Fighting Obsolescence

Energy performance is emerging as a key benchmark in how commercial real estate buildings are judged — and priced — in today's market. In fact, a growing number of institutional investors and corporate clients are not only urging, but also requiring, that green design be included in the commercial real estate properties they buy or lease.

Although “green” is a loosely used term to define all things environmentally friendly, the commercial real estate industry is increasingly turning to standards such as the Environmental Protection Agency's Energy Star program and the U.S. Green Building Council's Leadership in Energy and Environmental Design (LEED) certification to define the level of sustainable practices and products that have been put in place.

The strategy at Malvern, Pa.-based Liberty Property Trust is to build only LEED-certified office buildings and follow LEED guidelines wherever possible in its industrial construction. “That is based on a sense that to not do so is to build an obsolete project — at least over the long term,” says John Gattuso, senior vice president and regional director for Liberty's urban group. The $6 billion office real estate investment trust currently has 42 LEED-registered or certified properties.

According to an exclusive green building survey conducted by National Real Estate Investor and its sister publications, 51% of corporate respondents and 60% of developer respondents across all commercial property types indicate that they own, manage or lease at least some green properties.

In addition, 88% of corporate and developer respondents expect to own, manage or lease some green properties five years from now [Fig. 1].

That volume has increased even in the past year. When asked the same question in the 2007 survey, 84% of corporate users and 77% of developers said they expect to own, manage or lease at least some green properties over the same period.

While commercial real estate developers continue to raise the bar on green design to meet tenant demand and maximize property values, owners of existing buildings are bracing for a trickle-down effect. Some industry experts believe that buildings that are not energy efficient will be adversely affected when it comes to rents and sale prices.

Industry data reflects that surge in green building activity. In the past year, the number of LEED-certified buildings jumped nearly 40%, from 878 to 1,212 as of August 2008, according to the U.S. Green Building Council.

That volume includes some 133 million sq. ft. of new construction and major renovation on commercial and institutional properties. Another 8,088 buildings totaling 1.3 billion sq. ft. are currently in the process of obtaining LEED certification.

Indeed, familiarity with LEED increased substantially among all survey respondents over the past year [Fig. 2].

“We consider our sustainable facility program to be part of our overall corporate business strategy,” says Kevin Dollhopf, vice president of worldwide real estate at Winston-Salem, N.C.-based Hanesbrand Inc.

The apparel company's goal is to reduce its carbon footprint and conserve natural resources throughout its 27 million sq. ft. global real estate portfolio. Following LEED and Energy Star criteria are a key part of the program.

In order to gain greater insight into the activity and benefits of sustainable building efforts, NREI conducted its second annual Green Building Survey that drew responses from 164 developers of commercial real estate, 51 corporate users and 170 government officials.

Green investment pays off

Without question, the most compelling driver for green building in the U.S. is energy efficiency. “Energy costs are much higher than they were even two years ago, so you can create a strong financial motivation for green building practices,” says Eric Bowles, vice president of Atlanta-based CoreNet Global, a professional association for corporate real estate executives serving leading multinational companies.

Over the past year, heating oil prices have jumped 39%, natural gas has risen about 9%, and commercial electricity costs have increased 3.7%, according to the U.S. Department of Energy. Companies are finding that the cost of green development is achievable, and green buildings are proving to be cheaper to operate.

An overwhelming majority of respondents — 92% of corporate users and 83% of developers — believe lower energy costs is the biggest benefit associated with green design. Corporate respondents also cite the ability to have a low impact on the environment (77%), ability to differentiate in marketing (49%), and ease of resale (31%) as other benefits [Fig. 3].

Developers also value the ability to differentiate in marketing (74%), the low impact on the environment (71%), ease of resale (42%), and ease of leasing space (40%) [Fig. 4]. Nearly one-third of developers also cite higher rents and higher return on investment as benefits of green design.

Developers are hoping that green building will have a direct and immediate impact on the bottom line. Being at the forefront of green building also may help owners command premium pricing and property values. Although the fledgling industry needs more time to create any substantive data to support that claim, owners are generating positive results on an anecdotal basis.

A case in point is Liberty's new Comcast Center, which opened in downtown Philadelphia in June. The 58-story office tower recently sold for well above market value — $400 per sq. ft. Previously, the highest sale price in that market was $225 per sq. ft. Although the LEED status can't claim all of the credit, it was a contributing factor in the building's ability to attract top dollar, says Gattuso of Liberty.

