By Mychele Lord
Green is going mainstream. More and more, green is being incorporated into investment criteria. Integrating green criteria into our underwriting decisions is no longer for just do-gooders - it's sound risk management. Green criteria impacts real estate in three primary categories: location, physical attributes, and operational practices. Last month, I suggested a new set of criteria relating to the location of real estate that should be incorporated into our decisions. Part 2 explores criteria relating to the physical attributes of real estate that, if not built into the deal, will increase an underwriter's risk.
Capital-Intensive LEED Prerequisites
Does the building you're about to lease, purchase, or mortgage even have the ability to pursue LEED certification? To qualify for LEED certification, an asset must first meet the LEED prerequisites, and then must meet criteria from a selection of credits. LEED prerequisites are essentially the same across the various LEED rating systems. For an existing building to pursue LEED certification, or for the building to meet the needs of a tenant wanting to LEED certify the leased space under LEED for Commercial Interiors (LEED-CI), the building must meet certain prerequisites.
When underwriting, know whether or not the asset meets the capital-intensive, base-building prerequisites. If not, incorporate the cost into your pro forma. The capital-intensive, base-building prerequisites, which are discussed below within a broader context, are:
- Achieving a minimum level of energy efficiency.
- Meeting a baseline level of water usage based on the Uniform Plumbing Codes.
- No chlorofluorocarbons in the base-building HVAC&R equipment.
As demand for energy increases, so does its price. When we purchase a car, we know the fuel efficiency of the vehicle. The importance of fuel efficiency increases as the price of gasoline increases. The same will be true for the energy (electricity and natural gas) that powers our real estate.
Multiple indicators clearly tell us that the price of energy is going up: an over-burdened electrical transmission grid, increasing demand, rising costs, the need for energy independence, global climate change, and the regulation of greenhouse gases. When we buy a refrigerator or HVAC unit, we know its efficiency rating.
The EPA's ENERGY STAR® tools allow us to know the energy efficiency and resulting carbon emissions of our real estate - office buildings, retail stores, hotels, medical facilities, warehouses, etc. The free, online program generates a "Statement of Energy Performance." Knowing a building's energy-efficiency rating on a scale of 1 to 100 prior to signing a lease, purchasing an asset as an investment, or making a loan is basic risk management. When we purchase ENERGY STAR-labeled equipment, we know it's energy efficient.
We have the same choice with buildings. Buildings scoring 75 or above and validated may earn the ENERGY STAR label. ENERGY STAR Portfolio Manager allows for the tracking of energy and water. State and local governments across the country, as well as corporations and large real estate owners, are now adopting policies that leverage EPA's ENERGY STAR tools to reduce energy use in commercial buildings. In 2010, California will require the "Statement of Energy Performance" on all real estate transactions, including leases, loans, and acquisitions. Similarly, the District of Columbia will require that all real estate be benchmarked in ENERGY STAR Portfolio Manager by 2010. Cities, such as New York City and Dallas, are considering passing similar measures. Sooner than later, savvy investors and prudent lenders and tenants will require it.
The prerequisite for LEED for Existing Buildings is an ENERGY STAR score of 69; however, the higher the ENERGY STAR score, the more LEED points that can be earned - up to 15 points, which is more than any other credit. Room for improvement always exists, and significant savings are often found in the low-hanging fruit. So, how do you identify the low-hanging fruit?
Conduct an energy audit. Asking for an energy audit can be like asking for a box of cereal - there are many choices. Specify an ASHRAE Energy Audit. Following the prescribed scope of an ASHRAE audit as detailed in the organization's publication, titled Procedures for Commercial Building Energy Audits, will ensure standardization across your real estate portfolio and consistency across the industry.
When underwriting, add the following to your criteria:
- Has the asset been ENERGY STAR-labeled (score of 75 or above) in the last year? If it's labeled, the numbers have been verified by a professional engineer (PE).
- Ask for the current "Statement of Energy Performance." This is a report produced by the ENERGY STAR online tool once a building's data has been loaded.
- Ask for the most recent 14 months of utility bills (for all types of energy used by the building) to verify the above.
As the demand for drinkable water continues to increase, so will prices. The earth's population is growing at an exponential rate, and only 1 percent of the earth's water is fit for drinking. It has never been more important to use water as efficiently as possible.
Buildings waste a tremendous amount of water through irrigation, cooling towers, and indoor plumbing fixtures. Hedge against rising costs and new green-building codes; know the water efficiency of the buildings you are underwriting. As a guideline for an existing building, make sure the building's indoor plumbing fixtures at least meet the Uniform Plumbing Code (UPC). If upgrades are required, don't replace outdated fixtures with soon-to-be-outdated fixtures. Prepare your building and install new, ultra-high-efficiency fixtures.
gallons per flush
gallons per minute (gpm)
gallons per flush
Refrigerants in Buildings
Essentially, LEED says no to CFC-based refrigerants in HVAC&R base-building systems. Chillers are the big-ticket items that use these refrigerants. This LEED prerequisite extends to district plants supplying the building even when not owned by the building owner. Chlorofluorocarbons (CFCs) are halogenated substances that, when inevitably released into the atmosphere, cause ozone depletion. The United States and 160 other countries have signed the Montreal Protocol on Substances that Deplete the Ozone Layer. The treaty includes a timetable for the phase-out of production and use of such substances. CFC-based refrigerants ceased production in 1995, and are, thus, no longer available in new equipment. The first cousins to CFCs are HCFCs (R-22 and R-123). The most damaging HCFCs began to be phased out in 2003; all HCFCs are scheduled to be phased out of new equipment by 2020.
During due diligence, find out if the chillers use CFC-based refrigerant. If so, make sure your strategy for the asset is consistent with the LEED prerequisite governing CFCs in the building.
When equipment is replaced, insist on the use of HVAC&R equipment that: 1) does not use refrigerants, or 2) uses refrigerants with the lowest possible ozone-depleting potential (ODP) and the lowest global-warming potential (GWP), such as HFC-134a. This excludes appliances that contain less than 0.5 pounds of refrigerant.
These are the physical attributes of an existing building that are most likely to be your hurdles in the pursuit of a green building. These LEED prerequisites should be dialed into every real estate decision. Laws, building codes, energy prices, corporate governance - all are rapidly changing. Real estate decisions are often long-term commitments. Failure to account for a rapidly changing landscape in the due-diligence process could result in lost opportunity and overlooked variables or incorrect assumptions regarding the status quo. Would you buy a Hummer today as a long-term investment?