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Commercial Real Estate Finance:Going Green
Dan KastilahnUrban Habitat ChicagoMarch 5, 2008
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Topics
Traditional real estate finance in the capital markets– Portfolio lenders– Securitization – (CMBS)– Underwriting 101
Why green commercial buildings?– Corporate Sustainability Initiatives– Benefits of Energy Savings– Rents & Occupancy– Developers/Owners/Property Managers
How does “green” affect financing?– Lenders & Property Insurers
Investing in green commercial real estate
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Real Estate Finance
Portfolio lenders include:– Commercial Banks: regional & national
– Life Insurance Companies
– Pension Funds
Balance Sheet loans for long-term holds Conservative underwriting to mitigate risk
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Real Estate Finance
Securitization
– Commercial Mortgage-Backed Securities (CMBS)Industry 2007 Issuance: $230 billion of pooled commercial
property loans
Industry has seen a recent drop-off in issuance, but isanticipated to self-correct; will likely stabilize closer to$100 billion in annual issuance
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Real Estate Finance
Securitization
– Benefits: Risk is pooled, tranched and sold off as bonds of
varying quality; investors pick and choose their level ofrisk
Frees up cash in the capital markets to make moreloans on commercial property
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Real Estate Finance
Underwriting 101:– Revenues
Premium rents for premium properties– Class A vs. B/C; NNN vs. Gross leases
– Expenses Fixed
– Taxes, insurance Variable
– Utilities, Common Area Maintenance (CAM)
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Real Estate Finance
Underwriting 101:– Capital Items
Capital expenditures– Investments into building infrastructure (roof, systems,
HVAC) TI/LCs
– Tenant Improvements (new tenant vs. renewal)– Leasing costs (broker fees; new leases vs. renewals)
Revenues - Expenses - Capital Items = Cash Flow!
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Why Green Commercial Buildings?
Commercial Buildings:– Account for more than 71% of the nation’s
electricity consumption
Account for 40% of total energy use
This number increases to 48% when the energyrequired to fabricate the building materials is taken intoaccount
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Why Green Commercial Buildings?
Commercial Buildings:– Consume 12% of the United State’s water
– Generate 30% of all greenhouse gas (GHG)emissions
– Up to 30% of new and remodeled buildingsexperience acute indoor air quality (IAQ)problems
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Why Green Commercial Buildings?
Approximately 60 billion sf of existing commercialspace
2006 study by USGBC found that owners can save$.90/sf, on average, in energy and other costs byretrofitting older buildings
80% of corporations now consider “sustainability” anear-term business issue and are willing to pay apremium for environmentally-friendly space
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Why Green Commercial Buildings?
Study conducted by Economist IntelligenceUnit (EIU) showed that:
– More than half of all companies surveyed (of1,250 total) listed energy-efficiency as one of theirtop priorities
– Buildings are responsible for almost 75% of acompany’s total GHG emissions
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Why Green Commercial Buildings?
Study conducted by Economist Intelligence Unit(EIU) showed that:
– There is an implicit connection between share price &commitment to sustainability: “…companies thatrecorded 50% growth in share price over the past 3years prioritized social and environmental goals andwere more profitable on sustainability than thosecompanies whose share price declined by more than10% over that period.”
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Why Green Commercial Buildings?
Benefits of energy savings– Green buildings can reduce energy costs by up to 30%
according to the US Dept. of Energy
– A McGraw-Hill study found: An average expected decrease in operating costs of 8% - 9%
across the industry A predicted average increase in property value of
approximately 7.5% Average expected increase in Return on Investment (ROI) of
6.5%
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Why Green Commercial Buildings?
Rents & Occupancy
– Study done by UBS concluded green buildingsare expected to achieve:
3% premium on rents
3.5% increase in occupancy
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Why Green Commercial Buildings?
Rents & Occupancy
$30
$10
$36
$5
$0
$5
$10
$15
$20
$25
$30
$35
$40
$45
Traditional Property Energy-Efficient Property
Operating CostsRents
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Why Green Commercial Buildings?
Tenant attraction & retention– International tenant rep firm, Studley, launched a
Sustainable Real Estate Practice group in response totenant demand
Olivia Millar, a Studley LEED AP and head of the new practice:“A couple of years ago, it was folks who had a ‘green’core mission. Now, you’re seeing a lot of people whowant to go green because they’re concerned aboutrecruiting top talent, providing a sustainable workenvironment and increasing productivity.”
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Why Green Commercial Buildings?
Developers/Owners/Property Managers
– ProLogis, the world’s largest developer ofdistribution/warehouse properties, has committedto LEED certification for all new US projects
Why? => Building to certification standards can extendthe life of its buildings and broaden the sustainabilityagendas of its tenants
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Why Green Commercial Buildings?