One question that the commercial real estate industry is grappling with is whether tenants will be willing to pay more to lease green space.

Corporate respondents say they would be willing to pay an average of 4% more for LEED-certified buildings [Fig. 5], while developers say they can charge an average of 3% higher rents for green properties [Fig. 6].

United Properties anticipates that achieving gold-level LEED status for the core and shell of its new 8200 Tower at Normandale Lake Office Park in Bloomington, Minn. will help to boost revenues. The 275,000 sq. ft., Class-A office tower is expected to have operating expenses of between $10 and $11 per sq. ft. — a reduction ranging from 70 cents to $1 per sq. ft. thanks to LEED requirements such as energy-efficient lighting. The building is slated to open in January 2009.

The owner, TIAA-CREF, hopes to capture at least part of those savings through higher rents since most tenants compare space based on the total cost per square foot, says William Katter, senior vice president of investments and development at Minneapolis-based United Properties. “We also believe that the gold certification was a necessary requirement in order for the property to maintain a position as a market leader,” he says.

The larger impact for property owners is that a green designation could be a key factor in attracting tenants. “Given two buildings and similar locations and similar rental rates, most of the large companies are going to opt with the green building,” Bowles says. If this trend continues, developers whose buildings are not green might find it hard to attract tenants without offering a discount.

Cap and trade bill looms

A simmering cap and trade bill is likely to spark more interest in green building. Federal climate control legislation is aimed at reducing greenhouse gases. Specifically, it places a cap on how much greenhouse gases a U.S. business would be allowed to emit.

The legislation would allow businesses to trade or buy carbon credits, if they should exceed their limit. Because energy prices are likely to rise, new and existing tenants may well push landlords to improve their current building's energy performance.

The legislation failed to pass in 2008, but is expected to resurface at the federal level again in 2009. “Both presidential candidates right now are advocating a cap and trade system,” Bowles says. Most respondents — 88% of corporate users and 70% of developers — are aware of the federal cap and trade legislation. Conversely, 12% of corporate users and 30% of developers say they are not at all familiar with the legislation [Fig. 7].

Corporate respondents are more likely (44%) to believe that the legislation will pass during the next administration, regardless of who is elected. Developers remain skeptical, with only 17% expecting the legislation to be approved [Fig. 8].

“It could have a huge impact on all of us depending on what legislation comes down,” says J Glasgow, a senior vice president and a member of the sustainable leadership group at Colliers Turley Martin Tucker in St. Louis.

Commercial and industrial facilities account for half of all energy consumption in the U.S. at a cost of more than $200 billion per year, more than any other sector of the economy. These facilities also are responsible for nearly half of U.S. greenhouse gas emissions, which contribute to climate change, according to the EPA.

Rehabs gain traction

Corporations and developers also are stepping up efforts to introduce sustainable concepts, technologies and practices into existing properties. One-third of corporate respondents say they have previously retrofitted properties to make them more energy efficient, while another 29% are in the process of renovating and 41% also are considering such renovation work at this time.

On the developer side, 29% of respondents say they have previously retrofitted properties to make them more energy efficient, while another 29% are in the process of such rehabs. Nearly half (46%) say they are considering retrofitting properties to make them more energy efficient [Fig. 9].

“If I can look at a project and realize savings and improve net operating income, it's a no brainer,” says Jim Hill, senior asset manager with Great Neck, N.Y.-based Sterling American Property Inc. The real estate investment firm has invested more than $4.5 billion in commercial and apartment properties in 43 states.

Sterling is promoting sustainability throughout its 9.1 million sq. ft. portfolio. Efforts range from renovating properties to following best practices in green building maintenance and operations.

The company is in the midst of a $7.6 million rehab of its 200 West Adams in Chicago, a 700,000 sq. ft. office building. After acquiring the property in December 2007, Sterling initiated extensive upgrades throughout the 20-year-old office building in tenant spaces and common areas such as lobbies, corridors and restrooms. “We reviewed everything from a sustainable perspective,” Hill says.

Sustainable practices included items such as multiple energy reduction projects, water reduction techniques, sustainable construction materials, improved building automation systems, and even an interior storage for bikes to assist with alternative transportation efforts by tenants. The property has since qualified for Energy Star certification, and Sterling is pursuing a silver LEED EB, which is a certification for existing buildings.

