As I witness the fate of Detroit automakers, I can’t help but see potential parallels between the automotive industry and the real estate industry. It would have cost U.S. automakers more money – and cut into their profits – to make more energy-efficient vehicles that were better for the environment, but Detroit believed it wasn’t what their customers wanted.
Most of the real estate industry and its capital sources are waiting on “enough” quantifiable data to build new or retrofit existing buildings to high-performance green buildings that are healthier for occupants and better for the environment. Most are still unsure whether it’s what customers want, or whether customers (tenants) will pay enough to justify the added investment. Foreign automakers made the switch and made money.
It’s time to shift our thinking from seeking to quantify green returns to assessing the risk of not making sustainable choices.
Waiting on the Numbers to Value Green Buildings
The luxury of waiting on enough numbers to make a risk-free change is no longer. The risk is not in going green, but in failing to go green. Detroit’s big three automakers failed to make difficult but necessary changes.
Studies of first-cost green premiums consistently hover in the 0- to 2-percent range. Post-occupancy studies support reduced operating costs and higher absorption, occupancy, rents, and sales prices; however, there’s not enough quantifiable data to draw statistical conclusions to be inserted in traditional valuation models. Yet, data and common sense tell us that these studies are directionally correct.
Implementing green practices that improve efficiency and the environment is a sound business strategy. Move from looking for the value-add of a green building to underwriting the added risk of a non-green building.
A comprehensive report titled Globalization and Global Trends in Green Real Estate Investment (prepared by Andrew J. Nelson, vice president at Chicago-based RREEF Research, September 2008) identifies at least three major types of risk for investors:
- Market risk: Rising standards will make inefficient buildings obsolete over time.
- Regulatory risk: Governments may quickly alter the playing field and cost/benefit calculators.
- Environmental risk: Physical damages attributable to climate change may alter risk profiles.
According to Nelson’s report, global trends in green real estate investment hold the following implications for investors:
- Rapid transformation will move the market toward green-only construction.
- Studies uniformly conclude that green buildings command higher rents and occupancy rates, lower utility costs, and lower capitalization rates.
- Urban infill sites will be increasingly valued.
- Markets will flip from a green premium to a discount for obsolete construction.
- Immediate risks are to older, inefficient buildings whose obsolescence will be reflected in lower rents and occupancy.
- The greatest opportunities for green building investments will be in the United States due to its large stock of aging investible real estate and sizeable population growth.
Market Dynamics
The global market dynamics driving sustainability are undeniable. Consider the following:
- Worldwide population growth, particularly among developing nations.
- Increasing demand for energy in the United Sates despite mounting concern about energy security and independence.
- The need for large capital investment in new infrastructure, including energy, transportation, water, and communication infrastructure.
- Air pollution and the economic development and air quality impacts it has on America’s metropolitan areas.
- Global climate change.
- Stakeholders pressuring companies to be more responsible – environmentally responsible, socially responsible, and fiscally responsible.
Each one of these factors is already impacting the built environment through tenant space requirements, local building codes, land-use policy, and the surge in green buildings, as well as higher prices for energy, water, insurance, and construction materials.
Is It What the Customer Wants?
In a tenant’s market, there is always a flight to quality. Green buildings are the new Class-A. The cost of electricity will rise. Budget-conscious customers will seek energy-efficient buildings.
Green may or may not achieve higher rents, but a tenant will choose a green building over a non-green building. As non-green buildings face greater absorption risk, they also face risk of lower rents.
Yet, many landlords continue on the same old path, not making changes to improve the efficiency and environmental impact of buildings by arguing the case that tenants do not want green buildings. It’s both economically rational and environmentally responsible for a corporate real estate executive to choose a green building over a non-green building.
Benefits of green buildings include the following:
- Green buildings improve productivity.
- Green buildings are a visible message to customers, clients, and shareholders.
- Employees are attracted to green companies and want to work in green buildings.
- Green buildings are a “plug-and-play” solution for corporate social responsibility reporting, and the price of admission for landlords to be competitive in a tenant’s market.
- Green buildings can significantly reduce utility expenses for energy, water, and waste.
Fundamentally, sustainability is about becoming more efficient with the use of energy and natural resources, eliminating waste, removing toxins, improving indoor air quality, and supporting occupant well-being. There is tremendous business value in becoming more efficient and more sustainable.
That being said, it’s not solely up to the landlord to green a building. While landlords need to take leadership roles, green buildings require equal contributions from all their players – ownership, building management, vendors, suppliers, and tenants/occupants.
Wait Until We’re Forced to Change?
The U.S. Department of Energy tracks energy consumption and CO2 emissions by sector. The sectors are industry, transportation, and real estate. Real estate is contributing more CO2 emissions than the other two contributing sectors: transportation at 29 percent and industry at 32 percent. Of real estate’s 39 percent, 18 percent of emissions is attributable to commercial real estate and 21 percent to residential real estate. To reduce environmental impact of vehicle emissions, the transportation industry has been mandated to adopt CAFÉ (Corporate Average Fuel Economy) standards. The urgent need to reverse climate change has spurred numerous studies to determine the most immediate, low-cost solutions to reduce CO2 emissions. These studies consistently identify increasing the energy efficiency of real estate – new buildings and existing, residential and commercial – as the greatest opportunity for cost-effective CO2 reduction. As a result, anticipate government intervention at all levels to improve the energy efficiency of the real estate sector. Under the Obama-Biden plan, greater focus on the efficiency of existing real estate is promised. As government regulation increases and more and more buildings are green, non-green buildings will face greater and greater challenges.
Real estate is already being impacted through:
- Green building codes and more stringent energy codes.
- Land use policy aimed at reducing vehicle miles traveled.
- Incentives to increase the energy efficiency of buildings.
- Tax credits for new energy technologies and on-site power generation.
Just as the automotive industry is required to report the fuel efficiency of the cars we purchase, the real estate industry may soon be required to know and report the energy efficiency and carbon emissions of real estate, much like the European Union, California’s Assembly Bill 1103, and the District of Columbia’s Clean & Affordable Energy Act of 2008. Know the energy efficiency and carbon emissions of your real estate, and have an energy plan.
The evidence is clear. We cannot ignore the forces calling upon us to live more sustainably. If we acknowledge the presence of these forces, then it’s illogical and imprudent not to extend our better judgment to our real estate. Let us learn from others’ mistakes.
