obsolete.

Doug drove home his point about obsolescence in real estate with the example of the emergence of building air conditioning back in 1950/1960s. The technology was rapidly implemented, and buildings that did not incorporate air conditioning became obsolete. They faced appraisal risk, and their valuations decreased quickly. For owners, their failure to upgrade their properties increased their investment risk and devalued their real estate holdings.

Wanted: Experienced and Knowledgeable Green Developers and Investors

So now that your fund is focused on sustainable real estate, what’s next? Well, your next challenge is identifying experienced and qualified developers/operators who can reliably build your project in a way that gets you the great green benefits you (and your investors) seek.

In today’s market, a successful track record is key to investor confidence; and Doug made it clear that, while they are supporters of green real estate, they are not interested in any developer learning about it on their dime. However, since green real estate is still in its infancy, they realize that they have to be flexible in how they evaluate their partners, otherwise they will have a difficult time generating a sufficient level of investments.

“If you have a great idea, tell us how you are going to mitigate risk.”

So what do you do if you’ve got a great development track record, but are new to sustainability and want to attract green equity capital? From Doug’s perspective, if you want their money, you need to reduce the execution risk within the investment.  And creating strategic alliances between the experienced developer and firms with proven sustainability expertise is a smart way to mitigate those types of concerns.

And with that great team in place, what aspects about green real estate are driving JP Morgan Chase’s involvement in the sector?

• Green retrofits to existing buildings can be done profitably: JP Morgan Chase estimates that existing buildings which have been retrofitted green enjoy a 3% higher occupancy, a 7.5% higher valuation and use 25%-30% less energy than their non-retrofitted counterparts.

• There is no cost question about building green real estate: Despite the fact that many in the industry still talk (incorrectly) about hefty cost premiums to build green, JP Morgan Chase sees that an experienced developer of green property can deliver LEED-certified and LEED-Silver product to market at absolutely no cost premium whatsoever.

• Integrated design is the key: Engineer value at the beginning instead of value engineering at the end of a project. Also, integrated design optimizes both first and life-cycle costs.

Selling Your Deal: Know The 7 Fears of Real Estate Equity Funds

Doug finished the presentation by educating the audience on how to best position themselves and their transactions for investment by other funds like his. He presented seven key issues (or fears) that many funds have when it comes to sustainable real estate. By understanding and addressing these concerns, investors and developers can remove many of the roadblocks to getting funding for their projects. The seven fears are:

1. Fear of being too early. Equity funds fear the failure of your concept, because there is no protection for their capital. You need to have a lot of data to support what you are doing, and develop an executable business plan that can be understood by potential investors.

2. The fear of learning new stuff. As previously mentioned, bankers are conservative. They know certain things, and they know them well. They have their favorite product types, their favorite developers, and they have their risk management down to a science. Your project may represent a major departure from their investment machine, and they might resist. It is up to you to educate them, and to be persistent.

3. Loss of power. This fear is a derivative of fear #2. Changing the game forces individuals at the top of the corporate structure to either adapt, or risk becoming obsolete. When it comes to understanding sustainability, it’s your responsibility to educate your potential partners in a way that maintains their leadership as the smartest people in the room.

4. Maintaining deal flow. Equity funds don’t want to upset their developer partners; as that might  put their investment pipeline at risk. Therefore, they will tread lightly when it comes to convincing their existing partners to become more sustainable.  The antidote: re-read all of the above.

5. Fear of losing return. As a green developer/investor, you can use your potential equity investor’s fear of losing returns to your advantage; help them understand how their returns will be diminished if they don’t invest in green.

6. Fear of execution. Unfortunately, there is a flip-side to fear #5. If equity investors think that your sustainable real estate investments raise the execution risk for their capital, they will be less inclined to invest. Structure your deal and your strategic partnerships to mitigate as much risk as you can. (Our note: You should be doing this for every deal anyway)

7. Fear of being too late. Whether by law or by simple economics, green real estate will become the norm. When that occurs, the incentives for green building and the learning opportunities will be gone. If equity funds don’t understand how to evaluate and fund green investment before the market transformation, they will lose their competitiveness. Make sure that you emphasize this to your potential equity partners.

