Commercial Real Estate Finance: Going Green. Dan Kastilahn Urban Habitat Chicago March 5, 2008

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1 Commercial Real Estate Finance: Going Green Dan Kastilahn Urban Habitat Chicago March 5,

2 Topics Traditional real estate finance in the capital markets Portfolio lenders Securitization (CMBS) Underwriting 101 Why green commercial buildings? Corporate Sustainability Initiatives Benefits of Energy Savings Rents & Occupancy Developers/Owners/Property Managers How does green affect financing? Lenders & Property Insurers Investing in green commercial real estate 2

3 Real Estate Finance Portfolio lenders include: Commercial Banks: regional & national Life Insurance Companies Pension Funds Balance Sheet loans for long-term holds Conservative underwriting to mitigate risk 3

4 Real Estate Finance Securitization Commercial Mortgage-Backed Securities (CMBS) Industry 2007 Issuance: $230 billion of pooled commercial property loans Industry has seen a recent drop-off in issuance, but is anticipated to self-correct; will likely stabilize closer to $100 billion in annual issuance 4

5 Real Estate Finance Securitization Benefits: Risk is pooled, tranched and sold off as bonds of varying quality; investors pick and choose their level of risk Frees up cash in the capital markets to make more loans on commercial property 5

6 Real Estate Finance Underwriting 101: Revenues Premium rents for premium properties Class A vs. B/C; NNN vs. Gross leases Expenses Fixed Taxes, insurance Variable Utilities, Common Area Maintenance (CAM) 6

7 Real Estate Finance Underwriting 101: Capital Items Capital expenditures Investments into building infrastructure (roof, systems, HVAC) TI/LCs Tenant Improvements (new tenant vs. renewal) Leasing costs (broker fees; new leases vs. renewals) Revenues - Expenses - Capital Items = Cash Flow! 7

8 Why Green Commercial Buildings? Commercial Buildings: Account for more than 71% of the nation s electricity consumption Account for 40% of total energy use This number increases to 48% when the energy required to fabricate the building materials is taken into account 8

9 Why Green Commercial Buildings? Commercial Buildings: Consume 12% of the United State s water Generate 30% of all greenhouse gas (GHG) emissions Up to 30% of new and remodeled buildings experience acute indoor air quality (IAQ) problems 9

10 Why Green Commercial Buildings? Approximately 60 billion sf of existing commercial space 2006 study by USGBC found that owners can save $.90/sf, on average, in energy and other costs by retrofitting older buildings 80% of corporations now consider sustainability a near-term business issue and are willing to pay a premium for environmentally-friendly space 10

11 Why Green Commercial Buildings? Study conducted by Economist Intelligence Unit (EIU) showed that: More than half of all companies surveyed (of 1,250 total) listed energy-efficiency as one of their top priorities Buildings are responsible for almost 75% of a company s total GHG emissions 11

12 Why Green Commercial Buildings? Study conducted by Economist Intelligence Unit (EIU) showed that: There is an implicit connection between share price & commitment to sustainability: companies that recorded 50% growth in share price over the past 3 years prioritized social and environmental goals and were more profitable on sustainability than those companies whose share price declined by more than 10% over that period. 12

13 Why Green Commercial Buildings? Benefits of energy savings Green buildings can reduce energy costs by up to 30% according to the US Dept. of Energy A McGraw-Hill study found: An average expected decrease in operating costs of 8% - 9% across the industry A predicted average increase in property value of approximately 7.5% Average expected increase in Return on Investment (ROI) of 6.5% 13

14 Why Green Commercial Buildings? Rents & Occupancy Study done by UBS concluded green buildings are expected to achieve: 3% premium on rents 3.5% increase in occupancy 14

15 Why Green Commercial Buildings? Rents & Occupancy $45 $40 $35 $10 $5 $30 $25 $20 $15 $30 $36 Operating Costs Rents $10 $5 15 $0 Traditional Property Energy-Efficient Property

16 Why Green Commercial Buildings? Tenant attraction & retention International tenant rep firm, Studley, launched a Sustainable Real Estate Practice group in response to tenant demand Olivia Millar, a Studley LEED AP and head of the new practice: A couple of years ago, it was folks who had a green core mission. Now, you re seeing a lot of people who want to go green because they re concerned about recruiting top talent, providing a sustainable work environment and increasing productivity. 16

17 Why Green Commercial Buildings? Developers/Owners/Property Managers ProLogis, the world s largest developer of distribution/warehouse properties, has committed to LEED certification for all new US projects Why? => Building to certification standards can extend the life of its buildings and broaden the sustainability agendas of its tenants 17

