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  • 1. Commercial Real Estate Finance: Going Green Dan Kastilahn Urban Habitat Chicago March 5, 20081
  • 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 estate2
  • 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 risk3
  • 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 issuance4
  • 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 property5
  • 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 account8
  • 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) problems9
  • 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 space10
  • 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 emissions11
  • 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 occupancy14
  • 15. Why Green Commercial Buildings?  Rents & Occupancy $45 $40 $5 $10 $35 $30 $25 Operating Costs Rents $20 $36 $30 $15 $10 $5 $0 Traditional Property Energy-Efficient Property15
  • 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 tenants17
  • 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 1st 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/month19
  • 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 governments21
  • 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 Savings22
  • 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 borrower23
  • 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 by24
  • 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 assets25
  • 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 environment26
  • 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 sustainability29
  • 30. Urban Habitat Chicago  Questions?30
  • 31. Urban Habitat Chicago 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 200731