Future-proofing Tip: Use Green Building Rating System Critiques

I have posted before about future-proofing being the hot buzzword for industry pacesetters. Property owners now dedicate an increasing amount of time to (re-)positioning their teams and portfolios for the expectations of a sustainability-conscious world.

But while everybody gets the catchy phrase, how does ‘everyday future-proofing’ actually happen?

I recently met with a group of executives, who detailed their process of moving their firm towards being a socially responsible corporate citizen. They talked about how sustainability has injected elements of excitement and risk into today’s real estate industry. They were happy about ‘going green’, but also expressed frustration about being on a ‘hamster wheel’, since the good green building initiatives they were currently implementing could easily be superceded by “bigger, better, faster” improvements to building science and the regulatory environment.

Fortunately for many firms with this type of anxiety, the American Institute of Architecture has just published “Quantifying Sustainability”, a report in which they have issued new position statements about the Green Globes, LEED NC-v2.2 and SBTool 07 rating systems. It’s a not-too-dense ten pager and a quick read – if you can squint through the 6 point font they are using.

Here are the Cliff Notes from the AIA report:

• On Green Globes: the AIA recommends that Green Globes ratings systems adopt more specific and stringent requirements for energy reduction and building operational performance since these are the two most important dimensions of carbon production. Green Journey Notes: Making recommendations about requiring items which are at the heart of carbon production is a slap.

• On LEED NC-v2.2: The AIA calls for more implementation of Life Cycle Analysis, and would like to see the greater use of renewable energy and a requirement for greater carbon reduction for certified projects. Green Journey Notes: While the report says that the AIA is neutral about all ratings systems, they did take the time to refer to LEED as “providing a measure of environmental achievement” and said that the recommended changes would “continue to make this system an effective resource for architects”. None of the other rating systems evaluated received this level of praise. Second of all, the USGBC has already announced, and we’ve already posted here,  that the next upgrades to the LEED rating system incorporates all of these suggestions in some form of another. I am guessing that this paper was written before the USGBC’s announcement of the changes.

• On SBTool 07: The AIA recommends that this system would be a stronger tool if there was an increase in the number of required items vs those that are simply encouraged and if project documentation were required. Green Journey Notes: Ouch!

So how can this intel improve “everyday future-proofing”?

• Rating system weaknesses can contain clues: revealed by the critiques are direct pointers to the most likely changes that you will see to those ratings systems. They are also a comment about what will define good industry practice in the near future. So there’s your content for potential future proofing. Here’s the core of where you can mine your ideas about staying ahead of the curve in a sustainable world.

• Beware of minimum compliance: Just trying to achieve the minimum certification level leaves your firm open to the risk that your buildings could easily fall outside the newer standards of acceptability, once any ‘tweaks’ are made to the rating system.

• The endgame is low and no carbon: Understand the difference between a single asset checklist process and achieving concrete energy and operational performance targets across your portfolio that are tied to quantifiable carbon reductions. As you can see from the AIA’s position on ratings systems, this is the tough measure that they are applying which means that this the the industry standard they are driving towards, even if the current ratings systems might not reflect it.

Heard at the Fisher Center: Connecting Energy Price Risk with Real Estate Values

So I was at the Annual Fisher Center Real Estate Conference today, where the focus was “the state of real estate” from both an academic and practitioner point of view. The slant was residential, with high quality data and insights. A good bit of the perspectives  highlighted themes that are spurring the rise of interest in green development.

Robert Edelstein, Co-Chair of the Fisher Center, moderated a panel this morning on the state of the housing market. The panelists were James Saccacio of RealtyTrac, Bill Sumski of Paladin Pacific and Scott Ouellette of LandCap Partners. This question from the audience caught my attention:

“Do you think energy prices are impacting real estate values?”

Here’s a composite of the panelists’ responses:

“Yes, energy price risk has already been affecting consumers in significant ways. In the current wave of foreclosures, rising interest rates were the main reason that homeowners lost their homes.  Many people do not know the second reason - that the rising cost of gasoline and home energy also made the cost of homeownership too expensive, forcing people to give up their homes.”

“Energy prices are also forcing homeowners to reexamine the cost of their auto commutes. A panelist stated that he felt that homeowners are already starting to think that the tradeoff for a longer commute to be way less compelling.”

Ken Rosen, of Rosen Consulting, provided his usual in depth economic analysis of U.S. real estate. Some of his comments also drew a thick black connector line between energy price increases and the threat to consumer and business viability. Highlights of his comments:

“Oil price increases are like tax increases. With oil prices at $122/barrel today, this is a huge tax increase on the consumer.”

