Value Beyond Cost Savings - Green Building Finance Consortium

Value Beyond Cost Savings: How to Underwrite Sustainable Propertiesregulations regarding sustainability will increase, perhaps dramatically, in the comingyears. A building that cannot, at a reasonable cost, adapt to meet future regulatoryrequirements or capitalize on incentives, will be less valuable.Analogously, a building that cannot adapt to meet increasing demand for sustainability byspace users and investors will also lose value through economic obsolescence. Sustainablebuildings also reduce the risk of reliance on the energy grid (terrorism or natural disasters),limit exposure to energy/water cost volatility, and limit both current and future potentialliability due to building-related health issues. All of these benefits reduce exit or takeoutrisk by maximizing the potential pool of buyers or investors, and the availability offinancing.While the benefits related to cash flow risk can be significant, sustainable properties canalso increase cash flow/building ownership risk. For example, investments in newtechnologies, systems or products that are at risk of getting leapfrogged increases the riskof losing value due to functional obsolescence. Investors can also miss the market, overinvestingin sustainability relative to market demand. Worse, the potential elimination ofnon-sustainable features attractive to occupants may reduce tenant demand, increasingcash flow risk. The reliability and accuracy of energy forecasts, as well as the risk due toenergy price declines also can be important over a short time period. Finally, liability riskrelative to performance claims and marketing need to be evaluated.Risk Analysis and Capitalization and Discount RatesThe traditional way discount and capitalization rates have been generated is throughmarket research. Capitalization rates are calculated based on evaluating comparable salesof commercial properties, and discount rates are typically determined through an analysisof the most likely buyer of a project, and their rates of return requirements, throughsurveys or other means. Market derived discount and capitalization rates are then adjustedfor the specific concerns and considerations of the particular property, given its riskattributes.When market transactions are limited, and capitalization and discount rates are difficult todetermine based on market evidence, or the number of property sales for a particularspecialized property type is too low (as is often the case with sustainable properties), thederivation of capitalization and discount rates relies more upon a detailed articulation andreconciliation of the risk- increasing and risk-decreasing factors of a particular property.While anecdotal (based on many interviews and discussions, but not a random orstatistically significant survey), our research shows that for most institutional investors,new development projects are already seeking a relatively high level of sustainability, andinstitutions are moving rapidly to assess their existing portfolio’s sustainability relatedpotential for functional or economic obsolescence due to sustainability. Many of thelargest real estate owners are developing specific acquisition screens to eliminate potential135