Heard at ULI Boston: Four Forces Shaping Green CRE

There was fresh energy among folks recently at ULI’s 2010 Spring Council Forum in Boston — market opportunities are slowly coming back, but it would be a mistake for your firm to simply repeat all your old moves from the last cycle.

I heard four comments that represent the mood and actions of investors on green real estate now:

Here’s a synopsis of the forces I see those comments representing:

“The other shoe’s dropped, but no one heard it.”

Your plan → Get going on your green portfolio strategies, you’re already behind.

Professionals finally acknowledged that a) rumors of 30%-40% loss of value in commercial real estate are, for the most part, overstated and b) there is currently too much capital in the market chasing too few deals. The latter point has been creating the paradox of deals trading at aggressive cap rates amid a recession.

In the opening session, Equity Office Chairman Sam Zell explained the paradox. When real estate markets tumbled, investors had expected banks to dump lots of deeply discounted properties into the markets, which investors would snap up at rock bottom prices.

Wrong assumption. Instead, banks have focused on working out troubled loans and strategically offloading REO assets one-at-a-time, and as a last resort. That has given the market time to gradually readjust pricing, preventing fire sales.

Reality: on-going one-off REO sales cushioned the velocity and depth of property value loss. The practice has also frustrated distressed players, forcing them to compete for REO deals against high net worth individuals and other sources with more patient capital, willing to pay more. This way has helped the banks to achieve better than predicted pricing on their sold assets and the market again saw no drastic fall in commercial real estate pricing.

In response to the question of why so many investors still talk about doing distressed deals, in the face of this very different reality, one panelist replied “the other shoe has already dropped, but no one heard it”.

Lots of investors have been delaying their investments in green initiatives, n waiting for the market to return to health. The good news is that the market is now not as bad as everyone thought. That’s also the bad news — all the players with dough have already gotten started, so you need to keep up.

“Every day, 1MM square feet of real estate is being LEED-certified.”

Your plan → The shift to green is happening much faster than you might think. You need to speed up your firm’s own shift to keep up.

Doug Gatlin, of the US Green Building Council spoke at our Responsible Property Investing Council Meeting, about the current stats on LEED. Here’s one: LEED certifications are running at 1,000,000 sf/day, even during an economic downturn. One council colleague, calculating a corresponding value of several hundred million dollars per day, said this fact would definitely influence his market conversations in favor of green building.

There’s still quite a way to go before we can say that market transformation from LEED has really happened. One main premise behind Architecture 2030 goals is that the US either renovates or builds new a net 10 billion square feet of real estate each year. The 365 million square feet annualized velocity currently being LEED-certified represents 3.65% of the estimated 10B in annual square footage built or renovated in the US — so there’s much progress to be made.

Theory: For green building to influence leasing and investment activity in a market, the “tipping point”, “competitive mix” and “OS” factors have to all be balancing and reinforcing each other in healthy levels. A sufficient concentration of LEED-certified square footage in a sector can be enough to influence investment activity in that sector towards green buildings (tipping point). Note that “sufficient” needn’t be that much in absolute numbers.

That, plus LEED maintaining its relevance and dominance as a green building rating standard (competitive mix) and regulatory support on federal, state and local levels (operating system or “OS”) are the keys to further increasing green building volume. The lack of competitive mix and OS in a market or for a real estate asset class will result in no tipping point being achieved in the area being studied.

The tipping point and OS factors are already a particular force on investment real estate in some gateway metros. For example in San Francisco, brokers have been publishing their own reports showing higher occupancies in LEED-certified buildings. There are already whole classes of global investors who publicly refuse to buy inefficient buildings. So this force is already at work, even with a small proportion of US real estate earning LEED certification to date.

“Operators need the track record to execute on both traditional real estate and sustainability strategies.”

This was a fund manager’s answer to my question about what made her choose to invest with a certain real estate operator, who had brought her a deal with an extensive energy retrofit including adding renewable energy in the business plan.

With capital markets slowly thawing and the velocity of green building certifications growing, it’s time to ask yourself if you’re company will attract capital with a mandate for sustainable real estate. Fund managers are now speaking out about needing to work with partners who can execute on a sustainability plan.