“A year ago (April 2007), oil was $62/barrel, so its cost to the consumer has basically doubled in the past 12 months. At the same time in 2002, it was $20/barrel, a little over 1/6th of today’s price.”

“Official ‘core’ U.S. inflation is being reported at just below 2% currently. However, U.S. consumers, via buying so many products from abroad, are ‘importing’ a real inflation rate of 4%-4-1/2% p.a.. Part of that rate includes energy price increases. So the actual impact of energy price increases on the U.S. consumer and businesses is far greater than what is being measured and reported via the “official” data sources.”

But wait, (sadly) there’s more:

“For low income individuals, the real inflation rate is 7%-10% p.a. due to their greater exposure to food and energy price increases combined.”

So yes, the opinions were that real estate, including its value, is being directly and indirectly affected by consumers and businesses paying more for energy. This whole discussion did not even touch upon the increased cost of energy consumption of the buildings themselves.

A central thesis behind high-performance building is that the way a building gets built and is operated can lower its risk and preserve its value. Today I heard energy price increases  being called a direct tax on consumers and businesses. So to the extent real estate investors are tolerating energy inefficiency within their control, then they are also accepting a tax on their own return and forcing it on their tenants and shareholders. And this type of cost has a direct impact on a building’s ability to maintain or grow in value.

A green building may not totally eliminate the “energy tax”, but the methodology goes a long way in helping owners and tenants get smarter about operating and managing their real estate in a way to minimize negative impacts on their cash flows and property value.

Come to the Green Building Finance & Investment Forum

I’m spreading the word about the Green Building Finance & Investment Forum, 20-22 February here in San Francisco. Its tailored especially for green real estate investors, developers and their capital sources. (Full disclosure:My firm, Galley Eco Capital, is a leading conference sponsor.) Registrations are coming in at a pretty good pace and we are expecting a great crowd.

There’s a great lineup of Industry Pacesetters — that’s Green Journey talk for the early adopters within institutional real estate — those who are already committed to building and operating green real estate. They’ll be talking about how they’re making good returns by building and retrofitting green.

I’ll be teaching a class, moderating a panel on triple bottom line investing as well as on another panel talking away about, guess what — green finance. There will be a diverse group on that panel, covering emerging topics such as renewable energy finance, green real estate securitization as well as the role of incentives in underwriting green deals.

Participants will also get to hear from well known social investors who are active in investment real estate. They’ll get a dialogue going with the real estate crowd about why we see so little action from socially responsible investors in investment real estate — and what we can all do to change that.

Last but not least, topics like risk management, legal and valuation issues will be talked about as well.

Hopefully this forum will extend and deepen the network of committed green investors and developers, with more capital to follow.

Follow the link to check out the details.

ULI 2008 Fortune Telling: A Shortlist of Cool Moves Including Going Green

“Two years from now, a Class A non-green building will not be considered Class A.”

- George Denise, General Manager for Cushman Wakefield /Adobe Systems San Jose Campus. Overheard during a panel session on green building.

Like a lot of finance professionals, I was hopeful about attending the ULI Emerging Trends 2008 conference here in San Francisco — welcoming any port in the credit market storm. Added to that was the promise of a big discussion on green real estate for the first time by one of the mainstream real estate economists.

So let’s cut to the chase: now the message is that there will be an overall slowing of the economy (sigh…duh), investors are crossing their fingers in hope that consumer demand will remain at acceptable levels, and that interest rates do not become too much of a wild card. In short, Joe or Jane Q. Investor will have to surf choppy waters for awhile but in the end, should come out in good shape.

And they stress that current conditions seem right for making a few cool moves. Here is the ULI shortlist:

• Have Dry Powder (Or Go Get Some): Investors with strong relationships and liquidity are going to score now that there may be more motivated, overleveraged sellers in the market needing a lifeline.
• Buy Distressed Loans: Investors are looking at B and mezz loans, figuring that they can get their hands on a quality asset for a 10%-20% discount from its original value if the borrower is unable to repay the obligation.
• Focus on Global Pathway Markets: Traditional 24-hour megacities enjoy more buyer demand and upside potential, especially when capital gets nervous.
• Buy Public REITS: A panelist from BRE Properties, Inc., a top multifamily player, gave a great analysis of the value. Their high quality multifamily portfolio is valued at an implied cap rate of 6.8%, yet multifamily is expected to outperform other asset classes. Cap rates for Class A multifamily shouldn’t get too far above 6%! In the case of multifamily, many stock analysts lump them together with other residential stocks, like homebuilders, so they’ve been taking a harder beating than is really justified by their asset quality and performance.
• Use Demographic Strategies: Old school dirt investors like myself love this category, because it plays to our strength of intimately knowing communities and their potential. Seniors housing, second homes, medical office buildings, and even student housing play on baby boomer wealth accumulation and long lifespans. Also think about urban plays that penetrate markets with high immigrant inflows.

