Value Beyond Cost Savings - Green Building Finance Consortium

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Value Beyond Cost Savings: How to Underwrite Sustainable Propertiesthe net operating income in year eleven capitalized to obtain a residual value. 71 Theresidual value is important because the difference between the original acquisition priceand the eleventh-year sales price captures the appreciation in value over the holdingperiod. Revenues and operating expenses will change over a ten-year holding period basedon the terms of new and existing leases, changing costs, varying occupancy levels, andother factors.The capitalization rate is a measure of investor demand that reflects the return required byinvestors to acquire the stream of net operating incomes from a property. Thecapitalization rate can significantly affect the rate of return of a property. If a sustainableproperty generates increased investor demand, its capitalization rate will be lower,increasing residual value and net sales proceeds. The financial impact of the residual salesprice is reduced because proceeds are received in the future and must be discounted backto the present, but is still typically significant in a real estate investment.The DCF model is used by the appraisal profession as one of their three approaches tovalue. The three approaches are the Income Approach (typically a DCF Model), the SalesComparison, or Market Approach, and the Cost Approach. To calculate value from theDCF model one selects a discount rate (based on market evidence) to apply to the streamof cash flows to determine the net present value. The discount rate is the rate of returnrequired by most likely buyers to invest in the subject property’s projected net operatingincome. Accordingly, the discount rate, similar to the capitalization rate, incorporates themarket’s perception of the risk of a subject investment. The discount rate is used totranslate cash flows received over the holding period to a present value. The higher thediscount rate, the more risk an investor perceives in the pro forma cash flows, and thelower the net present value will be.The financial performance (internal rate of return value) of a property is determined by allthe specific financial inputs shown in Exhibit V-7. Some assumptions, like rent,occupancy, or energy costs are very important, and others, like water costs, trash removalor insurance, are less important.Consequently, in assessing how, and how much, sustainable property outcomes (energyefficiency, certifications, etc.) will affect financial performance; it is critical to understandthe relative magnitude of the different financial model inputs for the specific subjectproperty being evaluated. Typically, rent and revenue related assumptions would be moresignificant than operating cost assumptions. Accordingly, traditional sustainabilityfinancial analyses that ignore revenues are often inappropriate or inaccurate measures offinancial performance.71 A simple ROI or Life Cycle Costing model are variations on discounted cash flow analysis that incorporate morelimited assumptions and varying life cycles. Discounted cash flow holding periods will also vary significantlydepending on the strategy of the investor, with three, five and seven year holding periods often considered as analternative, or in addition to a ten year time frame.124
Value Beyond Cost Savings: How to Underwrite Sustainable PropertiesJust because water, trash removal, sewage and other operating costs are typically lesssignificant when looking solely at their relative magnitude to revenues and other operatingcosts does not mean they do not have value. Sustainability features, systems and practicesthat reduce water, sewage, and trash, or achieve other sustainable goals, contributesignificant public value and enable high level sustainability certifications, which can becritical to increased demand by regulators, space users, and investors. Demand by thesegroups drives potential revenue enhancement and risk reduction. Accordingly, “valueengineering” as it is typically done today that focuses only on costs can potentially lead tocuts that will significantly reduce the value of a sustainable property.Exhibit V-7Discounted Cash Flow ModelCalculation of NOIYear 1RevenuesContract and Market Rents $14,535,362Less: Absorption and Turnover Vacancy (1,939,548)Scheduled Base Rental Revenue $12,595,814Add: Expense Reimbursement Revenue 150,928Add: Parking Other Income 2,273,518Total Potential Gross Revenue $15,020,260Less: Credit and Vacancy LossEffective Gross Revenue $15,020,260Operating ExpensesJanitorial 222,572Porter 72,816Window Cleaning 44,625Supplies 42,483Trash Removal 28,150Fire and Life Safety Supplies 31,760Repairs and Maintenance 505,807Tools and Equipment 13,500Utilities- Electricity 647,633- Gas 43,883- Chilled Water 588,000- Water and Sewer 21,797Security 209,200Landscaping Contract 23,200Administrative 259,890Advertising and Promotion 25,900Real Estate Taxes 2,376,310Non-Reimbursable Expense 37,670Insurance 188,000Management Fee $300,405Total Operating Expenses $5,683,601Net Operating Income $9,336,659125
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Appendix FSustainable Property Fina
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Appendix GSustainable Property Cost
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Appendix HDiscounted Cash Flow Anal
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Property Type: CBD OfficeSquare Fee
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Value Beyond Cost Savings - Green Building Finance Consortium

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