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.

Key events on energy efficiency finance and triple bottom line investing

Meet us at the the following events. We’ll be presenting about:

- energy efficiency financing

- responsible property investment metrics for high performance portfolios

- taking the green economy to the next level

In the weeks ahead, Lisa Michelle Galley will be featured at a number of key industry conferences. The topics covered by Lisa and other leading voices in the sustainable investment community will highlight the  latest trends and provide a valuable forum to learn about innovative solutions to some of the most pressing challenges facing the green building and finance sectors.

Presentation on Energy Efficiency Financing

GSMI -The Sustainable Buildings Series: Retrofits

October 21, 2009; 11:15am – 12pm, Mission Bay Conference Center at UCSF
Lisa will cover the key considerations for different types of energy efficiency financing.  From there she will talk about how owners can more effectively coordinate their energy efficiency financing efforts across their portfolios. Lisa will be co-presenting with Peter Liu of New Resource Bank.

Presentation on Metrics for High-Performance Portfolios

Responsible Property Investing Council: 2009 ULI Fall Meeting
November 04, 2009 – Joint session of RPI and Sustainable Development Councils
Moscone Center South, San Francisco
Along with co-presenters David Wood, of the Responsible Property Investment Center and  Jean Rogers of ARUP, Lisa will offer fresh insights and recommendations developed in a year long study of the development and application of  responsible property investing metrics on institutional real estate portfolios. Lisa and Jean will discuss how the real estate investment ‘system’ has been impacted by sustainability.

Taking the Green Economy to the next level

Sustainable Industries Economic Forum in San Francisco
November 19, 2009; 9:30am -10:15am
St. Regis Hotel, San Francisco
Lisa will join a panel of industry leaders including Paul Hawken, author and CEO of the Pax Engineering Group, to discuss some of the most challenging aspect of successfully implementing triple bottom line solutions and how we can take the green economy forward. The event will offer valuable perspective on growing strategic partnerships as a core aspect of sustainable business.

If you would like to meet us at any of these events, please email us info@galleyecocapital.com

News about future events is available through our website.

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Heard at ULI Developing Green: Transwestern’s Green Retrofit Program

Long time no post, I know.

After many weeks on planes, trains, kayaks, bicycles and of course, automobiles — my long road trip ended at the Urban Land Institute’s Developing Green Conference in Beverly Hills.

There, I presented on financing energy efficiency and heard from some of the leading professionals in green building investing today.

Some of you were following me on Twitter that day and this post expands on those tweets.

Transwestern Talks Green Retrofits

Transwestern Exec’s Allan Skadowski and Scott Tausk talked the way we like at conferences (straight) and often don’t get enough of, no matter how much we pay.  They spoke about Transwestern’s development of its existing building retrofit capabilities including successes and lessons learned.

There was no powerpoint, no slick corporate infomercial, giving their talk the authentic vibe we crave over here on the Green Journey.

Note that I’ve done my very best to make the short snippets below reflect the speakers statements as closely as possible.