Developers/Owners/Property Managers
Jack Rizzo, MD of global construction: “We see agrowing preference among customers to leasespace in buildings that have been developed withenvironmental efficiency in mind.”
ProLogis became the 1st real estate company in theworld to join the Chicago Climate Exchange (CCX)
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Why Green Commercial Buildings?
Developers/Owners/Property Managers
– Property owner Steve Ludington’s “as-is” 50,000sf flex building on West Kinzie St., just minutesfrom downtown Chicago
Monthly heating bill (w/o tenants): $7,000
Translates into $.14/sf/month
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Why Green Commercial Buildings?
Developers/Owners/Property Managers
– Mr. Luddington’s 26,000 sf facility, also in Chicago, with ageothermal heating system installed: Monthly heating bill (in winter, fully leased): $650
– = $.03/sf/month Monthly bill before geothermal system installed: $3,000
– = $.12/sf/month
“The tenants get a bill for hundred bucks orsomething…it’s almost a joke. They can’t believe it”
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Why Green Commercial Buildings?
Other incentives:
– Tax credits for certified buildings
– Lending perks from financial institutions
– Expedited permitting from state and localgovernments
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How does “green” affect financing?
Lenders
– Banks have been quick to embrace the greenmovement (for their own space), but slow toadjust lending policies or to create a financialmodel that quantifies benefits like: Improved worker productivity and health Recruiting advantages Government incentives Energy Savings
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How does “green” affect financing?
Lenders
– “Sustainability” is not a property type
– 90% of the lending risks for green property are justfundamental real estate risks: Location, location, location Market dynamics
– Comparable properties & submarket occupancy– The greater lending environment: cap rates & interest rates
Financial strength of borrower
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How does “green” affect financing?
Lenders: Progress is being made
– Wells Fargo has surpassed $1 billion in loans for LEEDcertified buildings
– Bank of America announced a $20 billion environmentalinitiative that includes green lending practices, but detailsare hard to come by
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How does “green” affect financing?
Lenders: Progress is being made
– New Resource Bank (San Francisco) offers customersgreen commercial and residential loans.
Financial programs offer more money at lower costs to theborrower through lower interest rates and higher loan-to-value(LTV) ratios on certified properties.
The bank currently has more than $100 million in assets
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How does “green” affect financing?
Insurers
– Insurance companies support green constructionas there is generally less risk in “green” propertieswith: State-of-the-art technology
Higher appraised values
Provide a healthier work environment
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Investing in green real estate
Green Building Finance Consortium
– A research project launched to create a roadmap forinvestors and lenders to value sustainable property
– Founder Scott Muldavin: “…even 18 months ago, thewhole [green building] field was dominated by thepublic sector and the private sector had very limitedinvolvement. None of the analyses of cost-benefitlooked at it from the perspective of how people whohave money in real estate think about real estate.”
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Investing in green real estate
Green Building Finance Consortium
– Rating systems (i.e. LEED) have marketplacevalue, but lenders and investors need to lookbeyond the rating system to property’s individualsustainable features in order to assign value froma financial perspective
Not all LEED buildings are created equal!
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Investing in green real estate
Investor interest, evidenced by the growingnumber of “green funds”, has been fueled byincreases in:
Government regulation Tenant interest Energy costs Pressure on corporations by shareholders to address
sustainability
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Urban Habitat Chicagowww.urbanhabitatchicago.org
Questions?
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Urban Habitat Chicagowww.urbanhabitatchicago.org
Sources and Articles:1. Burr, Andrew C. “In Green Realty He Trusts” CoStar Realty Information, (1/23/08).2. Burr, Andrew C. “CoStar Green Report: The Big Skodowski” CoStar Realty Information,
(1/30/08).3. Burr, Andrew C. “CoStar Green Report: CBRE Says Industry Slow to Accept, Adopt Green
Practices” CoStar Realty Information, (9/12/07).4. Burr, Andrew C. “CoStar Talks Finance with Green Building Finance Consortium’s Scott
Muldavin” CoStar Realty Information, (9/5/07).5. Burr, Andrew C. “Stock Prices Linked With Sustainability, Survey Finds” CoStar Realty
Information, (2/27/08).6. Burr, Andrew C. “For Studley and ProLogis, Opposites Attract Green” CoStar Realty
Information, (9/12/07).7. Cortese, Amy “The Greening of Existing Buildings – They Don’t Have to Be New” The New
York Times, (1/26/08)8. Drummer, Randyl. “REITS Buying Into ‘Green Premium’”, CoStar Realty Information,
(10/17/07).9. Pardy, Sasha. “Retail Industry Will “Walk the Talk” of Green Building in 2008”, CoStar
Realty Information, (12/5/07).10. “Green Downtown Office Markets: A Future Reality” CB Richard Ellis, Summer 2007
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