Investment Real Estate Goes Green

Dec. 27, 2007
Throughout most of 2007, almost every investment manager I approached about greening his or her investment property responded in some form or another with: “Show me the money.” This is understandable, as investment managers have a fiduciary responsibility to their clients.

Throughout most of 2007, almost every investment manager I approached about greening his or her investment property responded in some form or another with: “Show me the money.” This is understandable, as investment managers have a fiduciary responsibility to their clients. But now, not even a year later, those same investment managers are working on creating strategies, metrics, and processes by which to green entire real estate investment portfolios, and to dial green into their acquisition underwriting. What caused such a sea of change? Is money no longer the most important bottom line in the triple bottom line of sustainability: economic, environmental, and social?

The value of green real estate is determined by the owner’s value equation. If all the attributes of a sustainable or green building are not variables in the owner’s equation of value, then a green building is worth more to some than others. Green buildings add value to: a) the physical asset, b) the financial asset, c) the building occupants, and d) public good (the environment).

The public sector, and then large, multi-national corporations, were the early adopters of green real estate. Why? As owners and/or users of green real estate, they have been able to capture all the benefits of green in their equation of value. Sustainable operation and maintenance procedures employed in a building add value the longer the holding period. For example, measured and verified care of mechanical equipment increases the equipment’s useful life. Sustainable products used to clean the floors are not only better for a building’s air quality and the environment, but also increase the longevity of the floors. These value-add practices are not currently captured in the value equation for investment property with a short holding period, but can be realized by long-term owners.

The greatest benefits of green buildings are the hardest to quantify: improved occupant performance, reduced absenteeism and turnover, and overall satisfaction. So, if the owner of the building is the beneficiary of occupant productivity and well-being, this is added to the company’s equation of value for a green building.

Since green buildings are more energy efficient, use less potable water, and reduce burdens on landfills, their utility costs are less than non-green (or “brown” buildings, as they have recently been coined). If the owner is not paying the utility bills (net leases), however, these savings won’t be included in the owner’s value equation.

This explains why the majority of LEED-certified buildings are owner-occupied, single-tenant buildings. In fact, there are very few multi-tenant investment properties holding LEED certification. So, why are managers of commercial investment property now looking at the need to green their portfolios? Market dynamics are altering the value equation of green investment real estate.

Leading the charge is tenant demand. Tenant demand for green buildings evidenced by rent and absorption premiums appropriately transfers tenant benefits of green buildings to the landlord’s equation of value. Additionally, in markets and among product types where tenants are seeking green buildings, investment managers have suddenly increased pressure to provide green buildings to remain competitive. This dials directly into their value equation. Failure to do so may, over time, alter tenant mix, require retrofitting large, single-tenant floors to multi-tenant floors to accommodate smaller tenants, and/or change the reclassification of an asset from Class A or B to a Class C or “brown” building.

Another market dynamic affecting real estate decisions is the potential of either market opportunity and/or risk due to the regulation of greenhouse gases (GHGs). The regulation of GHG will either directly or indirectly impact the real estate sector. How do real estate professionals address this new dimension of risk added to the value equation? Begin now to mitigate risk by knowing the energy efficiency and GHG footprint of your real estate portfolios and develop plans to improve energy efficiency within budget constraints.

Recognizing the value of green buildings to public infrastructure and the public good, more and more cities are going green as a competitive advantage and in anticipation of GHG regulation. Once ASHRAE 189 (the green building standard) is released in 2008, we will see a wave of its adoption into city building codes. This will add to the stock of available choices of green buildings, rendering greater pressure to green existing building stock or run the risk of obsolescence. To mitigate risk, begin now using LEED for Existing Buildings and ASHRAE 189 as a framework to green traditional operations and maintenance practices and to incorporate these standards into capital budget decisions and acquisition underwriting.

The good news for much of the existing building stock is that being green can be easy. While LEED for New Construction is about design and construction, LEED for Existing Buildings is about operations and maintenance. Too many people don’t realize this very important and opportunistic distinction. In fact, because there is market misunderstanding of what makes an existing building green, the U.S. Green Building Council (USGBC) changed the name of LEED for Existing Buildings v2.0 to LEED for Existing Buildings: Operations & Maintenance. “Operations and Maintenance” was added to address the misconception that LEED for Existing Buildings is about renovations and retrofits, and to underscore its intent to be focused on operations and maintenance. And, if you are wondering about ASHRAE 189, it currently appears to mirror the LEED rating system.

Investment managers looking to green their portfolios have not taken their eye off the economic bottom line. Quite the contrary, as they increasingly recognize that tenants are seeking and cities are requiring a new class of building – “Class G.”

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