Sustainable Real Estate

1. Sustainable Real Estate Kevin Chiang

2. Outline 1. The state of sustainable RE 2. Major rating tools 3. Costs and benefits of being green 4. Why being green can’t be easier? 5. A case—Equity Office

3. Sustainable RE • Sustainable RE is a notion that takes the impacts of the build environment at the site, neighborhood, and global levels. • The main issues are: energy efficiency, accessibility to public or clean transportation options, healthy indoor environmental (e.g., air) quality, reuse of materials and use of sustainable materials, building preservation and reuse (smart growth), water efficiency, and stormwater management.

4. It is coming! • Regardless of whether you believe that global warming is true, the uncertainty and the threat itself has already forced law makers and corporate executives to act. • The 2003 EU Energy Performance Directive requires the disclosure of energy performance? • Many states, e.g., Oregon, in the U.S. now offer subsidies and tax benefits for eco-labeled buildings. • Many cities, e.g., Baltimore and Sacramento, have incorporate green standards into their building codes.

5. Why uncertainty triggers business action? • Holding cash flows constant, shareholders’ wealth increases (decreases) when the risk profile of the firm decreases (increases). • The threat of global warming (a shock/risk to energy price and firms’ operating costs) introduces a corporate driver to reduce firms’ exposure to energy price shock. • An effective way to do so is to reduce the use of energy by adopting sustainable RE practices.

6. The 2008 Economist Intelligence Unit survey (1,254 executives) • This study focuses on corporate sustainability. • About half of respondents named RE-related sustainability goals/issues to be their leading priority. • These goals include (1) improving energy efficiency (19%), (2) improving the local environment around facilities (14%), and (3) reducing greenhouse gas emissions and/or waste/pollutants (13%). • Buildings are responsible for nearly ¾ of a firm’s total greenhouse gas emissions, excluding manufacturing.

7. EIU survey, II • 57% of executives said the benefits of pursuing sustainability out-weight the costs. • More than 80% of executives expect a minimal benefit to profitability. • They believe sustainable practices can (1) reduce costs, (2) open up new markets, and (3) enhance firm image.

8. The Jones Lang LaSalle and CoreNet Global survey (2008) • ¾ of firms (corporate tenants) consider energy and sustainability issues as a “major” or “tie-breaker” factor in making location decisions. • Corporate tenants report greater scarcity of green space that meets their needs today than a year ago.

9. The rise of eco-labeled buildings • LEED (Leadership in Energy and Environmental Design) certified projects represent 6% of new commercial construction. • 40% of new project registrations are LEED projects. • It takes about 2 years from registration to certification.

10. The impact of the build environment • Buildings account for about 40% (commercial 18%, residential 22%) of U.S. energy consumption. • Buildings account for about 68% (commercial 33%, residential 35%) of U.S. electricity consumption. • Buildings account for about 38% (commercial 17%, residential 21%) of U.S. CO2 emissions.

11. Major rating tools • Globally, there are several dozens of rating tools. • In the U.S., LEED and ENERGY STAR are the two most important rating tools. • Like any rating tools (hotels, mutual funds), they are not perfect tools. • Projects may not driven by best practices for a particular site and use, but by scoring points.

12. LEED • Certification is based on scores in a number of category: sustainability of location, water efficiency, energy and atmosphere, materials and resources, indoor environment quality, and innovation and design processes. • Based only on design and construction. • The LEED thresholds are primarily absolute. • 4 levels: Certified, Silver, Gold, and Platinum.

13. ENERGY STAR • This certification requires a building to achieve energy use in the best quartile of buildings in their business category. • It also has air quality requirement. • It requires monitoring a year of energy use for certification. • ENERGY STAR is rather an easy target because most commercial buildings are relatively inefficient.

14. Differences in LEED offices and ENERGY STAR offices • LEED offices tend to be smaller (median: 100,000 sf), shorter (median: 5 stories) , younger (median: 5 years), and rather diversely located. • ENERGY STAR offices tend to be large (median: 220,000 sf), tall (median: 10 stories) , older (median: 20 years), and located in major metropolitan markets.

