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Weekly UpdatesIn the case of owner-occupants, the costs and benefits of pursuing sustainability are calibrated in both dollars and what one might call "PR points." In other words, it's not always as simple as investing incremental dollars to yield incrementally lower operating costs. Many owner-occupants build a "green" trophy asset so that they can telegraph the message "I am an environmental leader' to various audiences from Wall Street to Main Street. It's unfortunate, but sometimes you see a real disconnect in decision-making--for example, when a CEO invests buckets of shareholder capital in a new, high-profile LEED* Platinum-rated headquarters while many of the company's other office buildings ignore even the lowest-hanging fruit, such as grossly inefficient lighting systems controlled by one light switch per floor.
On a related note, you're seeing more and more income-property owners and managers taking the same "trophy" approach to sustainable building, particularly in high-profile markets where tenants are starting to demand green attributes as they lease new space. Often enough, tenants are unclear themselves as to what constitutes green and are rarely able to see past the trophy sticker unless it inures to their bottom line.
Before long, you come face to face with the old "stock" versus "flow" question: If you focus all of your greening resources on the flow of new buildings, what do you do with the stock of grossly inefficient ones that you already own?
MODERATORS: Who has a greater motivation to take a portfolio-wide approach to sustainability, owner-occupants or income-property owners?
JEWELL: Well, that depends. One would think that income-property owners would be more highly motivated than owner-occupants when it comes to venturing beyond the trophy mentality and pursuing at least some elements of sustainability (especially the ones that influence net operating income) portfolio-wide. After all, every dime of higher rental income or lower unreimbursed operating expense per year holds the potential to support an extra dollar (or more) of incremental asset value, assuming a capitalization rate of 10 percent. If green attributes do, in fact, make space easier to lease and/or less expensive to operate, landlords should be very motivated to jump on the sustainability bandwagon to make all of their properties more competitive, profitable and valuable--not just the green trophy buildings they currently have in development.
Before you begin to harvest that increased net operating income and asset value, you have to determine how your existing leases would allocate the costs and benefits of doing so. And that is where so many landlords get stuck. Instead of actually benchmarking their existing buildings' energy performance (using the ENERGY STAR portfolio manager tool, for example), studying the expense-sharing provisions in their existing leases, and doing the calculations, they take the easy way out and make decisions based on myths: "Our properties are already as efficient as they can be." Or, "Our third-party property managers already have energy under control." Or, "Energy is a pass-through." Or, "It doesn't make sense to invest dollars in improving energy efficiency in mid-lease because the tenant would get all the savings."
Once you decide to base your decisions on math instead of myths, you should find plenty of motivation to apply at least some sustainability initiatives across your entire stock of existing income properties. Sure, you'll have to look at which leases are gross, net or fixed-base. And in the case of the fixed-base leases, you'll have to figure out where expected savings would be enjoyed by the tenants, the landlord or both (Figure 3). You'll also want to know which leases have language permitting the landlord to assess tenants for the cost of capital improvements that reduce operating expenses. In the end, though, the research and math will give you the confidence to invest time and capital in sustainability initiatives. That homework will help you answer the questions; "who should pay?" and "who would benefit?"
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MODERATORS: How should a landlord approach quanti-fying the sustainability value proposition?
JEWELL: As I mentioned earlier, you have to ask, "What are the costs and benefits of increased sustainability, and how are they allocated between the parties?" And in this context, costs and benefits include not only investments made to support enhanced efficiency and the resulting savings in operating expenses (for example, lower utility bills). You also need to consider indirect effects, such as the cost of increased vacancy when a building fails to compete in a world where a certain level of efficiency becomes "market," or conversely, the benefit of improved tenant attraction and retention if that same building's innovative energy-efficient systems, operating practices and/or other green attributes are admired in the marketplace.
MODERTAORS: Why do you think that rating systems such as LEED and ENERGY STAR have become so popular, and what influence have they had on the commercial real estate market?
JEWELL: We live in a culture where 30-second sound bites play a large role in influencing decisions, even if the underlying issues are complex-think global warming or the presidential election. Property management roles are over-tasked and understaffed. When it comes to hot button topics like "environmental," "green" and "sustainable," managers gravitate toward easy-to-understand proxies for "making the grade" or, in keeping with the hyper-competitive spirit of commercial real estate, "being better than the next guy" so that their building gets and keeps the best tenants. The ENERGY STAR label for buildings is 10 years old this year, and I would say that over the last decade it's had a profoundly positive effect on making the concept of normalized building energy performance accessible for a wide variety of real estate decision-makers. It really has become the "miles per gallon" sticker for buildings.