The Green Competition Factor

Green real estate was woven into the conference as a prominent economic factor affecting the direction of investment real estate in many ways. The economists explicitly cautioned that owners of non-green buildings in high development markets should start understanding the impact of new green developments being built around their properties. In short, the presence of green developments around brown real estate may decrease the competitiveness of brown real estate. The lead in quote to this post, from George Denise, of Cushman Wakefield, is his point of view. I would add that two years ago no one would have even understood what he was saying and now people might start to realize that his point is highly plausible.

Green Real Estate Plays for 2008

ULI’s take on busting a move with green real estate was still restricted to thinking about new development plays — so they still have a ways to go in my book. Also note that ULI didn’t delve into any discussion of defining green, which is appropriate for an economics-oriented conference. And here’s a couple of their recommended green plays for 2008:

Green equals competitive advantage: Okay, for the Green Journey crowd, this is preaching to the choir. But believe it or not, just thinking about building green at all is still pretty edgy for alot of market investors.

• Focus on Mixed Use and Infill: 24-hour residential environments with pedestrian-friendly layouts and varied living options are in. Particularly among empty nesters and career starters. Fringe subdivisions without amenities are losing appeal.

• Build Transit-Oriented Development: Condominiums, apartments and retail near lightrail or subway/train stops are becoming “increasingly attractive”.

Green Journey Takeaways

ULI did do a good job of evangelizing green from an economic point of view and started the process of translating green into an investment strategy — critical for market transformation of our industry.

I’m still waiting for one of the big firms to be a leader in discussing how we green existing buildings.

Photocredit: Flickr/Jai-to-Z

Industry Pacesetter: Digital Realty’s LEED-Gold Datacenter

Hurray! Digital Realty Trust (NYSE: DLR) recently announced that its datacenter at 350 East Cermak Road in Chicago has earned the first LEED-Gold certification in the US for a datacenter from the USGBC.

Click here to see more details on the property.

Note that none of the information available reports on the targeted performance improvements that are expected because the building has undergone a green renovation.

Digital Realty also reports that they are currently greening several other buildings in Chicago, Northern Virginia and Santa Clara with the goal of either LEED Silver or Gold for all of them.

Green Datacenters are a Great Leap Forward for Green Building

While all green real estate is good, a green datacenter gets special attention due to its deep impact on energy savings over conventional buildings and the great expansion of green building best practices for existing buildings.

Dave Ohara, who writes for Microsoft’s TechNet magazine, reported that “datacenters consume nearly forty times more energy than conventional office buildings”. He went on to say:

A typical US datacenter can account for up to 15%-20% of that company’s operating costs. Several studies report that datacenters in the US are responsible for between 1.2%-2.0% of the nation’s entire energy consumption. That means, if you analyze datacenters together as a single industry, their aggregate level of energy consumption would put them in the top five US industries with the greatest energy consumption.

350 East Cermak’s LEED-Gold certification was earned for greening an existing property – currently a tougher challenge in the industry. I know several investors who have become adept at developing green buildings from scratch, but still struggle with retraining their organizations, collaborating with tenants and raising the capital to green their existing portfolios in a way that generates decent returns. Digital Realty’s announcement of getting this done can provide a positive example of how market driven investors are using the green challenge to their, their shareholders and the planet’s advantage.

Get the Green Datacenter Video

Interested in best practices for greening a datacenter? Digital Realty’s Vice President of Engineering talked with InfoWorld about his company’s initiatives in greening datacenters a few months back and provided lots of specifics that help to better understand the decision process involved with greening this asset type. For practitioners serious about greening their assets, this video is definitely worth the time spent.

Now I can’t help but look ahead to the next question:

How will greening an existing investment portfolio affect a publicly-traded REIT’s stock price?

It will be interesting to see how that develops.

Photo credit: 350 Cermak - Digital Realty Trust

Next Page »