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Retail Landlords Get Their Green Act Together

Retail landlords historically haven't paid much attention to green building, largely because energy costs at most shopping centers are paid directly by retailers, leaving little incentive for owners to embrace conservation. Those attitudes are quickly changing, however, as a growing number of retailers embrace the concept of sustainability and tie it to their marketing efforts.

“On the retail side you tend to pass through a lot of the costs to the tenant, so there hasn't been a big incentive to make some of these changes,” says Michael Hammon, chief development officer in the Fort Lauderdale office of Ram Realty Services. Yet Hammon and other retail developers have discovered compelling reasons to incorporate green building into their portfolios, and those factors are a green of a decidedly different hue.

Energy-efficient elements reduce operating costs while boosting an asset's appeal to retailers and to investors on resale. This year, Ram and its partner, an affiliate of Pinnacle Housing Group, are developing Sheridan Stationside Village, a pedestrian-oriented mix of retail, office, residential and hotel space adjacent to a rail station in Hollywood, Fla.

With 300,000 sq. ft. of retail space, it is a pilot project for a new Leadership in Energy and Environmental Design (LEED) certification program of the U.S. Green Building Council based in Washington, D.C.

Green office buildings currently command higher prices than conventional office buildings, with investors accepting about 50 basis points less on their capitalization rate, or initial rate of return based on the purchase price, Hammon says. He estimates the green premium for retail is at least 25 basis points and may grow to 50 basis points. “Are there institutional buyers who are going to pay a low cap rate for a green project? We think there are.”

A niche blooms

After a slow start earlier this decade, sustainable design gained momentum among retail developers two years ago. In 2006, the number of retail projects registered to pursue LEED certification grew to 39, up from 17 in 2005. In 2007, projects seeking the designation mushroomed to 186.

“In 2007, the leading retailers realized this isn't going away and they began to respond to different consumer expectations and increased energy costs,” says Justin Doak, the Green Building Council's retail sector manager.

As Doak suggests, electric bills may be fanning the green flames in retail. Energy prices for commercial customers nationwide increased less than 2% from 2003 to 2004, but climbed 6% the following year and then swelled 9% from 2005 to 2006, according to the U.S. Department of Energy. Analysis for 2007 isn't yet available, but energy prices are expected to show continued acceleration.

Even so, sustainability has been on a back burner for most retail investors and tenants. Of 4,693 leases signed by retailers and wholesalers in the past two years, only 1%, or 34 deals, were in green buildings, according to CoStar Group.

Sustainability has been slow to catch on with retail developers in part because they have fewer tools to work with than their counterparts in the office sector. An office provider who wants to increase a building's energy efficiency can register the project with the Green Building Council and obtain a checklist of possible improvements. With enough green elements in the design, the project should pass muster for LEED certification.

The Council doesn't yet offer a single, standard checklist for LEED Retail certification. The organization's LEED Core and Shell certification program addresses retail and other commercial buildings apart from interior finishes. A separate interiors program rates the environmental impact of stores within a retail project. A single checklist for the two programs is expected to be available for a program kickoff this fall.

Pioneering efforts

Forest City Enterprises didn't wait for the LEED Retail program before embracing the sustainable design concept. In 2004, the Cleveland-based company registered its Northfield Stapleton lifestyle shopping center as a pilot project in the LEED Core and Shell program, earning certification from the Green Building Council for a portion of the project in 2006.

When Northfield was under development, the Council hadn't set up its LEED Interiors criteria, says Jon Ratner, Forest City's vice president of sustainability initiatives. So the company mounted its own outreach and awareness program to convince tenants of the need for sustainable design in their spaces. The company produced a whitepaper that is still distributed to its renters today. It also published a strategy booklet of steps a tenant could take to lower energy costs and usage.

Each tenant was required to act on at least 17 of 51 strategies, which specified water fixtures, air-conditioning and heating units and other available products to help with LEED certification. “Now we give them a LEED scorecard rather than our own 51-point system,” Ratner says.

Another pioneer in green retail is Regency Centers, a Jacksonville, Fla.-based REIT that owns 451 retail properties with 59.2 million sq. ft. in its portfolio. Regency is participating in the Green Building Council's pilot retail program with Shops of Santa Barbara, a 67,226 sq. ft. center anchored by a Whole Foods in Santa Barbara, Calif. Regency has also registered its Deer Springs Town Center in Las Vegas for LEED certification.

The company wants to pursue LEED certification for 20% of its new development projects in 2008, increasing that goal to 40% next year and 60% in 2010, according to Mark Peternell, vice president of sustainability for Regency.