That said, in the case of ENERGY STAR, the fact that a building scores in the 75th percentile (or higher) and receives the label does not mean that building has no room for improvement on the efficiency front. As an example, our engineers have identified plenty of cost-effective energy-conservation measures for buildings with scores of 90 and higher. So, one downside of the ENERGY STAR label is that some managers think of it as something that they hurry up and get so that they can focus on other things. Building owners shouldn't think getting an ENERGY STAR label means, "No potential for further efficiency improvements here."
By the way, unless a building scores 75 or higher and wishes to receive the label (which requires verification by a third party), you can't be sure that the right data points were entered into the benchmarking tool. I can assure you that there are plenty of buildings out there that have erroneous scores due to overstated operating hours and other specious inputs. Just because a building claims its ENERGY STAR score is 74 doesn't mean it is.
Using a LEED rating as a proxy for efficiency presents additional challenges. As you may know, LEED grades a building on many dimensions of sustainability, only one of which is energy efficiency. In the most recent version of LEED for Existing Buildings: Operations and Maintenance, if a building has enough points in categories other than energy, that building could attain LEED certification with an ENERGY STAR score of only 69. LEED provides a systematic approach to gauging some attributes of a building's sustainability. However, if your main interest is enhanced operating efficiency, you'll want to have more than a 30-second sound bite level of understanding when leasing, buying or selling commer-cial real estate.
MODERATORS: Until now, the basic methodology for the technical and non-technical studies often cited for sustainable outcomes have been pretty casual. This will begin to change as the level of objective scrutiny increases as well as the number of unbiased scholars interested in this area. Attempts are being made to acquire and analyze some data, though there are still fundamental problems with method and with adequate data for meaningful analysis.
Having looked at a swath of the extant literature regarding green building valuation, what have you concluded about the nature of the current research in this arena?
MCCABE: Quite frankly, on the valuation side, it is lacking. This really shouldn't be a surprise. The demand to collect and analyze information on green buildings or sustainability more broadly has quickly moved from a low hum to a high frequency. Shareholder initiatives, consumer campaigns and new legislation are requiring investors to be quick on their feet in addressing these issues when considering future risk and opportunities. Only recently has sustainability been seen as germane in effectively managing real estate assets.
Due to this rapidly changing landscape, we're playing catch-up. Unfortunately, we don't have hard numbers on the subject because there are limited means of screening the properties (LEED, ENERGY STAR, Green Globes rating) and no comprehensive mechanism to capture the data. We really need to do the work first to define the characteristics and variables that describe a property's sustainability, and then we can substantively start the process of tracking and measuring asset, portfolio and investment performance. All of this is going to take time.
MODERATORS: What kinds of data are available to draw on in trying to answer these questions?
MCCABE: Much of the analysis around sustainability has focused on first costs and projected energy efficiency. There is much less robust work around rental rates, vacancy, turnover and value premiums. The easiest way to analyze value enhancement is to compare returns on comparable green buildings to conventional properties. The data set is disappointingly small. CoStar recently upgraded its database to allow for designation as a LEED or ENERGY STAR property. By late 2007, CoStar had collected basic performance data on 355 LEED-certified properties and 973 ENERGY STAR buildings as compared to more than one million conventional build ings in their database. Taking a look at the CoStar date in more depth, RREEF published a paper in November 2007, "The Greening of U.S. Investment Real Estate--Market Fundamentals, Prospects and Opportunities," looking at the CoStar data in more depth. RREEF's drilldown analysis targeted the office sector. It identified 232 LEED-designated office buildings, 114 of which were designated Class A. This compares to 14,000 Class A properties across the CoStar universe. As a first cut, the LEED Class A buildings outperformed the broader data set both in rents ($39/sq. ft. vs. $29/sq.ft.) and occupancy (7.4 percent vacancy vs. 11.6 percent). While this study shows suggestive trends, it cannot be considered statistically significant based on its small sample size and because it was unable to account for location, age and other appropriate adjustments.
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