Additionally, you’ll need to assist the equity partner with understanding the value-add from green strategies being pursued, that will come from your local expertise.  The good news is that right now the market is wide open. Most of the US investment real estate firms who have achieved any progress on greening buildings have done so with a few buildings and many are still just focusing on low hanging fruit.

With the projected high increases in energy and water costs, nimble regional operators have a great chance at building a great track record on greening buildings that can get them hired over larger competitors. Plus, its a big market, anyway, with lots of room for more players. Remember what I said above, about 10B sf real estate being built and renovated in the US each year plus all the money out there chasing too few deals?

“We’re serious about being green, but we’re skipping commissioning on all our buildings.”

Your plan → Ignore free lunches. Compete via consistently delivering the best building performance possible.

This was said by an owner’s rep of an institution presenting their multi-billion dollar portfolio of institutional assets. He added:

“We are making our space LEED certifiable. We’re doing many things according to LEED for existing buildings, like green cleaning and updating the systems in our buildings, but we’re saving a couple hundred thousand dollars by skipping commissioning.”

“Pennywise and pound foolish” - even tired clichés are still true. If you attended our recent Competitive Edge workshop, Financial Considerations for Energy Efficiency Retrofits, you learned that Lawrence Berkeley National Labs (LBNL) research shows that on median costs of just $0.30/sf, commissioning alone achieved energy savings of 16%, with a 1.1 year payback and 91% ROI.

This means that our investor friend’s portfolio could probably deliver many more dollars in performance, which will literally go to waste via a) the properties remaining exposed to more energy price risk (current price plus escalations) than is warranted, b) not achieving the level of upfront energy savings that might have been possible, c) being in for longer-term, higher capital expenditures on their major systems since their performance was never audited to a commissioning standard.

Why is this unfortunate mindset a force on green building investing?  Actually — it’s pervasive to the point of being an archetype. You’ll find a similar mindset in a certain percentage of companies in every industry and at every point in the economic cycle. As the market matures, the economic downside of their inaction will become more apparent

Those of us who know better have to consistently incorporate building performance data into underwriting and valuation, and adjust prices accordingly. When a certain percentage of investors find themselves taking discounts at sale and losing enough tenants, then they’ll change their minds, improve their O&M - and even save themselves a few more bucks the process.

Download report: Net-metering winners and losers

As you head off to Thanksgiving, you can take stock of how your state has progressed on renewable energy (and based on what we’re showing here today, you can hopefully be thankful).

We follow renewable energy trends because one of the central challenges of district or regionally-focused green finance strategies involves having a base of renewable energy policy that the jurisdiction authority can build from.

Renewable energy policies which reward systems owners for electricity generation can go a long way to support sustainable finance funding mechanisms. These mechanisms, depending on their structure, can allow for a transparent flow-through of renewable energy benefits, and the creation of lower carbon districts as well as achieving regional greenhouse gas emissions.

Net metering update

Net-metering is a critical influence on the uptake of renewable energy, since it allows the solar power system owner to earn money by selling electricity back to the grid. So… is your state a pacesetter on net metering? What’s its grade?

Network for New Energy has put out some new figures, detailing how different states make the grade on renewable energy. You can download a copy of the slide deck on this page as well.

Winners

In terms of net metering policies, Network for New Energy names the following states as being top:

1. Colorado
2. Delaware
3. Maryland
4. New Jersey
5. California, Oregon and Pennsylvania (tied)

Losers

According to Network for New Energy, the following states have no policy on net-metering, which resulted in them receiving a failing grade:

1. Alabama
2. Alaska
3. Mississippi
4. South Carolina
5. South Dakota, Tennessee and Texas

Friday Photo - Green Finance Upgrades Opportunities

Property owners are very focused on getting stimulus (or any!) dollars to pay for energy efficiency retrofits and weatherization projects.  And accompanying those applications are the green jobs expectations of many individuals.

This is the 23 July scene at a Los Angeles green jobs fair for energy efficiency and weatherization, in full swing, courtesy of Life.com.

Approximately $40 billion from American Recovery and Reinvestment Act funds were allocated to green collar jobs in energy efficiency, weatherization and renewable energy.