15. Costs of LEED • 2 types of incremental costs. • Hard costs: about 0.6 for certified-level, 2% for silver- and gold-level, and 6% for platinum-level. • Soft costs (about 1%): additional design, documentation, commissioning, code-compliance delays, etc. • Commissioning: the process of ensuring building systems (e.g., HVAC, electrical systems, mechanical systems) are designed, installed, functionally tested, and capable of being operated and maintained according to the owners’ operating needs. • The median total cost is about 3%. • Developers tend to perceive a higher incremental cost (10% or more) than this.

16. Costs of ENERGY STAR • Two approaches are usually sufficient for most new commercial buildings to meet an ENERGY STAR target. • 1. Appropriate lighting design. Most buildings are over-lit and under-controlled. Too much energy use increases air-conditioning and ventilation costs (to remove waste heat). • 2. Building commissioning (to address design flaw, neglected maintenance, equipment degradation, etc.). • The incremental cost is about 1.5%.

17. Productivity and green buildings • Healthier and happier mainly due to natural light, good ventilation, and the absence of organic compounds (LEED puts more emphasis on this than ENERGY STAR). • Fewer sick days (2.88 days) for workers; i.e., higher productivity.

18. Financial benefits of LEED • LEED commercial buildings consume about 25-30% less energy than comparable buildings. • Rent premium. 4 estimates (4.4%, 9.68%, 17.3%, 50.5%). • Occupancy premium. 4 estimates (2.7%, 4.8%, 9.4%, 17.9%). • A lower cap rate? • Median IRR estimate: 116%.

19. Financial benefits of ENERGY STAR • ENERGY STAR commercial buildings consume about 40% less energy and emit 35% less CO2 than comparable buildings. • Rent premium. 4 estimates: 8.6%, 8.9%, 8.9%, 18.9%. • Occupancy premium. 4 estimates: 2.7%, 4.2%, 9.4%, 11.0%. • Median IRR: 119%.

20. Barriers to sustainable RE, I • Knowledge gaps, e.g., developers tend to overestimate the cost of being green because they have not done so; residential consumers tend to place higher value on the size of space and amenities over (less visible) energy efficiency and indoor air quality.

21. Barriers to sustainable RE, II • Ownership structure and operating cost responsibility. If developers will be selling the property immediately after completion of construction, they tend not to participate in sustainable practice. Or, if the tenants are responsible for utilities, owners may not want to participate in sustainable practice.

22. Barriers to sustainable RE, III • Funding issues. It may be difficult to package or sell non-traditional, sustainable mortgages to the secondary markets. • New learning curve for developers, local government officers, and build professionals. Some local government offices are not equipped to handle green permitting and approvals, which may cause delays and introduce risk.

23. Learning curve • Between 1995-2000, the premium to build a LEED silver building dropped from 3-4% to 1-2% in Portland, Oregon and from 2% to no premium at all in Seattle.

24. How local governments can help • Monetary incentives: tax breaks, grants, etc. • Non-monetary incentives: dedicated staff/officers for green projects, technical assistance, expedited permitting, floor area ratio bonuses. • Example: Chicago offers technical assistance, faster permitting, density bonuses, and green roof grants.

25. The case of Equity Office (the largest REIT) • The things that EO is doing: • Green cleaning (avoiding harsh chemicals) at the same cost. • Day (not night) cleaning, which saves electricity. • Recycle carpet. • Low-flow toilets. • Landscaping sprinklers do not come on when it rains.

26. Equity Office • The things that EO is doing: • Use fluorescent bulbs. • Install automation system, e.g., economizers for the rooftop heating and cooling units. Use nighttime outdoor cool air to cool the building. • Occupancy sensors for lights off. • For all these things that have done, EO is looking at a 2-3 year payback.

27. Equity Office • EO wants to and will do more, but the current RE condition is harsh; financing is not easy. • When considering a retrofit, EO is looking for a less than 2 year payback. • EO treats sustainability seriously. “Go green is not just a fad”. “There is a lot of legislation getting kicked around.” • More prospective tenants of EO are asking whether the building is a green building.

28. Acknowledgment • The majority of the materials in this note are from the Journal of Sustainable Real Estate. • Please visit the Journal’s website at www.ARESnet.org.