• Why are they going green? They made it clear that their goals are to be perceived by peers as proactive – not being a leader in going green. They were also reacting to tenant concerns in market.
  Not wanting to spend too much money – keeping it a low cost program. Transwestern operates a value-add fund. The average hold period is 4-5 years for assets. They have about 65 buildings in their portfolio. Decisions made on the basis of marketing and long-term cost control.
• What do their investors think about greening buildings? Some of their investors don’t care; some investors have it as a factor (but don’t want to pay much for it); a few care heavily about presence of green initiatives on properties.
• Like certification? Thumbs up on LEED EB 2009; LEED online version 3 is much more robust. They are now big fans of volume certification – earn points on your existing buildings as you go instead of waiting for a building to achieve all its points before submittal for LEED certification.
• What was their process to study retrofitting and certification within their portfolio? They chose 25 bldgs to move through certification. They are still currently pursuing 18 buildings. Eight or nine going through the process.
• How much do they pay for certification? “We’re paying $0.17-$0.18/sf to get buildings certified.” Interesting is that they point out that their certification costs have gone down quite a bit as they’ve gained more experience with LEED-EB. Also stated that most of the buildings they certify already are within an easier range of certification — focus on low-hanging fruit. They admitted that they are not taking any “dogs” through the LEED-EB process now; they estimated it’d cost ~$2.00/sf to certify buildings with very low EnergyStar scores like 40.
• Results from their program? They’ve done a scrub on the utility costs of the buildings they’ve certified realizing a 2% savings in utility costs which include substantial utility rate increases. Occupancy on their certified buildings is up 20%.
• Any differences in the cost/value of LEED certification? They had all bldgs evaluated at the start of their program on the basis of the cost to achieve LEED-Silver/Gold /Platinum status.  They found no cost difference between certified and Silver levels. However, Gold cost much more than Silver.
• On the value of retrocommissioning: this is a ‘must’ in their view. They now advise their owners that retrocommissioning results in unlocking serious energy expense savings and that it shouldn’t be left out of any retrofitting initiative.
• How do they know their green retrofit efforts have been successful? Transwestern  has no firm measurement system in place.  However, they say they are seeing lots of positive anecdotal evidence within their operations supporting certification. They indicated that there are definitely leases that have been done due to properties being Certified or Silver. They specifically cited a property in Houston, where a prospective tenant required them to put their promise to get LEED-Silver on a building in the lease agreement (my note: lawyers in the audience were scribbling furiously at this point).
• Has anyone paid them more on the sale of a retrofitted building? Not exactly. “However, the presence of a bidder who expresses interests in the property because its green helped to drive up the price at the end of the day”.
• What increased rents have you experienced? None. Market conditions today are too unstable to look at certification as a premium bringer. Certification value comes more from being focused on operating expenses.
• Green Lease Language in play? No.
• Payback example? They said that they do not focus on paybacks as a decision-making tool (my note: compare this with notes above about only certifying buildings which can be done for very low costs - i.e. short payback). However, they did offer their experience of chiller replacements having a payback in 6-7 years. They also stressed that in areas with high utility rates, like Houston, California and the Northeast, the payback looks great. Other areas with lower utility rates (Midwest) will show longer paybacks for now. As cap-and-trade legislation rolls out in some form, they expect that increased electricity rates will make the payback analysis even better even in currently lower cost utility areas.
• Are you doing any separate analysis and monitoring of the carbon footprint of your portfolio? This was my question. The answer they gave was telling: “We try to get LEED-Silver certification. Whatever that translates to in carbon emissions is what it is.”

Transwestern is, IMHO, at the upper tier of the commercial real estate industry when it comes to greening their existing buildings, when measured on the basis of having gotten a program off the ground and learning how to implement LEED and EnergyStar to their and their properties’ benefit.

They deserve props for their initiative and accomplishing much more than most other real estate platforms in our industry (at this moment in time). Yet, by their own admission, they don’t want to be known as leaders, just “proactive” — so I can’t archive this story under “industry pacesetters“, alongside other groups who both demonstrate competence and broader community stewardship greening their portfolios. Too bad that they equate leadership with “spending too much money”.

What do you think? Am I (un-)fair in my assessment?

ULI on the Financial Bailout as the Swedes Shake Their Heads Knowingly

Tired? I know, I know…

Staying on top of political theater and the daily collapse of banks can wear a body down.  Watching the never-ending series of CNN breaking news, checking your own bank’s solvency and reading the papers leaves nearly no time for work!

Well, we won’t tell you how to vote, but here’s a couple of items that might help you as you navigate the highly spun news on the financial bailout — or at least up your game at the next few cocktail parties.

And the green finance angle, you might ask? Well, because of our commitment to sustainability and responsible property investing, we monitor issues affecting the sustainability of communities, particularly their financial viability.  And with that, there are two items to help you in your thinking:

Item #1: Some nitty gritty on the bailout legislation impacting the housing market

We’ve been fans of  ULI’s blog, The Ground Floor, from the very beginning — way before they got their new cool lookin’ blog template.  John McIlwain’s post on the details of how the housing market could be assisted by the proposed bailout legislation spell out specific assistance actions that we do not normally hear about through the news media. He’s pulled out two core areas of focus, which depending on how they are implemented will determine whether we think the bailout was a good or bad idea. Those two areas are:

• program guidelines: this tells the entities getting assistance exactly when and how they should be creating programs and within what scope regarding their troubled assets. Specifically, these guidelines should contain:

(1) Mechanisms for purchasing troubled assets.
(2) Methods for pricing and valuing troubled assets.
(3) Procedures for selecting asset managers.
(4) Criteria for identifying troubled assets for purchase.

• foreclosure mitigation efforts: entities dealing in mortgages and related securities are empowered to offer assistance programs for homeowners that can help to avoid additional foreclosures.  Well, its about time! But, of course, we’ll have to see how both these issues evolve through the legislative process. It ain’t over till its over.

Item #2: Swedes Say ‘Been There, Done That’

Now for something related, but different. Take a look at this New York Times article about how the Swedes approached a similar financial crisis a few years ago. The focus: when faced with the same problems, they took a very different course of action. And the results were both positive and, more importantly, sustainable.

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.

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