The Green Behind the Green

[ By Ellen Rand ]

On the issue of financing green development, a few questions naturally arise: Is there a difference in cap rates for green development, versus non-green development? Should yield expectations be (a) higher (b) lower (c) the same for green developments as they might be for non-green developments? Are underwriting standards different? Do green developments command premium rents or do they garner top-of-the-market rents by virtue of simply being newly-constructed?

For the still relatively young phenomenon of green building -- against a backdrop of the continuously moving target of market conditions and financial hunger for real estate -- the questions may be largely unanswerable. That has not stopped the emergence of investment funds and other financing sources specializing in green real estate, however.

Last fall, for example, the international real estate firm Hines announced the closing of the Hines CalPERS Green Development Fund (HCG), capitalized with more than $120 million of equity that, with 75 percent leverage, will have the ability to invest up to $500 million.  HCG will concentrate on developing high performance, sustainable office buildings certifiable through the Leadership in Energy and Environmental Design Core and Shell Program (LEED-CS).  The fund will focus on developing office projects throughout the United States. Of course, those will all be Hines projects.

The fund has already invested in its first project, Tower 333 in Bellevue, Washington. Completion for this Hines-developed 20-story, 410,000-square-foot office project is expected in the fourth quarter of 2007. A second has been selected in Orange County, California; and if one more is chosen, three-quarters of the fund would be spoken for, according to Hines senior vice president and portfolio manager Dan Rashin.

Rashin noted that “We don’t expect to see results for a while,” since one development is under construction and the second is in the planning stages. Nor have return expectations been made public, but they would be “substantially higher than core and core-plus properties,” Rashin said. As for underwriting standards, Rashin said that “from the Hines standpoint, green is no different from other Hines development projects. Hines has been committed to sustainability for a long time. The economics are no different: we are focused on Class A development, and it has to be LEED Core and Shell certified.”

Hines and CalPERS share five other joint ventures, including chronologically: National Office Partners, LP; Hines CalPERS Mexico Holdings, LP; Hines CalPERS Brazil Interests, LP; Hines CalPERS Spain Interests, LP; and Hines CalPERS China Interests, LP. 

Focus on Rehab, Redevelopment
Sustainability has been an issue for new development much more than it has been for rehabilitation and redevelopment, but investment funds are stepping into that realm as well. One is the Rose Smart Growth Investment Fund, begun a year ago by third-generation developer Jonathan F. P. Rose. This $100-million limited partnership focuses on the acquisition of existing properties in locations served by mass transit. The idea is to meld socially-responsible, environmentally-friendly construction and rehabilitation with an ability to add value and boost a property’s bottom line.

Its first redevelopment project is under way in Seattle at the Joseph Vance and Sterling Buildings, two adjacent buildings located on a main bus line. The buildings were acquired for $23.5 million, with an additional $3.5 million earmarked for “green” renovations. As tenants move out, all 103,000 square feet will be renovated to the U.S. Green Building Council’s standards for existing buildings.

The Rose Smart Growth Fund is eyeing developments in the Boston-Washington corridor as well as Chicago and the Rocky Mountain region. In Baltimore, the Fund is undertaking a project – a former steel mill that has been redeveloped into a 147,000-square-foot mixed-use project -- with Struever Brothers, Eccles & Rouse. Investment funds are not the only green-oriented financing vehicle. In San Francisco, for example, New Resource Bank, a community bank focusing on serving entrepreneurs and sustainable businesses, opened in late fall 2006. Peter Liu, initial founder and vice chairman, said, “Part of our strategy is to meet head-on the growing green business market—while giving our depositors a safe and sound way for their money to work consistently with their values.”

Although the bank is only making loans in California for now, the state does not lack for opportunities: it recently passed legislation that commits the state to cut greenhouse gas emissions by 25 percent by 2020, opening the doors to new “clean tech” businesses. Other green business sectors such as organics and green real estate are similarly growing much faster than the rest of the state’s economy.

The bank is financing urban infill, mixed-use projects that incorporate energy efficient designs. One is a seven-unit residential development in Martinez; another is a mixed-use development in Berkeley, transformed from a rundown liquor store with a parking lot into a complex with 10 housing units and 5,000 square feet of retail space. Liu said that the bank takes a conventional approach to underwriting, coupled with greater understanding and focus, to provide low-cost capital for green real estate. “We understand the upfront costs in building green,” he said. “We will give developers a better loan-to-value ratio, which can translate into better returns for them. We also offer discounts in rates.”

New Resource Bank is offering financial incentives to green building developers, including a 1/8 percent discount on loans and a higher loan-to-value ratio. The bank has already funded projects including green residential developments in Martinez, Berkeley, Oakland and Sonoma California. Although Liu could not discuss business projections, since the bank’s stock is traded, he pointed out that so far lending volume is “ahead of plan.” Loans range from $3 million to $7.5 million – one was for $10 million, and part of that was syndicated. Liu hopes the bank will ultimately be able to expand beyond California.

“Translating” For the Investment Community
Do investors know what they want, when they look for green opportunities? Is there even a consensus about what green, or sustainable, development really means? Is there a way to “translate” the architectural/construction and “triple bottom line” features of green development into principles that investors, appraisers and ratings agencies can use? Those are just a few of the pressing issues Theddi Wright Chappell addresses regularly. Ms. Chappell is managing director, advisory services for Pacific Security Capital, as well as a LEED A.P., CEO of Sustainable Values, Inc., on the Board of the Green Building Finance Consortium (GBFC) and an ambassador for the Appraisal Institute for LEED and other sustainable initiatives.