Nearly half of respondents who are considering retrofitting properties will most likely seek either Energy Star or LEED certification. Among corporate respondents, 54% say they would pursue either Energy Star or LEED EB, while 58% of developers say they would pursue Energy Star and 49% say they would pursue LEED EB.

The commercial real estate industry will see the launch of its first all-green REIT in mid-November. Green Realty Trust plans to raise $1.5 billion from investors in its common stock offering. The REIT's strategy is to acquire existing buildings across a range of property types, including hotels, office buildings and shopping centers, and then add value by rehabbing the properties.

Adopting green brands

Although LEED and Energy Star brands are becoming more widely accepted standards, there is still some confusion in the industry as to what constitutes a green building.

Among respondents who have some green properties in their portfolios, 45% of corporate users and 29% of developers are unsure of the designation. Nearly one out of four respondents — 24% for corporate users and 20% developers — say space is LEED-rated, while 20% of corporate users and 24% of developers say at least part of their space is rated Energy Star.

Yet obtaining either Energy Star or LEED branding is becoming more important for corporate owners and real estate investors. “It is not enough to simply have sustainability built into your construction and design,” Bowles says. “To really realize the monetary benefits, there is a lot of value in going with a branded concept.”

While LEED and Energy Star offer standards for measuring energy efficiency, LEED offers a more comprehensive approach. A majority of respondents believe that LEED is an effective standard for energy savings and environmentally friendly buildings. More than half of developers (57%) and nearly two-thirds of corporate users (64%) believe LEED is an effective standard for energy savings [Fig. 10].

Among those corporate respondents who are familiar with LEED, 45% say a LEED designation is important or extremely important to the site-selection process.

“It is probably the best formalized program that looks at the operation and design of a building that we have found,” says Dollhopf of Hanesbrand. It is a standard that is accepted both in the U.S. and around the world. “The certification per se is not the end goal, but it provides the framework for us to look at a facility program to implement our goals of reducing our carbon footprint and to produce overall energy savings,” he adds.

As part of its sustainable facilities program, Hanesbrand is pursuing LEED certification for all of its new construction projects and prefers to lease space in LEED-certified buildings. In addition, while it may not be feasible to obtain certification for every existing building, the company's goal is to implement LEED practices wherever possible throughout its portfolio. Hanesbrand currently owns some 18 million sq. ft. and leases another 9 million sq. ft. of space in 22 countries.

Lending perks remain scarce

Favorable financing and insurance rates for green properties remain elusive for most corporations and developers. Respondents typically haven't tried to find favorable financing for green properties, or have found that financing for green is no different than financing for traditional properties.

Just 20% of corporate users and 25% of developers say they have found favorable financing [Fig. 11]. The question of finding favorable insurance terms for green developments drew a similar response. The majority of respondents say that they either have not looked, or that terms are no different than for non-green properties.

For the most part, green lending programs for commercial real estate properties remain a largely niche market. For example, Miami-based Union Credit Bank was the first community bank in the U.S. to sign the U.N. Environment Program Finance Initiative in March 2007. The initiative is a global partnership of some 160 financial institutions that are working to better understand the effects of environmental and social considerations on financial performance.

“That showed we were serious about what we wanted to do in this area,” says Fernando Capablanca, president and CEO of Union Credit Bank, which has $150 million in assets. It also provided an opportunity for the 7-year-old bank to distinguish itself from the roughly 270 other community banks operating in Florida.

Union Credit Bank offers a handful of green lending programs for consumers and businesses, including a new green construction financing program that grants green projects a reduction of 25 to 50 basis points on mortgage rates. “We are trying to give people some advantage from the financial side because we know it might be a little more expensive on the front end,” Capablanca says. Union Credit Bank currently has just three small green construction loans in the pipeline for the fledgling program.

“Sustainable development is clearly gaining traction in the industry,” says John Daniels, an executive in the commercial real estate banking product delivery division at Bank of America. Yet Daniels contends that it is a common misperception that special lending programs that target green building projects exist.

“While there may be some small programs, there is no special interest rate or collateral advance for a green project in the industry,” Daniels says. “We bring value to our clients and the industry by having knowledgeable client teams that can quickly and realistically assess project risk through the lens of sustainable development.”

