November 3, 2009 - From the October, 2009 issue

ULI-LA FutureBuild: ‘Going Beyond First Costs: The Dollars & Cents of Green Building'

TPR presents the following excerpts from a panel at ULI's FutureBuildLA event, entitled Going Beyond First Costs: The Dollars and Cents of Green Building Investment and Valuation. The panel features Norm Miller, PhD, director, University of San Diego MSRE Program; James Finley, commercial appraiser manager, Wells Fargo; and Theddi Wright Chappell, managing director, National Green Building & Sustainability Practice Valuation Services, Cushman and Wakefield.

Norm Miller

Norm Miller: The motivation for my research is several fold. Is it worth building buildings with green features? It is worth paying a premium in rent if you have to? Is this going to be a market that will be regulated or will the incentives provide what we need to move forward? I was a participant in what was an early academic study. It is amazing that it was only a couple of years ago and still considered an early study...We looked at occupancy and rental rates and a number of other factors using CoStar data. Since this study came out showing that there were economic benefits in going green, we have had validation from other academics. But we continue to study.

...We see that Energy Star buildings tend to have higher occupancy rates. The first point is that even if rents are the same the occupancy rates were higher. There should be a value impact. The direct rental rates from Energy Star also show premiums. We made great efforts to compare apples-to-apples-only multi-family and office...The LEED results also had higher occupancy rates.

We all know that we're in a down market. We all know that occupancy rates are going down. For Energy Star and non-Energy Star, we saw both rates going down, but this is a surprise: the LEED properties actually had a positive net absorption in the beginning of 2009. I can't tell you that it's going to hold. I can tell you that on a relative basis, it is a surprise. It means that despite the soft market, the buildings that are getting tenants are better buildings with green features...

... Right now I am doing something with CBRE and we are finding different results that are always positive. Green buildings are paying off significantly. Why these results? Why these kinds of premiums and rent differentials? 70 to 80 percent of public firms now have a sustainable mission statement; they have to put their money where their mouth is. It is either demand or supply, and we don't have that much of a supply yet. We are in the city with the highest absolute number of green office buildings in the country, and it is still under 1 percent. That is a tiny amount. The California GSA and the federal GSA have to move in this direction, so sometimes there is significant demand for these buildings. Even with all of the registered projects going through LEED it is still a very tiny percentage. Office leads the market. Industrial and retail are well behind. Residential is even further behind. We have a long way to go on this.

What do the tenants want? Are they willing to pay more for it? We are working with CBRE, with 700 tenants responding to what they value. The full results will be presented at the USGBC's GreenBuild in Phoenix. The kinds of things we have been investigating that we believe should matter are natural lighting, better ventilation, humidity and temperature control, and a more efficient use of energy and water. People like buildings where you can actually bring in fresh air and natural light.

In our first survey we had 2000 tenants and 534 of them responded. Forty-two percent agreed and 12 percent strongly agreed that they were more productive after a move from a non-green building to a green building. These are mostly Energy Star buildings. Some of those were LEED buildings. We couldn't find a difference between them, but generally people said they were more productive. In terms of sick days taken, 45 percent said they had fewer sick days. 45 percent said they had the same amount and 10 percent said they had more...If you ask them directly if they are willing to pay more in rent for these features, in 2007 they said yes only 5 percent of the time. Now they say yes 18 percent of the time. Let's take the cynical view-82 percent are not willing to pay any more money. That is how you could look at it. If I had asked the question the other way-"If you didn't have these features would you require a discount on the rent?-they would probably all say yes. We have to be careful how we ask questions like this, but empirically we do see that they are willing to pay more. If you look at the productivity and sick time and combine that, it is about a $25 per square foot per year impact. That's about the same as the rent so that is a pretty significant impact.

We do have a new journal, of which I am the editor, called The Journal of Sustainable Real Estate. It's global and we have authors and an editorial board from around the world. Our first issue is coming out in November...

James Finley: I am the appraisal manager for Wells Fargo bank. My day job is to order appraisals. In that capacity I order most of the appraisals for lending on LEED and high performance buildings...

...In July 2005 the bank made a commitment with a ten-point environmental plan including a target of $1 billion in lending for environmental projects. We joined Equator Principles, which is an international financial commitment to transparency reporting. Our involvement in sustainability covers renewable energy investments: tax credit driven utility grade solar and wind...

...We have lent about $3 billion. $2 billion of that is part of Wells Fargo Legacy and about $1 billion of that is from Wachovia through our recent merger. Wells Fargo is an old school bank. We have a fundamental way of looking at finance and lending. It's all about people...As an appraiser I look very closely at real estate, where it is, why it is there, who is in it, and what they are doing. In the context of high performance lending there is that green thing. This hierarchy is important to shine a light on the priority of sustainability within the lending context. There are a lot of things placed ahead of sustainability in priorities even though it is going to become the standard eventually.

We are big construction lenders and some of our biggest projects are LEED certified. One thing about proposed construction is that you are making a bet on the future. It is tough to make predictions about the future. The example I am going to use here is the difference of risk in a project with photovoltaics versus energy efficiency. PV is a great, stable technology. The sun comes up every day and the photovoltaic panels have 25-year warranties. I have a meter that shows exactly how much money comes out of that little machine. With energy efficiency, there are problems with occupancy and utility rates and it makes the calculation much more complicated. This is the kind of balance we have to make when looking at risk as an appraiser and lender when we look at a high performance property.

