Value Beyond Cost Savings - Green Building Finance Consortium

Value Beyond Cost Savings: How to Underwrite Sustainable PropertiesF. Step 4: Evaluate Financial Implications ofCosts/BenefitsNow that sustainable property costs and benefits have been identified and evaluated, thenext step is to determine how the subject property’s sustainable costs and benefits willinfluence the financial performance of the property.1. Linking Costs and Benefits to Financial PerformanceFor real estate investor, developer and lender decisions, financial modeling typicallyinvolves an estimate of the development, acquisition, or retrofit costs and construction of apro forma cash flow statement outlining actual or projected revenues and operatingexpenses on a monthly, quarterly, and/or annual basis. Revenues are calculated based onassumptions for rents, periodic rent increases, absorption/lease-up timing, equilibriumoccupancy levels, tenant retention and other variables. Operating expenses are estimatedbased on an analysis of energy, water, maintenance, management, landscaping, propertytaxes, and other operating expenses. For multi-tenant properties, financial models to assessincremental investments in sustainable attributes must also incorporate a specificconsideration of the allocation of landlord and tenant costs and benefits based on leaseterms.Discounted cash flow analysis (DCF) is the standard approach used by real estate investorsto assess commercial property value and financial potential. In DCF, the net present value,or return, on a project is determined by looking at the project outflows (development &operating costs) and inflows (revenues & net sales proceeds) over time. The net costs orrevenues over time are converted to present value through a discount rate that reflects therisk of the cash flow as determined by investors.While the specific type of financial model will vary based on the type of decisions beingunderwritten, the logic and structure of a DCF model provides the conceptual frameworkneeded for interpreting how sustainable features influence return and/or value. Even ifperfect data is not available, by thinking through the specific assumptions within a DCFmodel, users can gain important insights about the magnitude of the financial implicationsof sustainable property investments. The key financial model inputs of the DCF modeldirectly affected by sustainable costs and benefits are shown below in Exhibit V-6.113