By David Kozlowski
reen buildings are going mainstream. While their number is relatively small, their impact on corporations and institutions is growing.
Ford, Hines, Gap and U.S. General Services Administration are just some of the large entities that have embraced aspects of environmental design.
But clearly slowing their acceptance is the fact that the marketplace hasn’t accepted them as beneficial to the bottom line. And not until that happens are green buildings likely to have a significant impact on the conventional building stock.
From Cost to Value
Green buildings have what investors want, says Christine Ervin, president and CEO of the U.S. Green Building Council (USGBC).
“The investor who is looking for a good return will be drawn to green buildings,” Ervin says. “Eventually, the superior attributes we find in green buildings should start getting reflected in things like lower insurance rates, better refinancing options or help getting a critical loan in place.”
Ten years ago, green buildings weren’t a blip on the radar screen of commercial and institutional building professionals. Since then, designers have gained experience, developers have gained a certain comfort level, and manufacturers have increased their product offerings so that green buildings have become cost-effective.
The “secret” to building green cost-effectively is plenty of preplanning and an integrated design process that involves everyone, from the owner to subcontractors. To many proponents, this way of constructing a building follows simple common sense.
It is also logical that green buildings, with lower operating costs, better indoor air quality, plenty of daylight, more comfortable space and a less damaging environmental footprint, should have a higher value in the marketplace.
After all, they benefit the owner, occupants and community more than a conventional building.
This argument is being tested now using energy efficiency. Determining the value of energy efficiency is important to green buildings because it is a big part of what green buildings are about. Energy efficiency comprises 25 percent of all the possible credits in the USGBC’s LEED Green Building Rating System.
The value of buildings based on their energy use is making headway among those who have influence on building valuation: appraisers and lenders.
Energy costs can have a significant effect on the net operating income (NOI) of a building - if the NOI goes up the value goes up. A common appraisal method - the income-capitalization method sets the asset value of a building based on the NOI divided by the prevailing cap rate.
According to an analysis by the Rocky Mountain Institute, for example, if the cap rate is 10 percent and the NOI for a building is $100,000, the capital value of the building is $1 million. If an owner spends $40,000 to make building systems more energy efficient, that may yield energy cost savings of $10,000 annually, increasing the NOI by that amount. Therefore, the capital value increases to $1,100,000; thus, the $40,000 investment yields a $100,000 capital value increase plus an immediate bonus of the energy cost savings.
This prospect of added value was important to Kevork Derderian, owner of Continental Offices Ltd., when his team was renovating a 25-year-old, 130,000-square-foot office tower outside of Chicago. The cost of new energy efficient equipment was funded by an operating lease from Northern Trust, a Chicago bank, and was based on the value of the energy savings.
Energy efficiency equals higher value. This seemingly simple calculation has a problem, Derderian says: The market doesn’t generally recognize energy efficiency as added asset value. There’s not a lot of knowledge or interest on the part of appraisers to go through all the bother of determining NOI based on energy savings.
That’s where Mark Chao, senior program director for the San Francisco-based Institute for Market Transformation (IMT), comes in.
Chao and a team from IMT have been working on ways to bring commercial building appraisers and the lenders for whom they work up to date on energy efficiency in buildings. IMT’s projects in California and New York have yielded positive responses from appraisers. Many recognize the importance of energy in an appraisal but say they lack the necessary tools and comparisons to verify their calculations.
Part of the problem is a classic Catch-22: No one is doing the valuation, so there are no comparisons for verification. And there are no comparisons because no one is doing the valuation.
The next step is to develop courses to help appraisers use energy costs in NOI and to introduce them to available databases, such as the U.S. Environmental Protection Agency’s Energy Star Building Benchmarking Tool for Buildings and the Department of Energy’s Commercial Building Energy Consumption and Expenditures databases. Both can offer appraisers the verification they may need, Chao says.
Commercial investors are also beginning to look seriously at NOI and energy costs, says Ted Cauklin, associate director of Cushman and Wakefield, California. He says buyers are doing much more extensive evaluations of buildings, and it is beginning to be reflected in the purchase price of some buildings. But, Cauklin says, because there are so few green buildings sold, it is difficult to draw the kind of trends and comparisons the market likes. Like the issue with appraisers, it’s a matter of reaching some kind of critical mass, Cauklin says.
Certainly the Real Estate Board of New York thinks value based on NOI is important, says Debra Beck, executive vice president. She says green buildings should be important for building owners because they do lower operating costs and can easily add a dollar or two per square foot to rents.
“With energy costs rising, this seems even more important,” Beck says.
Turning the positive attributes of green buildings into dollars and cents means not only increased rents and higher resale value, it can also mean more generous loan underwriting.
According to Chao and David B. Goldstein, Ph.D., senior scientist and director of the Energy Program with Natural Resources Defense Council, even if a building were not for sale or raising its rents, the owner could still benefit from an appraisal based on energy.
Chao and Goldstein argue that energy valuation in the NOI formula could serve as the basis for refinancing at a more attractive rate. Because lenders carefully consider the ratio of the proposed loan to the value of the property, if energy efficiency affected the value of the property, it would also affect the loan amount.
That NOI and energy are connected makes sense for building owners, says Robert Sauchelli, program manager for Energy Star Buildings. The owner of commercial space that is higher in quality and has lower operating costs has several choices, he says. One is to keep the rents the same, increasing margins and profitability; valuation of the property, then, would eventually reflect that. Or, if the lease is such that energy costs are not passed through and the property is in a more competitive market, the owner could pocket the energy savings, reduce rents, improve occupancy and therefore increase profitability. Or the owner could, of course, increase rents and profitability, getting a double boost.
Higher Values, Higher Property Taxes?
Derderian agrees with energy-NOI valuation, but he’s not seeing much movement in the Chicago area on value. His projects, which offer energy efficiency and good indoor air quality and daylight and are fully leased, but can’t garner extra rent because of the competition.
Plus, he says, there’s an obvious downside to getting appraisers to value buildings on their energy efficiency: A building with a higher value will ultimately pay higher property taxes. This is the biggest nut to crack, he says.
“Building owners go out of their way to make sure their property assessments don’t go up,” he says. “Anyone coming to the door saying I can increase your building’s value is going to get the door slammed pretty quickly.”
Jonathan Rose, president of Jonathan Rose and Company, a developer and owner of mixed-use properties, says he’s not so sure that the NOI-energy equation will have a direct effect on property taxes because assessments can vary greatly from market to market even within the same city for lots of reasons.
Nonetheless, there’s a solution to the appraised-assessed quandary green building or energy tax credits. And New York State is the first to be trying them. The tax credits apply to green design attributes, which include energy efficient goals that are significantly better than New York State’s tough energy code.
New York isn’t the only state moving forward on green building tax credits. California is also pursuing a similar system of green tax credits. Even the U.S. Congress is seriously considering energy efficiency tax credits. Bills that address tax credits for energy efficiency have been introduced in both the U.S. Senate and House.
David Goldstein, energy program director for the Natural Resources Defense Council, says the congressional bills provide tax deductions for improving building energy efficiency by 50 percent above the current ASHRAE 90.1 standards, and for installing advanced high-efficiency heating, cooling and hot water systems, and solar hot water and photovoltaic systems. The bills enjoys bipartisan support.