Value Beyond Cost Savings - Green Building Finance Consortium

Value Beyond Cost Savings: How to Underwrite Sustainable Properties1. Property Risk FocusThis book focuses on the assessment and integration of risk analysis into property-leveldecisions. Property specific decisions include building retrofits, commercial interior buildouts,acquisition of an existing building, or new construction. The presentation anddiscussion of risk occurs in many different situations:• Feature Decisions: Risk and uncertainty are often part of the general discussionand presentation of a simple payback, simple ROI, or life cycle costing analysisfor a specific feature (green roof, HVAC system, etc.).• Investors/Valuers Cap Rate Selection: Risk is, or should be, a centraldeterminant in the selection of an appropriate residual capitalization rate in anexisting property acquisition. This is most often discussed in assessing therelative cash flow and related risks of sales comparables.• Investment Due Diligence: In the context of decision makers evaluating thereasonableness of a rate of return estimate from a DCF analysis. The rate ofreturn (typically an internal rate of return) reflects the mathematical result of theunderwriter or valuer’s opinion on scores of specific inputs, without fullconsideration of risk or uncertainty. For example, three different retail propertyinvestments might have forecasted rates of return of 7%, 9% and 11%. Todetermine which is a better investment, investors consider the relative risksassociated with each project and determine, on an informal “risk-adjusted” basis,which project best fits their needs. While this process of considering risks is not aformal mathematical process, it can, and should be, rigorous and well reasoned.• Corporate Real Estate Decisions: Corporate real estate decision-makersconsider many similar factors to an investor, but typically have different, andoften unique, investment considerations and return hurdles. Businesses areparticularly sensitive to risks that would threaten their ongoing operations andlong term company value.• Valuation: Valuers must also consider risks and uncertainty in theirdetermination of discount and capitalization rates in order to calculate valueusing the Income Approach to Value. This is often done while evaluating the“comparability” of sales or rental comparables.• Lending: Lenders’ consideration of risk is more focused on the probability ofdefault (which is a function of risk and uncertainty in the cash flows required topay debt service) and the severity of losses in the event of default (which isprimarily a function of the loan to value ratio). Risk mitigation is key becauseunlike investors, lenders do not directly share the “upside” if a risk pays off, onlythe downside if it fails.132