The problem is that there is simply insufficient information, in the way of case histories and track records, about green building right now. Enter the GBFC -- whose goal, she explained, is to put together objective criteria related to valuation, appraisal and ratings. “We can’t do it quickly enough,” she said. “It’s like a snowball. Every day I get more calls. Energy, cost, volatility are significant enough so it’s going to get looked at more. There need to be methodologies in place to assess it and we’re trying to figure out a methodology that everyone can use.”

The GBFC has identified 15 areas of research. “To create the criteria to do a valid business case would be enormously valuable,” she said. “The goal is informational and educational.” The GBFC Research Program includes:

• Dissemination of valuation/finance knowledge
• Understanding sustainable property investing
• Cost-benefit framework for sustainable properties
• Select key risk/cost analyses
• Select key benefit analyses
• Current private sector sustainable building investment practices
• Valuation and risk measurement methodologies
• Integration of social and environmental benefits/costs into value
• Energy
• Worker productivity and health
• Regulation and incentives: monetization of public benefits
• Sustainable sites/land use and transportation
• Water
• Existing buildings
• Case studies/database development

Pacific Security Capital started as a development company but has expanded beyond that in the last several years. It is planning to do a sustainable resort community and wants to do it as a case study, Chappell reported.

Reality Check
As Chappell explained, “Some investors explore sustainable properties because they want to be responsible investors, but for the majority, the bottom line is what counts.” According to Daniel R. Winters, managing principal of Evolution Partners, a boutique real estate investment advisory and private equity firm specializing in financing high-performance, environmentally responsible real estate projects, the process by which investors determine that bottom line is not very different from that of conventional developments.

One of the underwriter’s challenges is to determine if a specific project is penalized by its peer group. If the industry average for energy cost is $2 a square foot, for example, “you underwrite at that level unless you have two years’ experience to show otherwise. So if your building will be 30 percent lower, you’re still marked to market. That’s a fight we articulate to lenders.”

Are certain lenders amenable to this argument? “Yes,” he said. “It’s a question of education. Green is a series of features. My job is to ‘arm’ a sponsor and convey the quality of sponsorship and project.”

Certainly, non-green factors enter into the financing picture these days, such as whether or not there is pressure on a financial institution to deploy its funds in a short period of time. Or, in representing a green building sponsor, the financial consultant may whisper in the ear at the 11th hour that an institution is “coming in #2; that #1 is 92 basis points over 10-year Treasuries,” Winters said. “You’re not going to get away from those basic realities.”

In the meantime, the march to green continues. Winters observed that “the premium to build green has come down. More manufacturers have come out with more products and product pricing is declining. We’re transforming to where green is the de facto standard. But will that happen in five years? In the next cycle?” Winters sees 2007 as a more active year for green building financing than 2006. Why? Not only has tenant demand improved, but also pressure is building from corporate America because it is becoming accountable on the issues of sustainability and keeping a competitive edge by investing in people – of which a healthy and efficient workplace is a part. Prospective tenants are asking about green features from developers and owners, while real estate brokers are becoming more interested and educated as well.

How does one make the best financing case? Winters advised developers and owners to make it a point that all green building components be tried and true, not new and esoteric.

“No one likes risk,” he said. “It’s a sales job. Because markets have been so frothy for five years, there is money that needs to be invested no matter what. And there’s still willingness to waive a lot of due diligence to get the deal done. Where a lot will come out in the wash is in a down market – but we’re not likely to see that in 2007.” Winters cautioned: “Are you going to get 10 basis points less on your loan? No.”

For more information
Green Building Finance Consortium:
www.greenbuildingfc.com

Building Insurance Goes Green While conventional insurance policies cover the cost to restore a building to its original condition, under the Fireman’s Fund Green Building Replacement, Green Upgrade and Commissioning coverages, commercial property owners and managers are able to rebuild and replace with green alternatives. Fireman’s Fund Insurance Company introduced Certified Green Building Replacement and Green Upgrade coverages specifically for green commercial buildings, addressing the unique risks that are acquired with sustainable building practices. These coverages protect buildings that are green-certified as well as buildings and facilities whose owners would like to capture green benefits. The coverage for LEED-certified buildings offers a discount, owing to lower risk factors. Fireman’s Fund has worked closely with the U.S. Green Building Council’s (USGBC) LEED program as well as the Green Building Initiative’s (GBI) Green Globes program to ensure that its coverage and upgrade options align with the industry’s major green certification processes. As part of the program, Fireman’s Fund will pay for the application process for the building to become certified by these organizations. For buildings that are green certified by the USGBC or the GBI, Fireman’s Fund will cover sustainable building elements such as vegetated roofs and alternative energy and water systems. In case of a total loss, Fireman’s Fund will cover for the rebuilding to also be green certified. For buildings that aren’t quite there yet, but are looking to go green, Fireman’s Fund provides an upgrade package as part of its green product. For example, if there is a fire in the building, Fireman’s Fund will pay for the upgrade to replace the carpet with green certified carpet and energy star office equipment. Here again, if there is a total loss, Fireman’s Fund will cover for the entire rebuild to be green certified. Steve Bushnell, product director at Fireman’s Fund, said that the company is encouraged by the products’ initial success, since being introduced in fall 2006. As a not-insubstantial side benefit to the company, their very availability has given Fireman’s Fund an opportunity to negotiate with prospective customers. The company is not releasing any revenue expectations for green coverage for 2007, but expects to grow its total real estate book. “Led by the green program, we expect double-digit growth,” Bushnell asserted. For more information Fireman’s Fund: www.firemansfund.com

Ellen Rand is contributing editor to Development.