Appraisers love numbers. Underwriters love numbers. Any type of finance guy is going to want to see good records, and so anyone involved in a project with a sustainable feature, I recommend that you keep good records. I am shocked at how the record-keeping is just not as good as it could be when I am given a package about a new building. It is exciting to see new technologies like smart metering. Commissioning is really about benchmarking a building's performance to the engineering model. Real-time commissioning, with constant, instantaneous feedback is something that all high-performance, net-zero buildings have now. As an appraiser that is exactly what I want to see. I want to see this heavy data.


The holding period of buildings and the occupancy cycle is a key part of risk. Institutional, educational, and public buildings have a very long holding period with very consistent occupancy. You have the opportunity to recapture investments easily and can capture them slowly over time. Owner-user or single tenant investment properties are sort of the next tier of risk where you have the simple recapturing of all those benefits to a single party without any confusion about the third category, which is multi-tenant. With multi-tenant you have a split incentive problem where the landlord invests in upgrades but the tenant really benefits the most. The problems around the split incentive problem dominate the conversation. If you look at the LEED certifications you will see that quite a few of those are in the first categories. When I speak to investment advisors right now, they are really concentrating on the renovation opportunities in single-tenant-repositioning old 70s and 80s buildings with a single tenant-which avoids that split incentive problem...

...Looking ahead, I am keeping my eye on certain things and periodically I am asked to give an update on what is coming up. I see smart meters and the micro grid as a big play in the utility market. Carbon pricing-anyone who is powering their electricity with coal is going to get a wake up call pretty soon. We are missing energy audits. It is still pretty primitive. I'd love to see more of that. I call it a "resource appraisal." Basically it is what goes in and out of a building-water and waste. That is still an unwritten book. I look at net zero buildings. I crawl the internet all of the time looking for these buildings because that is where the real lessons are. Benchmarking is getting better through LEED, and Energy Star is a fantastic, low, easy metric that I think has a lot of transparency. I personally am really big on behavioral economics and these kinds of Freakonomics books where the occupants of the buildings really don't need that much. You just need a little bit of feedback to get some very easy behavioral changes. That can have a big, bottom-line impact. Keep the faith. It is still early.

Theddi Wright Chappell: The challenge for my profession as an appraiser is to get across the benefits relative to sustainability. How does green translate to value? Part of our challenge is that the vernacular and terminology is not familiar. It is not how valuation professionals have been trained and it is not the information they have been given when they've been trained to value properties. What oftentimes gets missed is that, yes, there is an environmental component, but this is about best practices. Sustainable development is about creating the best product for the consumer and the environment. Where we run into difficulty many times is that the appraisal profession isn't familiar with exactly what sustainable development is. They know it is green but they do not know the vernacular. They do not know the terminology so they can't carry on the conversation to figure out the benefits. Everybody gets the cost, but the benefits are hard to articulate and document... is a great site. When we look at an appraisal we need to be aware of what the codes are. They are changing dramatically. The regulatory mandates in place today are very different from what they were two years ago. Two years from now they will be different still. There are a number of incentives to date. Most of these have been around municipal sites. Certainly sticks or other types of mandates have focused on public buildings as opposed to private but we are seeing more and more incorporation of mandates from local and state governments on the properties that are being built there. Codes are something that have to be considered in valuation. They are something that I need to know about and whether or not buildings meet certain codes. Those could be density bonuses.

Under the sticks category, Portland, Oregon, is looking at a new code that would require that new buildings in the private sector be built to a certain level of sustainability. If they are built to a standard that is higher then they will get the equivalent of a tax rebate. If it is lower they will effectively pay a tax. Currently Oregon has a lot of incentives but few mandates. If this passes, that will change dramatically...

...What do you need to be aware of if you or one of your clients is considering green development? First of all, there are a number of potential benefits. The capital could be different. There could be incentives. I worked on a project in Oregon where the Energy Trust of Oregon, because a winery was using PV panels, actually underwrote and loaned them money at 300 points below conventional financing. They did it as a direct incentive, which means you could consider it in a direct valuation process and it effectively eliminated the associated first cost. It could be-and there have been instances where it has been shown-that maintenance and operating costs are lower as well as capital reserves. Some of these components last longer. That is going to impact the assumptions that an appraiser makes relative to the valuation or risk profile that a property will have.

Looking for value and the kinds of benchmarks you can use, there are other benefits through sustainable development. It could be quicker absorption, better tenant retention or less down time between leases, and lower tenant improvement costs. What are the risks? Right now lenders are just as interested in what could go wrong as what could go right. As appraisers we face a lack of empirical data. We rely on costing services to provide us with estimates for our appraisals. They haven't had green components in them. Now they may have green components but unless you involve an engineer, you can't really consider the aspect of integration because that is not our area of expertise.

There is a lack of qualified professionals: more and more we are finding that if we get a proposal we have to look at the probability of whether or not that is going to be achieved. There is a lack of engineers. There is a lack of commissioning agents and property management. Even if you built the greatest property in the world, if you don't have trained property management, and they don't operate it properly, you won't get the results you anticipate. Finally, there is a lack of appraisers...there are not very many appraisers who really understand what sustainability is. If they don't, they will miss something.

What is the risk? What if you make the decision today that you're not going to go this route? How will the market view your decision? Appraisers don't agree on many things, but across the country they will look at this and say that the possibility of early obsolescence-if it is not at the very least energy efficient-is greater. If your building isn't in the very least energy efficient it is going to be deemed obsolete in three to five years...

...Environmental risk is an issue. We can't control the cost of utilities or fuels. I work a lot with the Northwest Energy Efficiency Alliance and they assure me that those things are going to go up. But we can't control consumption. The prudent investment solution-the thing relative to risk for your property-would be whether or not you choose to create a more energy efficient and sustainable property....



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