The company launched its first sustainable project in Santa Barbara, where an ordinance requires green building for new developments. In the process, Regency discovered a development niche.

“More and more municipalities and counties have certain green building requirements and/or incentives that make it more economically attractive,” Peternell says. “Often those are markets that we want to be in.”

Means to a green end

An environmentally responsible project is easier to market to retail tenants than conventional space, according to developer Mark Schuster, founder and CEO of The Schuster Group in Seattle. “We've been able to increase our marketability to companies that are trying to align with those values,” he says. The group is developing Mosler Lofts, a mixed-use condo and retail project in Seattle.

Mixed-use and infill projects meet important objectives for green building, says Dawn Clark, a principal in the Seattle office of global architecture firm NBBJ. “The first issue is the use of land and the re-use of land that has already been developed, not using greenfield sites,” she says.

After site selection, the developer's next priority is a super-efficient heating, ventilation and cooling system. High-quality insulation and a white, heat-reflecting roof help make the most of mechanical systems. Using sustainable materials helps preserve natural resources while improving interior air quality.

Meeting LEED standards with environmentally friendly materials increases construction costs by about 1% over conventional methods. Upon completion, most owners reap sufficient savings through reduced operating costs to recoup the extra expense in as little as six months to two years, says Doak.

Image sells

The gradual return on investment generated by green building projects presents a problem for tenants constructing their own retail interiors, however. Many chains revamp their stores annually and have less opportunity to enjoy an overall savings from using costly green materials and furnishings.

“Usually the life cycle is what chokes retailers because they can't amortize the cost over a longer period like a developer can,” says Eric Lagerberg, a principal in the retail studio of Callison, a Seattle-based architectural firm.

Store operators' support of a green platform is due more to shopper expectations than energy savings, Lagerberg says. “The more proactive retailers are adopting an environmental position to differentiate themselves from their competitors who may not have that position.”

Green chic is changing the way architects incorporate green elements into retail design, moving solar panels from an inconspicuous section to where customers can see and appreciate their presence. “Now they're almost brought out like a billboard,” Lagerberg says. “The challenge is to bring some sophistication to that.”

Properties that provide bicycle racks, access to mass transit, natural lighting, water-conserving landscape and other green features help to reinforce any pro-environmental stance taken by tenants — a bargaining chip in demanding premium rent. “If they're built into the infrastructure, it's a great launch point for a retailer trying to go green,” Lagerberg says.

Green may boost a developer's chances of landing financial leverage as well, says Clay Wilson, executive vice president of commercial real estate lending at Coral Gables, Fla.-based BankUnited. “A green-oriented project would have one more item in the plus column,” he says. “Having another plus is an advantage when lenders have a higher level of scrutiny of all commercial real estate projects.” With $14.4 billion in assets, BankUnited is the largest Florida-based banking institution.

Over the horizon

While developers have made strides toward sustainable shopping centers and retail additions to mixed-use projects, the industry must overcome unique challenges if green building is to become standard practice. Aside from government mandates, widespread adoption of sustainable design hinges on whether developers find ways to benefit from tenants' reduced energy consumption.

One solution would involve restructuring retail leases, which typically require tenants to pay utility consumption costs directly to the provider. An alternative might require tenants to pay the landlord part of the savings the retailer enjoys from reduced monthly operating costs as a result of green building features.

The industry needs to calculate the energy savings of green techniques and systems before landlords can participate in a tenant's utility savings, says Peternell of Regency Centers. “Out of the gate, we're not expecting to capture higher rents. Once we have proven that a green building operates more efficiently, either higher rents will be paid, or there will be a way to share those savings.”

Another objective for the industry is to coordinate energy-saving features of shell buildings with each tenant's interior construction. Unlike office providers, the retail developer leaves much of a building's interior construction to tenants.

That can put the developer and tenant at odds, such as when a developer provides natural light via skylights that don't match the retailer's lighting scheme. In this case, the result would be increased utility bills from heat loss through the skylight without a corresponding savings in lighting.

“The key to success in green design is integrated design, meaning the entire project team is working to accomplish the goal,” Peternell says. “If those two groups [landlords and retailers] don't start working more closely to achieve integrated designs, the retail sector will never be able to achieve the same level of sustainability as the office sector.”

Green retail will undoubtedly become more profitable as retailers and municipalities grow more aware of the nation's proliferating eco-friendly shopping centers. The effect of increased demand on rent — and any consequences for non-green retail centers — remains uncertain.

Ratner of Forest City says the green phenomenon is just starting to take hold in the shopping center industry with many issues still unresolved. “We're at the beginning of the curve in understanding how far this can go.”

Matt Hudgins is an Austin-based writer.

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