Much ado has been made about residences and businesses going green. Proponents state it is environmentally responsible and is necessary to save the planet. Because of that we have seen numerous strategies crop up in the past decade like carbon credits, tax incentives, and utility rebates to begin to bring green buildings more affordable.
So what is a green building? A green building will consume less energy, water, and waste than other properties. Green buildings may also be made with recycled or use environmentally friendly materials that provide a healthier environment for its inhabitants. There are also various shades of green. One building may just elect to change all its lighting to LEDs, while another one utilizes renewable energy to go completely off the grid.
While I am not a tree hugger by any means, I am interested in something else that is green—money. Does adding green features or making a building more environmentally sustainable worth the money? Efficient buildings may reduce ongoing operating costs compared to non-green properties. This will result in a higher NOI and therefore will be worth more than a similar building with a lower NOI.
Studies by the Institute for Building Efficiency show that green buildings have higher asset values than their conventional counterparts. On average the differential in asset values is proven by a 6 to 35% increase in higher resale values, 2 to 17% higher rental rate, 30% lower operating costs, and a 1 to 18% higher occupancy rate. One of the main drivers of the increased value is lower operating costs. Green properties are cheaper to operate due to lower utility costs, less water usage and reduced maintenance costs.
Energy costs are important to manage, since that cost can comprise up to 30% of the building’s operating cost. The Environmental Protection Agency estimates that owners can increase their property value by $3 for every $1 invested in energy efficiency technologies. This figure reflects the net present value of future energy savings added to the property’s resale value. One example is a 50,000 sf building that pays $2/sf in energy costs, a 10% reduction in energy use adds up to an additional $10,000 annually in NOI. Using a capitalization rate of 8%, this translates into a $125,000 increase in the asset value, according to Energy Star.
A second major driver is marketability. As green buildings become more in vogue, investors and tenants will continue to recognize the green building label. Sustainable multifamily buildings may have improved air-quality, lighting, and thermal comfort. CoStar recently published a study that stated LEED-certified apartments command an average rent premium of 25% over non LEED properties. Sustainable buildings tend to offer a more comfortable workspace, leading to increased productivity by employees, resulting in an increased bottom line for the business.
Green buildings may also be less impacted by increasing energy prices. Possible upcoming regulations by communities, such as mandatory disclosures, building codes, and laws banning inefficient equipment, may have adverse impacts on rental income and thus the future value of non-green real estate.
But green does not always provide an adequate return. I know of a large refrigerated warehouse that spent over $500,000 after rebates on a photovoltaic solar system for their building. They initially expected energy savings of nearly 75%. What actually occurred was savings of 5%. They failed to realize a factor in their commercial utility billing was the demand charge. On a hot day, their electrical usage would spike, kicking them into a higher charge per kilowatt hour that impacted the entire billing period. The result was a system that they expected to payback in 5-8 years now took 40 years. A lender who may have leveraged up the company for the solar install, while projecting a large decrease in utility costs may find this credit to be on the watch list with the company not realizing the projected savings.
With any energy improvements, analysis should be completed in the fashion known in the CCIM industry as a “T-Bar Analysis”. This simply takes into account the various cash outflows for the costs of the green system and any ongoing maintenance, and looks at any inflows such as higher rental income, utility rebates, tax credits, and lower utility and water cost. This is good to determine a breakeven time frame for the green investment and a rate of return utilizing a discount interest rate. If the plan is to market the property at some specific time in the future, the net projected sale price should be considered.
Going green is a worthwhile endeavor for the commercial or agricultural building owner at times. But the ultimate judgment of the value is how much additional green it will put into the wallet of the owner.
On another note, I would encourage those interested to contact us about our upcoming “Basics of Agricultural Lending” course held on October 8-9 in Miles City, Montana. At the time of this writing we already have 17 students. We look forward to seeing you there.