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Weekly UpdatesIn March 2008, CoStar released the results of a new study, the Peer Selection Approach. The findings were broadly disseminated and widely communicated. This approach concluded that LEED buildings command an $11.33 rent premium over their non-LEED peers, sold for $171 per square foot (64 percent higher) and reflect 4.1 percent higher occupancy. Using the same analytic approach, it found that ENERGY STAR buildings command a $2.40 rent premium and 3.6 percent higher occupancy.
The conclusions reached by this analysis are limited by its small sample size and the challenges inherent in adequately considering all of the variables that contribute to rents, vacancy and valuation. The authors' alternative conclusion using the Hedonic Pricing Model was not widely communicated. This approach found that LEED certification contributes $24 per square foot (a 9 percent premium). This approach also is limited statistically by its small sample size, but is better controlled for age, size and location. While the adjusted R-square is low at 47 percent, the authors did conduct an analysis of the residual error to check for systematic bias. They did not find any systematic bias, and therefore have some confidence in these results. Because the underlying methodology was not fully presented, it is difficult to make an assessment of the quality of the information or its applicability in making investment or underwriting decisions.
With regard to long-term financial performance and the impact on value and discount rates, again, the data is sparse. Clearly, if energy efficiencies translate into lower operating costs, then, as compared to a conventional property, a sustainable one would have higher net operating income and consequently a higher value. One can also posit that these properties have inherently lower risk of exposure to volatility in price and resource availability, which again should translate into lower capitalization and discount rates.
MODERATORS: What types of common difficulties have you seen in the data and what provisional conclusions have you drawn?
MCCABE: The two most common errors are considering sustainable features as distinct and separate from the overall real estate investment decision, and drawing broad conclusions from a limited data set, or one derived from opinion or hypothetical numbers. There are unique risks and benefits that accrue to sustainable features. What is important is that the analysis incorporate a sophisticated discussion of the risk calculation inherent in investor decision-making and valuation, and provide a framework for evaluating the impact sustainable attributes will have on the bottom line.
Do sustainable design features lead to higher rents, faster absorption and lower turnover? It's difficult to say. Some anecdotal evidence and even some analysis suggest that sustainability has a positive impact on absorption and turnover. At this point, we don't know if tenants will pay more for sustainable features.
Are sustainable properties more valuable over the long term? Once again, there's not enough data to answer this question. Still, logic suggests that a higher net operating income (due to lower operating expenses) will lead directly to higher property values. We should also keep in mind that energy costs, which are increasingly influenced by developing markets around the world, will continue to exert pressure on overall pricing and availability. If we lower our exposure to energy price volatility and resource availability, we reduce our risk. This should mean a lower capitalization rate and/or discount rate.
MODERATORS: We have little data to help resolve the question of valuation of this new type of building. If these buildings can actually increase NOI as a result of decreased operating expenses, or have a lower capitalization rate in recognition of risk reduction from energy price or supply shocks, many in the industry would see this as more than adequate reason to pursue a green strategy. However, to achieve these ends the buildings would have to perform not only at inception but over their operating lives at a higher level, particularly in terms of energy consumption. This improved performance can be achieved, but it is not yet clear at what cost or if rating system certifications can act as viable proxies for energy performance during the operations phase.
In very general terms, what should an owner know at the outset when thinking about building or purchasing a green building?
WOODS: In today's excitement about sustainable, high-performance and green buildings, it is unclear what is meant by "building performance." Each of those descriptors alludes to some improved building performance over a baseline or reference which is seldom defined in measurable or verifiable terms. As a result, accountability is seldom realized for delivering or operating buildings that meet objective, measurable criteria that are of primary importance to the building owner or tenant.
One of the promised outcomes of sustainable, high-performance, green buildings is reduced energy consumption. Expectations have been raised that these buildings can reduce energy consumption by 30 percent or more compared to the existing building stock. This promise is not new: reduced energy consumption in buildings has been a goal since the energy crisis of the 1970s. When the first version of the standard on energy conservation in new buildings was published in 1975 by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE Standard 90-75), the average annual energy consumption of existing commercial buildings exceeded 100,000 Btu/gross sq.ft. (GSF), according to the Commercial Building Energy Consumption Survey (CBECS) database maintained by the U.S. Department of Energy. Since 1982, the target for annual energy consumption of CBECS buildings has been 55,000 Btu/GSF, but the actual consumption has been statistically flat at 88,000 Btu/GSF. The fact is that the targets for decreased energy consumption have not been met for the last 25 years and are unlikely to be met in the near future. This doesn't mean that some buildings may not achieve these targets, especially if they are driven by measurable and verifiable performance metrics, only that a large-scale average reduction from the benchmark will be quite difficult. In part, this is a result of the continued increase in energy consumption pointed out by Roger Bezdek earlier. Current targets being bandied about such as "net zero energy consumption" or "carbon-neutral" by 2030 pose challenges far beyond the 55,000 Btu/GSF target which has proved unattainable. It should be kept in mind that even in highly rated green buildings, energy consumption can be far below or far above the benchmark.
It is important that green buildings first provide the functions for which they were intended by the state and the owner: health, safety, security, comfort and well-being, occupant performance, productivity, and attractive rate of return on investment. Thus, building performance should be defined as a set of measured responses of a building, as a system, to actual or anticipated physical or social forcing functions. In this regard, energy consumption is a required component to achieve these measured responses, but energy should not be wasted. This principle leads to a goal of increasing energy efficiency, which may be defined as the ratio of the energy required to provide for the health, safety, security and functions within the building divided by the energy consumed to do so. In this context, the difference between energy required and energy consumed is energy wasted, which is to be minimized together with the energy required. Accountability can then be ascertained in terms of a defined set of building performance criteria.
My experience in reviewing cases of sustainable, high-performance and green buildings, as well as those that were not so labeled, reveals that building performance assessment requires compliance with a comprehensive set of criteria. Otherwise, the focus of the assessment becomes biased toward selected limited criteria. For example, a goal for a low-energy consumption rate may lead to a decrease in occupant productivity if there is an increase in occupant discomfort. Functional considerations often clash with green attributes, just as one green attribute may clash with another. My own experience has indicated that there are major award-winning green buildings that do not stand up to closer scrutiny once they are fully operational. I cannot say if this is a common or systemic problem, but I can say that owners need to be particularly careful if they are actively seeking to increase the real performance of their buildings.
Achieving and maintaining a sustainable, high-performance or green building requires early and clear definitions of site-specific measurable criteria. Without such criteria, and the measurement and verification protocols to determine compliance, few buildings can deliver the outcomes with adequate accountability to create higher asset value. In fact, the more often owners hold the programming, design, construction and operation parties accountable for improvements in building performance, the greater the chances of reaching the worthwhile goals of this kind of building.
MODERATORS: One of the more hidden aspects of green building remains the legal risk for the parties involved. Proper leasing language, surety bonding concerns, constitutionality of green zoning or building requirements, fiduciary duties of portfolio managers preferentially acquiring green buildings, and the developers failure to meet the expectations of tenants or condo purchasers are just some of the issues. A specific area of concern has been the role of the architect (and engineers as well) in this process. You have talked about the realignment of the traditional architectural scope and delivery of building performance and how that poses some fundamental legal risk for both the owner and the architect, especially since the traditional affirmative duty of due diligence and unbiased counsel to the owner may be changing.
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