Some industry observers contend that creating green lending programs is a missed opportunity for banks. “The big banks are increasingly aware of it, but they haven't been able to latch onto the opportunities,” Bowles says. Both Citi and Bank of America have announced major commitments to green lending, but the question with some of these programs is whether they go beyond the business-as-usual model to offer real financial incentives. “I think these programs are taking time to evolve, and are being inhibited by current problems in the financial markets,” Bowles says.

Digging for incentives

Federal, state and local governments offer a variety of initiatives, ranging from tax rebates to fast-track permitting. Such incentives can be a huge benefit for green projects. “You have to look at all of those things when you're figuring out your project because you can leave a lot of money on the table if you don't,” Glasgow says.

In fact, more than 70% of corporate and developer respondents say that government incentives have at least some impact on decisions to purchase, lease or develop green properties, while 25% of developers and 29% of corporate respondents indicate government incentives play no role in the decision-making process.

Developers are taking advantage of various incentives to help cover green building costs, which respondents believe add an average of 6% to total building costs. In addition to government programs, a number of utility companies offer energy rebates. For example, United Properties was able to take advantage of energy rebates from local power companies to save more than $100,000 on the approximately $45 million construction cost of the 8200 Tower in Bloomington, Minn.

Overall, 93% of respondents say they have noticed at least some increase in green building initiatives from federal, state or local governments [Fig. 12]. Yet nearly two-thirds of respondents say they have not taken advantage of any government incentive programs.

Those respondents that have made use of government incentives are most likely to have used tax breaks (24% corporate and 21% developer), streamlined permitting (10% corporate and 13% developer), and shared costs of infrastructure development (10% corporate and 9% developer).

The challenge for many cities across the U.S. is not only to implement sustainable building practices into their own facilities, but also to encourage the private sector to follow suit. For example, the U.S. Conference of Mayors created a Sustainable Development Task Force in the 1990s to foster education on green building, as well as share best practices on specific projects and programs that have been successful.

“We have been working in all of our departments to get green building projects going, and now we're taking it out to businesses and residents too,” says Santa Barbara Mayor Marty Blum, co-chair of the sustainable development task force.

Rising energy costs and pressure from elected officials are driving the growing number of government initiatives for green building. Among the 170 government respondents to the survey, 69% say energy costs were the main influence, followed by elected officials (63%), and residents (54%) [Fig. 13].

One of Santa Barbara's main incentives for green building is offering a fast-track permit and approval process, which can shave weeks off of a project. The city also has three of its own LEED projects under construction including a fire station, airport terminal and public works building.

“Each one of our staff members has an orientation in green building, whether they work for the parks department or the library,” Blum says. “We think that's very important for government to be educated on green building and lead by example.”

Growing momentum

The green building movement has a strong foothold in the corporate and commercial real estate arena, and it is continuing to gain momentum. Developer respondents (72%) say green design is important or extremely important compared with 51% a year ago. Meanwhile, 63% of corporate respondents say green design is important or extremely important compared with 46% in last year's green building survey.

The industry is in the early stages of adopting green design into new and existing space, but the intent to grow the green space is there. Corporate and developer respondents indicate that they currently have an average of 6% and 14% of their portfolios respectively dedicated to green properties. By 2013, corporate respondents anticipate 17% of their portfolios will be green compared with developers who predict that an average of 28% of their portfolios will be green five years from now.

Certainly, there is a growing list of corporations that are not only implementing green building into their real estate portfolios, but also adopting a broader strategic commitment to sustainability.

One reason for that increase is that companies are recognizing that there is a payoff. “It does make good business sense,” Glasgow says. “Being sustainable is a good business model, which is why companies are embracing it.”

Survey Methodology

Penton Research e-mailed invitations on Aug. 11 to participate in an online survey to a total of 24,943 subscribers of National Real Estate Investor, Lodging Hospitality, Retail Traffic and American City & County magazines selected on an nth name basis. Each group received a survey with questions that were specific to their business. A link to the survey was also included in the National Real Estate Investor e-newsletter sent Aug. 20 and Aug. 26.

The survey yielded 385 total responses. Here is the breakdown:

  • Government officials (170)
  • Commercial real estate developers (164)
  • Corporate users of real estate (51)

For more information on survey results and analysis, contact NREI Managing Editor Sibley Fleming at [email protected].
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