Mar 12, 2010


alstria as a real estate company is very much interested in the debate relating Green Buildings and the better understanding of the fundamental of this new key development is an important factor in setting up the future strategy of the company. As part of background research work, I read recently a report called “Doing well by doing Good? Green Office Buildings”. It can be freely accessed following this link.

According to the study, it provides “the first credible evidence on the economic value of the certification of “green buildings”. The release of this report had a great impact and was widely commented by the real estate press (thus my willingness to read the study directly). You might have heard that Green Buildings command a 6% premium on rents and 16% premium on sale price. Well, this is where theses numbers come from.

When I finished the reading, I remembered three research laws, that I learnt back when I was working/studying in a research institute (doing research on the behavior of fiber reinforced concrete in major construction projects… nothing really exiting).

1- The Williams and Holland's Law of statistic: If enough data is collected, anything may be proven by statistical methods.

“The green buildings are much newer, averaging about 24 years in age while buildings in the control sample are about 49 years old, on average. Because they are older, the control buildings are much more likely to have been renovated than are the green buildings” (page 12)

That is an interesting result of the study. So Green Buildings as defined by the study (ie LEED certified buildings, or Energy Star certified buildings) are 24 years old on average. That is despite the fact that the Energy Star for commercial buildings only exists since 1995 (or 15 years) and LEED since 1999 (or 11 years). Rather than concluding that the Green Building must have been heavily refurbished recently (otherwise they would not be “Green”) the study concludes the opposite. It is the “control” building that are likely to have been renovated. Strange logic, but what do I know.

2- Murphy's Law of Research: Enough research will tend to support your theory.

The results suggest that the LEED rating has no statistically significant effect upon commercial rents, but the Energy Star rating is associated with rents higher by 3.3 percent.” (page 16)

That is one of the main interesting comments in the study. This is why, one should not stop reading the press coverage, nor the abstract which claims that “We find that buildings with a “green rating” command rental rates that are roughly three percent higher per square foot than otherwise identical buildings – controlling for the quality and the specific location of office buildings”. The actual finding is that Energy Star buildings command this premium, and that LEED have no impact. To be fair to the research, the conclusion of the paper does highlight this point too. More interestingly is the fact that the study found that “Ceteris paribus (means everything being equal, I had to look it up too), rents in a commercial office building less than ten years old are twelve percent higher than those in a building more than forty years old”. This is regardless of whether or not a building is a “green” building. In short, rents in new building are higher than rent in old buildings (I hope you learnt something here)

Given that most of the “green” buildings are less than 15 years old, it makes perfect sense that they command a higher rent. The 3.3% higher rental rate can simply be justified by the fact the building is newer than the immediate vicinity competition, being green is for that matter not really decisive (actually 3.3% seems rather a low premium for a new building…). But again what do I know.

I could use the same arguments to underscore why I believe that the sale premium shown in this research is not linked to the green characteristic of the asset, but simply to the fact that theses are more recent assets than the other assets of the sample.

3- The Truman's Law: If you can't convince them, baffle them with science.

I must confess that I did not clearly understood all the methodological instruments used in this research (I had to look into Wikipedia for what a “regression model corrected for heteroskedasticity” is; if you are interested here is the link to the Wikipedia page).

I do not believe that trying to demonstrate at any cost that there is more value in a Green Building than in a regular building is really helping the prospect of sustainability in real estate. Ceteris paribus, a green building does not have more value. It is the non green that building has less value. Ceteris paribus, a green building does not commend a higher rent. It is the non green building clearly does command a lower rent.

This is not a simple question of semantic. It is a fundamental difference in the appreciation of what is sustainability for the real estate industry. While the kind of study above is looking to prove that sustainability is a way to increase financial returns for a real estate investor, I believe that sustainability is about protecting value. It is not about opportunity, it is about risk.

The non green buildings have a higher obsolescence risk, it will require higher costs to be rented. It will have a lower capital value to its owner, considering the costs it will require to be upgraded to sustainable standard. Compared to expected returns on real estate, it is not the green building that should command a premium, but the non green building that should command a discount.

The rent which is paid for a building is commended by the market, and so far I have seen only anecdotic evidence of tenants willing to pay more than the market for any building (whether green or not). What I have seen (mainly in Australia so far and not so much in Europe yet) is that tenants are not willing to consider a building if it does not have a sustainable label.

When air bags were first included in cars, some car manufacturers were wondering whether they could be able to increase their sale prices with such a feature. Today, airbags are standard features of many cars (including the low cost DACIA cars). Having airbags do not help selling a car, or increase its value. Not having airbag, would just prevent sales to happen. The same will be true for sustainable buildings. Sustainable buildings are going to become a major topic for all new constructions, not because they will add value, but because not being sustainable is going to lead to significant value destruction.

When looking at sustainability issues at alstria we do not really look at how much money we could make, but how much we could loose if we were not to look into the matter.

PS: I haven’t in this post touched the mere concept of Green Buildings, which probably would deserve to be defined once and for all. If you are interested by another point of view than the mainstream an excellent starting point can be found here (MIS-LEED-ING)


No comments:

Post a Comment