Many real estate professionals I know are not so sure how these funds will actually improve conditions in real estate finance and investment, due to the underlying weakness in market fundamentals, and the credit markets in particular.  They point out that an upside down loan on an energy efficient property is still, well — upside down.

And will directing short term government funding towards retrofitting real estate improve life for those green collar job holders?

The green finance angle for energy efficiency retrofits appears to be one of ‘upgrading relative competitiveness’ for those concerned. That is, upgrading energy performance and job skills to create relatively more competitive properties and workers.  A kick start as opposed to a final solution.

Nonetheless, given what we all know now about the financial meltdown and its effects on real estate, a green financial kick start on those two fronts — albeit experimental — provides at least an opportunity to improve the status quo beyond what we would otherwise be able to do.

The rest of the heavy lifting still remains on our shoulders.

Photo credit: Life.com

Part 1: Lessons for Future-Proofing Property Values

Since when has any firm achieved competitive advantage by just goin’ along with the crowd? Even in the current tough capital markets environment, excellence in real estate demands a continuous search for the newest ways to protect and advance asset values. This first installment of our Special Series on the Green Building Finance and Investment Forum New York,  features highlights from the talks by industry pacesetters that make sustainable real estate’s tomorrow happen today. It was a workshop chaired by Leanne Tobias, of Malachite LLC, and Galley Eco Capital’s Lisa Michelle Galley. Specifically, the session addressed threats and opportunities for investors created by rising energy costs, carbon policies, green building regulations, and changing tenant demand.

Fast Facts:

1. In today’s tenant markets, green buildings are the entry price for retaining corporate tenants - and their top talent.
2. On-site power generation and other new building technologies are not ‘star wars’ experiments, rather pragmatic, down-to-earth tools for energy price risk-mitigation.
3. Special taxation districts are a way to create financial solutions for community-scale sustainable development.

“I advise my clients to only consider

green facilities.”

– Peter Miscovich, Managing Director of Strategic Consulting, Jones Lang LaSalle

Green Buildings Are Plug-and-Play Solutions for Tenant CSR - and an Entry Requirement for Competitive Landlords in a Tenant’s Market

Peter Miscovich advises Fortune 100 companies on their corporate sustainability strategies. At GBFI, he laid out the 10-15 year roadmap on how tenant demand and demographics will dramatically impact real estate values. So what’s he saying?

• Corporate sustainability is now a permanent issue that will influence all organizational decisions, including real estate. Companies are paying attention to their energy use, and green buildings will be the required tool in their strategy toolbox to mitigate their exposure to energy and operating expense price risk. This will have major implications for the owners of existing, conventionally built commercial and industrial properties.
• Corporations will reduce their real estate footprint. Existing facilities are structurally underutilized, and the advent of telecommuting, office hostelling, and remote data management (from 3rd party vendors) will further reduce demand for office and flex/industrial space.
• By 2012, we will have a nationwide carbon policy, and those policies will directly impact real estate patterns.
• The suburban corporate campus model is outdated.
• Over the next 25 years, the vast majority of new household growth will be childless. There will be an increase in demand for smaller housing units, developed around transit.
• Given these impending changes, metropolitan areas that have scalable urban and suburban public transportation systems will prosper.

These expected changes point to demand and value implications for all commercial property types. Certified green buildings are a plug-and-play solution within overall corporate sustainability strategy. And in tough economic times, when it’s a tenant’s market, tenants — and their top talent — have more leverage to demand the green space they seek.

This has harsh implications for those landlords who want to retain corporate tenants, but will not or can not adapt space to the tenant’s corporate sustainability requirements. At the market level, this means that green commercial real estate sited near public transportation and affordable urban housing will be the favored locations of corporations over conventionally built property, because it provides them with significant soft and hard cash benefits.

Future-proofing Property-level Energy Price Risk: On-Site Power Generation and ESCO-led Retrofits

Incorporating on-site power generation into new construction and existing properties is no longer the province of special use properties like research labs and hospitals; today’s market considerations show this to be a pragmatic energy strategy that is gaining traction among the investors within the “four food groups”, too.