Doug’s perspective was well received by the audience at the conference, and we think that green developers and investors would be wise to heed his recommendations.

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TBLI, Paris: Sustainability Heavy Hitters & Green Building Transparency

As you think about your green real estate strategy, have you defined how transparent your property’s energy performance and environmental impact will be to tenants, other investors and lenders? Do you measure and report environmental outcomes based upon internally derived or neutral third party standards? As you think about it, read on for examples of how the same questions are being approached in the European Union.

Last week I was in Paris speaking about financing green real estate at the Triple Bottom Line Investing conference hosted by Brooklyn Bridge, a powerful organization run by Robert Rubinstein out of Amsterdam. TBLI is at the cutting edge of global sustainability, allowing corporate social responsibility representatives from traditional organizations such as TIAA-CREF and Allianz Global Investors to share perspectives with socially responsible and/or mission-based groups like Calvert Investments and Environmental Defense.

The green building session was packed with a savvy, enthusiastic international audience of developers, venture capitalists, NGO’s and financial institutions. Turns out that they were all busy chiseling out their green real estate strategies or updating their intelligence on how green building’s emergence may be affecting some other key area of their business.

My main TBLI takeaway can be summed up in one quote from an SRI professional, overheard during another session on carbon offsets:

“Transparency makes a market”

This reminded me of the recent Costar Green Report, which listed the latest green building initiatives by heavy hitters such as CBRE, Simon Property Group (SPG), Glimcher (GRT) and Jones Lang LaSalle. It’s great that US real estate is going green in a big way, but I still see lots of subjective picking and choosing of green initiatives with only vague mentions of concrete, meaningful energy performance improvement and environmental impact. This essentially relegates the green real estate investment proposition to being a cat in a sack – so long as a property owner does not have to disclose the true energy and environmental impacts of their green initiatives, buyers can not objectively value (i.e. pay for) the green benefits they expect to receive. So, in the spirit of Carnegie Mellon professor Randy Pausch, I’d like to introduce you to The Elephant in the Room:

“Which, if any of these companies are executing initiatives that deliver the real value and impact expected by their investors and communities? And if they are, how can we compare and judge their initiatives relevance and success for ourselves against what objective standards?”

Examples of Transparency from the European Union

The European Union has already passed the ‘Energy Performance of Buildings Directive’, requiring member countries to implement laws regulating building energy efficiency.

Generally, the regulations:

• define what areas of a building’s energy performance and environmental impact will be measured,
• compel building owners to obtain the evaluation at certain junctures in the building’s lifespan and
• require the property owner to make the official certification of the most recent evaluation to occupants and prospective buyers.

I talked with green building professionals from Germany and Britain about how these regulations have already caused investors within their countries to tie a portion of a property’s value to its objectively certified energy performance and environmental impact.

In Britain, the Energy Performance Certificate, is the official document verifying a buildings energy performance and environmental impact. The evaluation results are plotted on an A-G scale, where A is very efficient and G is highly inefficient. The EPC is required any time a property is built, bought or sold. It is required to be displayed near the building entrance at all times, to inform all occupants of the building’s actual performance (!). I talked to a London-based property professional who reported of the quick action by investors to begin retrofitting buildings once they learned that their tenants and buyers would know of their building’s potential lower grade – and possible devaluation. Predictably, the retrofitting of buildings has become a very lucrative market by itself. Representatives from British engineering firms also reported that they were already scouting out the North American markets for potential expansion.

