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Green Value: The Economics of a Green Building


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With the economic rationale for the development of sustainable buildings based almost entirely on anecdotal evidence, real estate developers and property investors are uncertain about how far to go in implementing environmental investments. However, solid academic evidence is changing the debate. Dr. Nils Kok discusses his research on the topic in "Doing Well by Doing Good: Green Office Buildings." This widely cited study provides the first systematic analysis of the impact of LEED and ENERGY STAR certification on the sale prices and rental rates of U.S. commercial office buildings.

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Green Value: The Economics of a Green Building

  1. 1. Doing Well by Doing Good: Green Office Buildings Nils Kok UC Berkeley Maastricht University John M. Quigley UC Berkeley Piet Eichholtz Maastricht University San Diego February 2010
  2. 2. Climate change and the built environment The macro and micro economic perspective 1.  Climate change and its consequences are a global (economic) threat   Carbon emissions and buildings are closely related   At least 30 percent of global greenhouse gas emissions stem from buildings (construction and subsequent economic life)   Built environment offers largest potential for greenhouse gas abatement   McKinsey cost abatement curve 2.  Energy costs are single largest expense in provision of office space   30 percent of operating expenses   10 percent of total housing costs   Salience can only increase with rising energy prices 3.  Awareness is growing and the importance of “green building” practices has increased…
  3. 3. Usage of “green building” in the popular press…
  4. 4. …and visitors to the “Greenbuild” conference
  5. 5. What about the importance in the marketplace? Top-25 “green” commercial office markets
  6. 6. The value case for eco-efficiency in real estate Costs versus revenues in ‘green’ buildings A higher initial outlay…   Not clear how much higher (0 – 20%)   ‘Smarter’ building managers/software … may be compensated by ‘green’ value drivers   Cost savings   Energy savings (up to 35%)   Emission reduction   Increased rents   Reputation effects   Improved indoor air quality   Increased economic lives, reduced depreciation  lower risk (e.g. less variation in occupancy)   Case studies on the economic implications   Focus often on new buildings, but annual new construction is only 1%-3% of total stock   Results are hard to generalize
  7. 7. This study: economic effects of ‘green’ label U.S. property sector offers laboratory
  8. 8. “Green” buildings Two programs: Energy Star (EPA) and LEED (USGBC)   Dataset of existing sustainable office properties (U.S.)   EPAs Energy Star for Commercial Buildings (1995)   Efficiency in source energy use is in top quarter relative to CBECS   Standardized for building use (occupancy, hours) and climate   Certified by professional engineer   Based on real energy consumption (at least one year of bills)   Our sample: 2,759 Energy Star-certified buildings   USGBCs Leadership in Energy and Environmental Design (1999)   Scoring systems based on 6 components of “sustainability”   Energy efficiency one component   Various systems and versions (eg. NC, EB, O&M, ...)   Based on design stage (and now verified after construction)   Our sample: 716 LEED-certified buildings
  9. 9. Defining conventional comparables Systematic match on location   Based upon longitude and latitude, we use GIS to identify all conventional office buildings in a 0.25 mile radius
  10. 10. Example: 401 W A Street, San Diego Energy Star certified (‘01, ‘02, ‘04, ‘08, ‘09), LEED Gold 401 W A St Columbia Center This copyrighted report contains research licensed to Maastricht University - 382753.
  11. 11. Example: 50 Hurt Plaza, Atlanta Energy Star certified, LEED Gold
  12. 12. Clusters of green and control buildings Minimum of one control building per cluster Chicago, IL Houston, TX Columbus, OH
  13. 13. Defining conventional comparables Systematic match on location   Final sample   Rental sample   1,943 green buildings   21,395 control buildings   Transaction sample   744 green buildings   6,065 control buildings   To further control for differences in quality, we estimate a propensity score for each building (Rosenbaum and Rubin, 1983)   Logit model including all hedonic characteristics
  14. 14. Descriptives: green sample vs. control sample Green buildings are larger and younger Propensity score weighting substantially reduces differences
  15. 15. Methodology How to correct for differences in location and quality?   Methodology: standard valuation framework   Rin is the rent, effective rent or transaction price per sq.ft.   Xi is a vector of hedonic characteristics   Size, age, renovation, class, amenities, public transport, …   Percent change in employment in service sector (CBSA) to control for regional variation in demand for office space   Cluster cn dummies to control for location – 1,943 (744) separate dummies in the rental (transaction) sample
  16. 16. Results: rents, prices, and green ratings Green premium ranges from 2% – 13%
