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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   July 2016

Putting a Price on Green

With competent assessments, borrowers can make the case for the value of energy efficiency

Illustration by Dennis WunschHigh-performance, or green, commercial buildings are consuming an ever-increasing share of the commercial real estate market. Whether these projects come online via retrofits or new construction, this trend makes it increasingly important for borrowers to effectively demonstrate the value of green and energy-efficient features.

Credible appraisals must be supported by market data and information, and in the case of high-performance properties, this includes information on the property that helps explain why it stands out from similar conventionally built properties. From a risk-management perspective, borrowers can make a strong case to lenders that they would be wise to assess green and energy-efficient building features, and that collateral risks may be reduced if green premiums are being paid in the marketplace.

How green fits in

The four components of value shed light on the worth of high-performance green buildings and should be considered by lenders during the appraisal and underwriting process.

Those components are as follows:

  • Revenue: In many markets, rental premiums are rising in high-performance buildings, as many high-quality commercial tenants are increasingly willing to pay extra for green spaces. For these tenants, leasing green space is an opportunity to demonstrate a commitment to sustainability, attract the best employees and improve productivity. With green on the shopping list of many companies, trophy office buildings in leading U.S. markets are chasing the best tenants and rents by making green investments increasingly common.
  • Occupancy: To demonstrate that green features will result in higher building occupancy, prospective borrowers should present a detailed analysis of the occupancy benefits to the lender’s underwriter. Savings may be experienced as a result of tenant retention and the corresponding reduction in lost rents, reduced retrofit costs upon releasing of the space, lower vacancy at turnover and improved lease terms.
  • Operating expenses: The most straight forward value proposition for high-performance buildings is lower utility bills — realized from steadily improving energy codes; green-certification requirements such as LEED (Leadership in Energy and Environmental Design) and Energy Star; and well-executed retrofits. The resulting energy savings reduce operating expenses and increase net operating income, which can have positive effects on value.
    Depending on the lease structure, owners may benefit only from common-area energy savings, as tenants often pay only their own utility bills. Regardless of the market, energy cost savings should be a clear indication to a lender that an asset is less risky, as operational savings will enhance an owner’s net operating income, and thus the ability to repay outstanding loans.
  • Risk: Of the four components of value, risks associated with high-performance buildings — and how those risks affect value — tend to elicit the most attention from lenders and underwriters. High-performance buildings can offer protection against changing consumer preferences, increasing energy prices and local green-building ordinances.

In addition, the better market positioning afforded by a green building is more likely to protect the going-out cap rate. Recognizing the relative safety of green assets, one major insurer now offers discounts for high-performance buildings.

Green-building performance and value can show up across the board in quantifiable property metrics and favorable adjustments made during appraisal and underwriting.

Appraisers will reconcile the primary approaches to valuation (income, cost, and sales comparison), assigning relative weights to each based on the quality and quantity of available data. Viewed in the context of an operating statement, green-building performance and value can show up across the board in quantifiable property metrics and favorable adjustments made during appraisal and underwriting.

Navigating the process

Borrowers and lenders can take steps to help ensure that high-performance building features are taken into consideration during the valuation process. Those steps are as follows:

  • Scope of services: Valuing a high-performing asset should typically require an expanded scope of services for the appraisal that accounts for the complexity of high-performance buildings. The party ordering the appraisal can require that green elements are built into the scope of services provided to appraisers bidding on the assignment. The appraiser is the one who develops a scope of work for the appraisal, but the scope-of-services request should be included in the bidding for the assignment.
  • Finding a qualified, experienced appraiser: To establish an accurate value of an energy-efficient building, borrowers and lenders should insist on appraisers who have experience with high-performing assets and local market knowledge. Additionally, it is worthwhile to ask whether the appraiser has received any specialized education on the valuation of sustainable buildings. Later, during the review stage, as the underwriter is analyzing the appraisal, a more detailed review and additional consultations with the owner’s technical consultants may be necessary.
  • Data demands: It is critical that owners provide as much data as possible. Some examples include a market study with comparable properties; energy audits or bills; equipment specifications and monitoring plans; construction or retrofit costs; a pro forma and other due diligence. Information on tenant demand for green features — preferably with a list of tenant-representative contact information — can help as well.
  • Appraiser interview: In this case, the owner tells the story by designating a knowledgeable individual to describe a property’s green attributes to the appraiser. This designee could be an owner, architect or consultant.

• • •

Real estate transactions require credible opinions of value. To produce them, appraisers need as much data as possible. Collaboration between lenders, property owners and appraisers in delivering that information benefits everyone involved in the transaction.


 


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