Portfolio Greenness and the Financial Performance of REITs

Green Properties and the Financial Performance of REITs Piet Eichholtz Nils Kok Erkan YönderMaastricht University Maastricht University Maastricht University Tilburg University December 2011

Growing interest in green properties

Financial performance of green propertiesgreen properties generate economic premiums Green properties generate economic premiums (Eichholtz, Kok, and Quigley, 2010).  Premiums of rents are 5% for LEED-certified and 3% for Energy-Star-certified buildings.  11% and 19%, respectively, for transaction prices Fuerst, McAllister, 2011; Miller, Spivey, Florance, 2008; Wiley, Benefield, Johnson, 2010 Premiums to certified buildings have not significantly been affected between 2007 and 2009. (Eichholtz, Kok, and Quigley, 2011) Higher occupancy, energy savings, increased economic lives, lower risk (reduced depreciation) (Eichholtz, Kok, and Quigley, 2011)

Corporate social responsibility (CSR) and corporatefinancial performance Greater loyalty of employees, customers and local communities (Ribstein, 2005) Growth in charitable contributions is positively related to subsequent revenue growth. (Lev, Petrovis, and Radhakrishnan, 2010) Improved reputation (Turban and Greening, 1997) The slack resource theory (Waddock and Graves, 1997)  The issue of causality Margolis, Elfenbein and, Walsh (2007)  Overall positive relation between CSR and financial performance  The literature does not provide firm conclusions regarding the direction of causality

Portfolio greenness and financial performance…has not been (sufficiently) documented The aim of the paper is twofold:  Identifying the green properties owned by REITs  The first study that identifies the portfolio greenness of REITs  Investigating the effect of portfolio greenness on the financial performance of REITs  Dynamic measure of portfolio greenness  Two channels  Benefits at property level  Benefits from making CSR investment  Causality issues

Green certificationLEED and Energy Star LEED  The program has been initiated by the US Green Building Council (USGBC).  LEED covers six different components of sustainability, including energy performance and material selection.  31,705 registered, 10,121 LEED-certified commercial buildings as of September 2011. Energy Star  Founded in 1992 by the U.S. Environment Protection Agency (EPA) and the U.S. Department of Energy (DOE).  Energy star evaluates the efficiency of buildings‘ energy use with respect to a base building of similar size and quality.  15,146 Energy Star-labeled commercial buildings as of September 2011.

REIT property portfoliosdata matching Using GIS software, we convert the addresses of buildings into a unique combination of longitude and latitude. Data Matching Step 1: Format addresses from USGBC, EPA, SNL Financial Step 2: Perfect matches Step 3: Decomposing addresses of a portfolio of properties Step 4: Searching for similar addresses Annual greenness of portfolios for each REIT  Considering year of acquisition, sale and certification

Green buildings in the portfolios of US REITsincreasing number of green properties 800 80 700 70 600 LEED 60 # of Properties 500 50 # of REITs 400 40 300 30 200 20 100 10 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 # of REITs owning Leed Certified Properties # of REITs owning Leed Registered Properties # of Leed Certified Properties # of Leed Registered Properties 1000 80 900 70 800 700 Energy Star 60 # of Properties # of REITs 600 50 500 40 400 30 300 20 200 100 10 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 # of REITs owning Energy Star Certified Properties # of Energystar Certified Properties

Greenness measuresratio of green properties to whole property portfolio We create 3 different measures of portfolio grenness:where i stands for REIT i, t stands for year t, l stands for property l and g isthe certification, which is either LEED or Energy Star

The diffusion of green properties in REIT property portfolios.06 .05 .04Square feet .03 .02 .01 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Year LEED Energy Star

Model specificationcausality issues We apply 2 staged regression (OLS & random effects FGLS) Endogenous measures of greenness  2 measures for greenness of the environment  The weighted locational greenness (WLG)  The weighted locational green policy (WLGPL)  where i stands for REIT i, j stands for MSA j and t stands for year t

Modelgreenness & financial performance We estimate the following equation:where i stands for REIT i, and t stands for year t. Greenness stands for Number_Certified, Sqft_Certified and Score_Certified for both LEED and Energy Star certifications. Financial Performance stands for ROA, ROE, Funds from Operations (FFO)/Total Revenue, Alpha and Beta. Z covers a vector of control variables.

Operating performance – ROA (1) (2) (3) (4) (5) (6)VARIABLES LEED LEED LEED Energy Star Energy Star Energy StarNumber_Certified 2.21* 0.76**(Predicted) [1.18] [0.38]Sqft_Certified 1.69* 0.35**(Predicted) [0.96] [0.16]Score_Certified 0.06* 0.01**(Predicted) [0.03] [0.00]Total Assets -0.67* -0.68* -0.64* -1.05*** -0.71* -1.04***(in log) [0.37] [0.38] [0.37] [0.40] [0.38] [0.39]Price-Book Ratio 0.01** 0.01** 0.01** 0.02*** 0.01** 0.02*** [0.00] [0.00] [0.00] [0.00] [0.00] [0.00]Age 0.06** 0.05** 0.06** 0.06*** 0.06** 0.07***(years, in log) [0.02] [0.02] [0.02] [0.02] [0.02] [0.02]Year-Fixed Effects Y Y Y Y Y Y Property Type Y Y Y Y Y YConstant Y Y Y Y Y YObservations 1,000 1,000 1,000 1,000 1,000 1,000R-squared 0.17 0.16 0.17 0.17 0.17 0.17