  17. 17. Substantial variation in label increment Expensive location: green label less important
  18. 18. What explains the green premium? Signalling value…or a better building   The variation in the premium for green buildings:   Energy characteristics of the building   Sustainability characteristics of the buildings   “Label premium”   For 209 LEED-rated buildings, we have information on:   Registration versus certification   Standardized numerical rating (37 – 100)   Score achieved in six components of LEED evaluation   For 1,719 Energy Star-rated buildings, we have information on:   Source/site energy consumption   Energy bill   Local climate (heating and cooling degree days)
  19. 19. Detailed information on LEED-rated buildings Standardized indices of buildings’ sustainability
  20. 20. Explaining the premium for LEED rated buildings Certification score is important determinant of rent increment   LEED-certified, score 40: effective rent of 2 percent higher than otherwise identical, registered building   LEED-certified, score 60: effective rent of 20 percent higher
  21. 21. Information on Energy Star-rated buildings Emissions of efficient buildings are still substantial…   Average emission of a building in our sample: 4,326 tons of CO2   750 cars, 9,000 barrels of oil, …   Energy Star-rated buildings emit at least a quarter less carbon as compared to conventional office buildings
  22. 22. Explaining the Energy Star increment Energy efficiency is reflected in “green” price increment   A $1 saving in energy costs is associated with a 4 percent premium in market capitalization   At the point of means ($245/sq.ft.), this implies a cap rate of 10 percent
  23. 23. Some first conclusions Eco-investment real estate sector is not only ‘doing good’   Ceteris paribus, green buildings 1.  Have higher rents by 2% 2.  Have higher effective rents by 6% 3.  Have higher selling prices by 13%   The green increment is systematically related to the underlying characteristics of energy efficiency or “sustainability”   Market seems to be relatively efficient in pricing these aspect   LEED and Energy Star measure somewhat different aspects of “sustainability” and complement each other
  24. 24. Market dynamics and green buildings (I) 2007 – 2009 was a painful period… Office rents –30% Vacancy rate +40% Unemployment +115%
  25. 25. Market dynamics and green buildings (II) 2007 – 2009 was a painful period… Office rents –29% Vacancy rate +50% Unemployment +111%
  26. 26. But... “green” office space flourished Fraction of certified “green” space in 150 CBSAs
  27. 27. Dynamics of green building Substantial increase in rated space in a contracting economy   We investigate the differences in rental developments in rated space and otherwise comparable space   8,182 observations as of September 2007   694 rated buildings and 7,488 nearby control buildings   Rents, occupancy rates, effective rents   Same sample as of October 2009   Some control buildings were converted to “green” during the sample period   Developments in rents, occupancy rate, effective rents
  28. 28. The returns to green buildings “Brown-green” is the biggest loser…
  29. 29. Regression results effective rent …controlling for differences in quality and location logRinT − logRinτ[ ] = αT −ατ( )+ βi XiT − Xiτ( )+ δT giT −δT giτ + εinT −εinτ( )
  30. 30. Conclusions and implications “Green” is getting mainstream   Increased awareness of global warming and the role of the real estate sector have increased attention upon “green building”   Demand-pull is necessary to reduce carbon impact of built environment   Voluntary labels can help in creating transparency in energy efficiency and sustainability   Energy efficient and sustainable office space is getting mainstream   This may have economic implications for investors, tenants, and policymakers   Buildings certified by Energy Star or LEED command higher rents and prices in the marketplace…   The “green premium” has slightly decreased during the crisis   Private market incorporates signal of energy efficiency and/or sustainability
  31. 31. Global green building certification A label jungle • 

  32. 32. Does this evidence hold for Europe as well…? Tentative evidence points in a similar direction   UK study   BREEAM-labeled offices (1,000 buildings)   IPD financial data   Outcome: 88 matches…   Institutional property investors have not (yet) embraced BREEAM   First results   Difficult to control for quality differences   Similar economic implications for rent and value   Cap rates for BREEAM-labeled buildings seem to be lower   More later this year… …but what about other labeling systems?
  33. 33. EU Energy Performance of Buildings Directive Originated January 2003, revised December 2009 “Member states shall ensure that, when buildings are constructed, sold or rented out, an energy performance certificate is made available by the owner to the prospective buyer or tenant”
  34. 34. Study value of EPCs in Dutch housing market The “greener” the better… The EPC seems to be effective: we document a price premium that varies with the label outcome, which is driven for a large part by future energy savings
  35. 35. Questions? Remarks?