18 Why Green Commercial Buildings? Developers/Owners/Property Managers Jack Rizzo, MD of global construction: We see a growing preference among customers to lease space in buildings that have been developed with environmental efficiency in mind. ProLogis became the 1 st real estate company in the world to join the Chicago Climate Exchange (CCX) 18

19 Why Green Commercial Buildings? Developers/Owners/Property Managers Property owner Steve Ludington s as-is 50,000 sf flex building on West Kinzie St., just minutes from downtown Chicago Monthly heating bill (w/o tenants): $7,000 Translates into $.14/sf/month 19

20 Why Green Commercial Buildings? Developers/Owners/Property Managers Mr. Luddington s 26,000 sf facility, also in Chicago, with a geothermal heating system installed: Monthly heating bill (in winter, fully leased): $650 = $.03/sf/month Monthly bill before geothermal system installed: $3,000 = $.12/sf/month The tenants get a bill for hundred bucks or something it s almost a joke. They can t believe it 20

21 Why Green Commercial Buildings? Other incentives: Tax credits for certified buildings Lending perks from financial institutions Expedited permitting from state and local governments 21

22 How does green affect financing? Lenders Banks have been quick to embrace the green movement (for their own space), but slow to adjust lending policies or to create a financial model that quantifies benefits like: Improved worker productivity and health Recruiting advantages Government incentives Energy Savings 22

23 How does green affect financing? Lenders Sustainability is not a property type 90% of the lending risks for green property are just fundamental real estate risks: Location, location, location Market dynamics Comparable properties & submarket occupancy The greater lending environment: cap rates & interest rates Financial strength of borrower 23

24 How does green affect financing? Lenders: Progress is being made Wells Fargo has surpassed $1 billion in loans for LEED certified buildings Bank of America announced a $20 billion environmental initiative that includes green lending practices, but details are hard to come by 24

25 How does green affect financing? Lenders: Progress is being made New Resource Bank (San Francisco) offers customers green commercial and residential loans. Financial programs offer more money at lower costs to the borrower through lower interest rates and higher loan-to-value (LTV) ratios on certified properties. The bank currently has more than $100 million in assets 25

26 How does green affect financing? Insurers Insurance companies support green construction as there is generally less risk in green properties with: State-of-the-art technology Higher appraised values Provide a healthier work environment 26

27 Investing in green real estate Green Building Finance Consortium A research project launched to create a roadmap for investors and lenders to value sustainable property Founder Scott Muldavin: even 18 months ago, the whole [green building] field was dominated by the public sector and the private sector had very limited involvement. None of the analyses of cost-benefit looked at it from the perspective of how people who have money in real estate think about real estate. 27

28 Investing in green real estate Green Building Finance Consortium Rating systems (i.e. LEED) have marketplace value, but lenders and investors need to look beyond the rating system to property s individual sustainable features in order to assign value from a financial perspective Not all LEED buildings are created equal! 28

29 Investing in green real estate Investor interest, evidenced by the growing number of green funds, has been fueled by increases in: Government regulation Tenant interest Energy costs Pressure on corporations by shareholders to address sustainability 29

30 Urban Habitat Chicago Questions? 30

31 Urban Habitat Chicago 31 Sources and Articles: 1. Burr, Andrew C. In Green Realty He Trusts CoStar Realty Information, (1/23/08). 2. Burr, Andrew C. CoStar Green Report: The Big Skodowski CoStar Realty Information, (1/30/08). 3. Burr, Andrew C. CoStar Green Report: CBRE Says Industry Slow to Accept, Adopt Green Practices CoStar Realty Information, (9/12/07). 4. Burr, Andrew C. CoStar Talks Finance with Green Building Finance Consortium s Scott Muldavin CoStar Realty Information, (9/5/07). 5. Burr, Andrew C. Stock Prices Linked With Sustainability, Survey Finds CoStar Realty Information, (2/27/08). 6. Burr, Andrew C. For Studley and ProLogis, Opposites Attract Green CoStar Realty Information, (9/12/07). 7. Cortese, Amy The Greening of Existing Buildings They Don t Have to Be New The New York Times, (1/26/08) 8. Drummer, Randyl. REITS Buying Into Green Premium, CoStar Realty Information, (10/17/07). 9. Pardy, Sasha. Retail Industry Will Walk the Talk of Green Building in 2008, CoStar Realty Information, (12/5/07). 10. Green Downtown Office Markets: A Future Reality CB Richard Ellis, Summer 2007