Operating performance – ROE (1) (2) (3) (4) (5) (6)VARIABLES LEED LEED LEED Energy Star Energy Star Energy StarNumber_Certified 5.54** 1.85***(Predicted) [2.48] [0.69]Sqft_Certified 4.32** 0.75**(Predicted) [2.05] [0.29]Score_Certified 0.14** 0.02***(Predicted) [0.06] [0.01]Total Assets -0.49 -0.53 -0.42 -1.41* -0.53 -1.39*(in log) [0.55] [0.55] [0.54] [0.78] [0.54] [0.77]Price-Book Ratio 0.03*** 0.03*** 0.03*** 0.04*** 0.03*** 0.04*** [0.01] [0.01] [0.01] [0.01] [0.01] [0.01]Age 0.09** 0.08* 0.09** 0.11** 0.09** 0.11**(years, in log) [0.04] [0.04] [0.04] [0.04] [0.04] [0.04]Year-Fixed Effects Y Y Y Y Y Y Property Type Y Y Y Y Y YConstant Y Y Y Y Y YObservations 1,000 1,000 1,000 1,000 1,000 1,000R-squared 0.18 0.18 0.18 0.18 0.18 0.18

Operating performance – FFO/Total Revenue (1) (2) (3) (4) (5) (6)VARIABLES LEED LEED LEED Energy Star Energy Star Energy StarNumber_Certified 16.74** 4.81**(Predicted) [7.28] [2.36]Sqft_Certified 13.19** 2.36***(Predicted) [5.90] [0.90]Score_Certified 0.42** 0.05**(Predicted) [0.18] [0.03]Total Assets 2.72 2.56 2.90 0.57 2.43 0.62(in log) [2.62] [2.66] [2.59] [3.09] [2.60] [3.07]Price-Book Ratio 0.02 0.02 0.02 0.05** 0.03 0.05** [0.02] [0.02] [0.02] [0.02] [0.02] [0.02]Age 0.08 0.05 0.08 0.14 0.08 0.14(years, in log) [0.18] [0.18] [0.18] [0.18] [0.18] [0.18]Year-Fixed Effects Y Y Y Y Y Y Property Type Y Y Y Y Y YConstant Y Y Y Y Y YObservations 904 904 904 904 904 904R-squared 0.45 0.45 0.45 0.45 0.45 0.45

Stock performance – Alpha (1) (2) (3) (4) (5) (6)VARIABLES LEED LEED LEED Energy Star Energy Star Energy StarNumber_Certified 0.057 0.024**(Predicted) [0.037] [0.012]Sqft_Certified 0.043 0.008*(Predicted) [0.030] [0.004]Score_Certified 0.001 0.000**(Predicted) [0.001] [0.000]Total Assets -0.008 -0.008 -0.007 -0.021** -0.008 -0.020**(in log) [0.006] [0.006] [0.006] [0.010] [0.006] [0.010]Price-Book Ratio 0.000*** 0.000*** 0.000*** 0.001*** 0.000*** 0.000*** [0.000] [0.000] [0.000] [0.000] [0.000] [0.000]Age -0.001** -0.001** -0.001** -0.001 -0.001** -0.001(years, in log) [0.001] [0.001] [0.001] [0.001] [0.001] [0.001]Year-Fixed Effects Y Y Y Y Y Y Property Type Y Y Y Y Y YConstant Y Y Y Y Y YObservations 750 750 750 750 750 750Model Chi-squared 55.57 55.24 55.56 57.40 56.32 57.40

Stock performance – Beta (1) (2) (3) (4) (5) (6)VARIABLES LEED LEED LEED Energy Star Energy Star Energy StarNumber_Certified -0.068*** -0.012***(Predicted) [0.010] [0.003]Sqft_Certified -0.057*** -0.007***(Predicted) [0.008] [0.001]Score_Certified -0.002*** -0.000***(Predicted) [0.000] [0.000]Total Assets 0.149*** 0.150*** 0.148*** 0.153*** 0.149*** 0.153***(in log) [0.002] [0.002] [0.002] [0.003] [0.002] [0.003]Price-Book Ratio 0.000*** 0.000*** 0.000*** 0.000** 0.000*** 0.000** [0.000] [0.000] [0.000] [0.000] [0.000] [0.000]Age -0.000 -0.000 -0.000 -0.000** -0.000 -0.000**(years, in log) [0.000] [0.000] [0.000] [0.000] [0.000] [0.000]Year-Fixed Effects Y Y Y Y Y Y Property Type Y Y Y Y Y YConstant Y Y Y Y Y YObservations 750 750 750 750 750 750Model Chi-squared 7165.64 7167.21 7165.68 7135.14 7159.13 7135.23

Main Findings We identify that, on average, 1% and 6% of the REIT property portfolios are green-certified in 2010 for LEED and Energy Star, respectively. We find that greenness enhances operating performance when we estimate ROA, ROE and FFO/Total Revenue.  Different from analysis of financial performance of green properties, these measures are net of costs. We partially find an effect of greenness on abnormal returns. Greenness decreases market risk.  Possibly, due to sustainable returns of green properties.  Properties in the portfolios are less exposed to energy price fluctuations.

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Portfolio Greenness and the Financial Performance of REITs

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