Germany implements the EU directive through an Energieausweis (‘energy certificate’) — see a sample certificate above — similarly certifying to occupants and potential buyers a building’s performance level on the same dimensions. The Energieausweis must be created/updated at the time of construction, rental, leasing or sale. Public buildings have to display their certificates as in Britain, but private building owners simply have to make their certificates available upon request by tenants and property purchasers. Interestingly, the energy evaluation for commercial buildings can be made based upon either the property’s actual energy consumption or its calculated requirement, based upon its construction and use. Again, the energy audit and building retrofit business in Germany has been big business for years and now will probably grow in relevance for the industry.

Since the implementation of the EU directive is still in its early stages, there is not any data on the actual environmental impact of this directive nor on exactly how property values have changed as a result. Both the colleagues that I spoke with however, said that the energy certificate results are utilized by investors to assess a property’s operating efficiency and sales price by transparently comparing a certain result with national standards and those outcomes achieved at similar properties in the market trade area. So the laws have brought some amount of transparency to these aspects of the investment property market.

And what about the USA?

It is a good time for us to begin an industry level conversation about objective standards of measurement and disclosure as the basis of investor perceptions and action on energy preformance and environmental impact – in order to better promote green building, protect its integrity and allow the real stewards of best practice to be properly rewarded for their efforts.

At the present time, many of our cities and states have begun to enact laws and regulations, which implement green building and LEED ratings criteria into code. This is great for new construction, however it still does not address the greening of existing buildings nor do investors have a relevant, comparative benchmark for environmental performance when they are evaluating a potential acquisition. Also bear in mind that, while LEED-certified buildings generally have a lower energy usage and environmental impact, no particular LEED rating assures that a property has actually achieved a certain level of energy performance or environmental impact.

Here in the US, we are keen fans of transparency. This time, American green real estate can benefit from learning how our colleagues across the Atlantic have been approaching the same issues.

Green Journey Reading Recommendation: Check out Germany’s GreenBuilding program. This is not a green building program like the USGBC LEED rating system, rather a special program , administered by the German Energy Agency (’dena’), designed to inform and help German property owners to green their buildings. The program’s overall setup, content and implementation is ‘high protein’ information for industry professionals who are participating in similar programs here in the US. Both sites contain English translations of all information.

GE Real Estate Announces Green Initiative

Go big or go home!

That has got to be GE Real Estate’s motto concerning their green real estate initiative, announced at Greenbuild 2007 in Chicago earlier this week and covered in this week’s CoStar Green Report.

Under the new program, GE intends to imbed sustainability into its entire investment and asset management process. They are doing this through a partnership with the Clinton Climate Initiative. That alliance allows GE to “tap into CCI’s resources to improve the environmental performance of properties”.

Initiative Highlights

• Energy audits and retrofits of properties “where profitable”.
• Tracking of environmental and energy metrics alongside financial performance.
• Incorporation of LEED rating system and international equivalents into their ongoing property assessments.
• Sharing best practices with customers.

GE’s $30 billion a year operation is large enough to influence the actions of of their owners and partners throughout the property financial system.

Pay attention to the fact that they limit their commitment to retrofit to situations where it would be profitable. That is one of the biggest questions investors wrestle with these days. As I’ve written before, greening existing investment properties seems to be harder for investors to achieve than building brand new green buildings. It also raises questions about how they will judge the post-retrofit profitability of the property and what environmentally beneficial retrofit work might be avoided on a property because the benefits are not profitable enough in their view.

GE’s integrating energy and environmental metrics alongside financial indicators is a needed best practice. They have the financial strength and platform to cause these types of metrics to proliferate throughout the real estate industry. Of course, we will have to see what exactly those metrics are and hope that they result in transparent, verifiable reductions in their portfolio’s carbon footprint.

The Green Journey Synopsis: The content of GE’s key real estate initiatives is excellent intel on where investors should focus their efforts as they build environmentally responsible investment platforms.

We will not know any of these answers until we see GE’s performance over the coming years, but one thing’s for sure — they have got everyone’s attention.