comm realestate-finance-green

1

Commercial Real Estate Finance:Going Green

Dan KastilahnUrban Habitat ChicagoMarch 5, 2008

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

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

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 isanticipated to self-correct; will likely stabilize closer to$100 billion in annual issuance

5

Real Estate Finance

Securitization

– Benefits: Risk is pooled, tranched and sold off as bonds of

varying quality; investors pick and choose their level ofrisk

Frees up cash in the capital markets to make moreloans on commercial property

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)

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!

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 energyrequired to fabricate the building materials is taken intoaccount

9


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 buildingsexperience acute indoor air quality (IAQ)problems

10


Approximately 60 billion sf of existing commercialspace

2006 study by USGBC found that owners can save$.90/sf, on average, in energy and other costs byretrofitting older buildings

80% of corporations now consider “sustainability” anear-term business issue and are willing to pay apremium for environmentally-friendly space

11


Study conducted by Economist IntelligenceUnit (EIU) showed that:

– More than half of all companies surveyed (of1,250 total) listed energy-efficiency as one of theirtop priorities

– Buildings are responsible for almost 75% of acompany’s total GHG emissions

12


Study conducted by Economist Intelligence Unit(EIU) showed that:

– There is an implicit connection between share price &commitment to sustainability: “…companies thatrecorded 50% growth in share price over the past 3years prioritized social and environmental goals andwere more profitable on sustainability than thosecompanies whose share price declined by more than10% over that period.”

13


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%

14


Rents & Occupancy

– Study done by UBS concluded green buildingsare expected to achieve:

3% premium on rents

3.5% increase in occupancy

15


Rents & Occupancy

$30

$10

$36

$5

$0

$5

$10

$15

$20

$25

$30

$35

$40

$45

Traditional Property Energy-Efficient Property

Operating CostsRents

16


Tenant attraction & retention– International tenant rep firm, Studley, launched a

Sustainable Real Estate Practice group in response totenant 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 whowant to go green because they’re concerned aboutrecruiting top talent, providing a sustainable workenvironment and increasing productivity.”

17


Developers/Owners/Property Managers

– ProLogis, the world’s largest developer ofdistribution/warehouse properties, has committedto LEED certification for all new US projects

Why? => Building to certification standards can extendthe life of its buildings and broaden the sustainabilityagendas of its tenants

18



Jack Rizzo, MD of global construction: “We see agrowing preference among customers to leasespace in buildings that have been developed withenvironmental efficiency in mind.”

ProLogis became the 1st real estate company in theworld to join the Chicago Climate Exchange (CCX)

19



– Property owner Steve Ludington’s “as-is” 50,000sf flex building on West Kinzie St., just minutesfrom downtown Chicago

Monthly heating bill (w/o tenants): $7,000

Translates into $.14/sf/month

20



– Mr. Luddington’s 26,000 sf facility, also in Chicago, with ageothermal 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 orsomething…it’s almost a joke. They can’t believe it”

21


Other incentives:

– Tax credits for certified buildings

– Lending perks from financial institutions

– Expedited permitting from state and localgovernments

22

How does “green” affect financing?

Lenders

– Banks have been quick to embrace the greenmovement (for their own space), but slow toadjust lending policies or to create a financialmodel that quantifies benefits like: Improved worker productivity and health Recruiting advantages Government incentives Energy Savings

23


Lenders

– “Sustainability” is not a property type

– 90% of the lending risks for green property are justfundamental real estate risks: Location, location, location Market dynamics

– Comparable properties & submarket occupancy– The greater lending environment: cap rates & interest rates

Financial strength of borrower

24


Lenders: Progress is being made

– Wells Fargo has surpassed $1 billion in loans for LEEDcertified buildings

– Bank of America announced a $20 billion environmentalinitiative that includes green lending practices, but detailsare hard to come by

25


Lenders: Progress is being made

– New Resource Bank (San Francisco) offers customersgreen commercial and residential loans.

Financial programs offer more money at lower costs to theborrower through lower interest rates and higher loan-to-value(LTV) ratios on certified properties.

The bank currently has more than $100 million in assets

26


Insurers

– Insurance companies support green constructionas there is generally less risk in “green” propertieswith: State-of-the-art technology

Higher appraised values

Provide a healthier work environment

27

Investing in green real estate

Green Building Finance Consortium

– A research project launched to create a roadmap forinvestors and lenders to value sustainable property

– Founder Scott Muldavin: “…even 18 months ago, thewhole [green building] field was dominated by thepublic sector and the private sector had very limitedinvolvement. None of the analyses of cost-benefitlooked at it from the perspective of how people whohave money in real estate think about real estate.”

28


Green Building Finance Consortium

– Rating systems (i.e. LEED) have marketplacevalue, but lenders and investors need to lookbeyond the rating system to property’s individualsustainable features in order to assign value froma financial perspective

Not all LEED buildings are created equal!

29


Investor interest, evidenced by the growingnumber of “green funds”, has been fueled byincreases in:

Government regulation Tenant interest Energy costs Pressure on corporations by shareholders to address

sustainability

30

Urban Habitat Chicagowww.urbanhabitatchicago.org

Questions?

31

Urban Habitat Chicagowww.urbanhabitatchicago.org

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

comm realestate-finance-green

Business