Fred Fucci, a partner at Arnold and Porter, LLP, addressed some of the challenges to creating and managing on-site generation capacity, as well as two other potential methods to minimize the impact of high energy costs:

• Utilize an energy services company (ESCO) to assess energy usage of existing structures, and enter into a performance contract to make recommended capital improvements.
• Use less energy, period. (Our comment: Everybody laughed when Fred said this, but heck - who can challenge that?).

Taking future-proofing one step further, Ed Brzezowski of Noveda Technologies, expanded the boundaries of technologically possibilities with his presentation of Noveda’s 31 Tannery project,  a 42,000 square foot office/flex structure with “net-zero electric” operations.

31 Tannery, in Branchburg, New Jersey, enjoys the rare Energy Star score of 100 and is a living showroom for high-performance, sustainable building technologies. Noveda, who’s business is to provide technology tools for monitoring real-time information about building energy use, were in need of new office space, wanted to show off their innovative capabilities and were resolute about walking their talk. The result? 31 Tannery uses less than 20% of the energy consumed in a conventionally-built structure, and reduces its carbon footprint by more than 1 million pounds of CO2 per year.

But wait, there’s more…. The most impressive number was the expected payback period for the advanced energy systems of 6 to 7 years, which is well within the investment horizon for institutional investors.

But participants had critical questions for Ed: do all those cutting-age systems actually cost out? Ed’s response? Yes, if you properly monitor your system performance. At 31 Tannery, they track real-time system performance down to 10 seconds, which allows them to catch and fix every system glitch that could negatively impact energy performance, and undermine their expected return on investment.

Special Taxation District Enables Community-Scale Sustainable Development

Frank Owens presented Georgetown Land Development Company’s vision of future-proofing: a to-be-built, transit-orientated, new-urbanist, mixed-use, brownfield development with on-site energy generation.

This $90 million re-development of the Gilbert & Bennett industrial site in Redding, Connecticut, will feature 300,000 square feet of commercial space, and 415 housing units, which includes loft-style apartments, townhouses and single-family homes. The 55 acre site will also feature a passenger rail link into New York City.

The development will create a special taxing district to provide low-cost financing for environmental site clean-up, rail-station improvements, and renewable energy systems. The district is a financing platform that can issue bonds, temporary notes, and other financial instruments, which are payable through the district’s fees, revenues, or benefit assessments. An important feature of this district is that, unlike tax incremental financing (TIF), the local municipality and state are not liable for the district’s debt. There is no specific limit to the number of financial instruments that the district can offer.

While the real estate market is in a downturn, and other projects are being canceled, this sustainable real estate project has lined up financing, and will proceed with medical office and local-serving retail in the project’s first phase.

By incorporating on-site energy generation, multiple transit linkages, and a compact urban format featuring multiple uses, this project is hedging against many of the forces that are affecting real estate values. Have you done the same yet with your portfolio?

*  *  *

Don’t forget to read the other installments of our Special Series on the Green Building Finance and Investment Forum New York. Our series brings you perspective and frank discussion from the industry pacesetters that are making sustainable real estate’s tomorrow happen today.

Photo Credit: 31 Tannery Project, Copyright 2008 Ferreira Construction

Photo Credit: Georgetown Land Company

Renewable Energy Market Status

“Where you stand depends upon where you sit.”

A famous politician might have thought he was dispensing pithy political wisdom when he said this, but he was also, perhaps inadvertently,  framing our understanding of the relative potential of renewable energy markets going forward.

Growing renewable energy markets from a staggered start

Remember, it has only been a week since HR 1424 was passed, extending government tax credits for renewable energy and related equipment.  And we think it is a good time for Green Journey readers to take a look at where the renewable energy markets have stood recently in terms of installed capacity.

This chart comes from the Commission on Environmental Cooperation for North America, which has put together a fantastic series of map layers depicting all sorts of environmental geographic data. You can dump the desired data into Google Earth with a click and nerd out to your heart’s content.

This particular map is a couple of years old, but still points to the idea that, with these tax credits being extended just now, many markets will be starting to increase their installed renewable energy capacity from very different positions.

Great to understand as we all monitor events in the renewable energy sector going forward.

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