Studium Generale, October Piet Eichholtz Maastricht University Sustainable Buildings: Performance, Users, Investors

“Green” building in the marketplace? Top-10 “green” commercial office markets

Commercial property and “green” investments Industry can play crucial role in reducing carbon emissions Property industry consumes resources and pollutes 40% of global consumption raw materials (even 55% of wood) At least 30% of global CO2 emissions Energy represents 7–9% of total occupancy cost Many energy-efficiency investments in property have positive net present value … Better insulation, technology, and building management all create shareholder value at current energy prices (McKinsey, 2009) First evidence shows very high IRR’s for energy investments Academic studies show indirect returns on “green” or energy efficiency … so “green” property investments often do not conflict with financial goals of (institutional) investors

Do we still see economic effects of green labels? Investment dynamics and the source of green increments Sample of 28,000 office buildings (2009 cross section), 3,000 of which are certified by EPA or USGBC 1.New evidence on the economic premium for green office buildings  Rigorous control for quality differences (PSM)  Label vintage 2.Identify the sources of rent and value increments  Explicit link to leading building-level sustainability labels  LEED and Energy Star

How do we measure greenness? LEED and Energy Star  LEED  The program has been initiated by the US Green Building Council (USGBC).  LEED covers six different components of sustainability, including energy performance and material selection.  Lower operating costs and healthier and safer working environments for occupants.  Energy Star  Founded in 1992 by the U.S. Environment Protection Agency (EPA) and the U.S. Department of Energy (DOE).  Energy star evaluates the efficiency of buildings‘ energy use with respect to a base building of similar size and quality.  35 percent less energy consumption and 35 percent less carbon dioxide emission than average uncertified building.

Example: 101 California St, San Francisco Energy Star certified, LEED Gold

Methodology How to further correct for differences in location and quality? Standard real estate valuation framework  R in is the rent, effective rent, or transaction price per sq.ft.  X i is a vector of hedonic characteristics  Size, age, renovation, class, amenities, public transport, …  Percent change in employment in service sector (CBSA) to control for regional variation in demand for office space  Cluster c n dummies to control for location – 1,943 (744) separate dummies in the rental (transaction) sample  g i = dummy variable if building i has green label  Dummy variables for year of sale in transaction sample

Findings and implications Eco-investment real estate sector is not only “doing good”  Ceteris paribus, green buildings 1.Have higher rents by 2-5% 2.Have higher, and more stable, occupancy 3.Have higher effective rents by 6-7% 4.Have higher selling prices by 11-13%  The average non-green building in the rental sample would be worth $5.6 M more if it were converted to green.  The average non-green building sold in would have been worth $11.1 M more if it had been converted to green.  This suggests that property investors value the lower risk premium inherent in certified commercial office buildings  The missing piece…what are the costs of “greening” properties?

Further regression results There seems to be an optimal LEED rating

Information on Energy Star-rated buildings Emissions are substantial, and energy savings create value  Average emission of a building in our sample: 4,326 tons of CO2  750 cars, 9,000 barrels of oil, …  Energy Star-rated buildings emit at least a quarter less carbon as compared to conventional office buildings  A $1 saving in energy costs is associated with an increase in effective rent of 95 cents  A $1 saving in energy costs is associated with a 4.9 percent premium in market capitalization, which is equivalent to $13/sq.ft.  This implies a cap rate of about 8 percent

Conclusions on building performance LEED and Energy Star labels seem to be complimentary  Effects on rent and value still present despite economic crisis and increased supply of green office space  The green value effects are systematically related to the underlying characteristics of energy efficiency or “sustainability”  Market seems to be relatively efficient in pricing these aspects  LEED and Energy Star measure somewhat different aspects of “sustainability” and complement each other  Low correlation between LEED-score and EUI-score  Low correlation between LEED score and energy consumption

Why would users rent green (and pay more)? Theoretical framework 1. Direct economic benefits  Lower service costs of housing by reduced energy costs  Higher employee productivity 2. Indirect economic benefits: Improved reputation and image  Investors – cost of capital  Employees – labor market  Customers – sales and prices 3. Ethical behavior  “Do the right thing”  Non-profit, government, and governmental organizations

Green space utilization of major tenants Fraction of firm’s office space housed in green buildings

Green space utilization per industry Fraction of office space located in green buildings

And what do property investors do? Portfolio greenness and the financial performance of REITs The aim of the paper is twofold: 1. Identify the green properties owned by Real Estate Investment Trusts (REITs)  The first study that identifies the portfolio greenness of REITs 2. Investigate the effect of portfolio greenness on the financial performance of REITs  Dynamic measure of portfolio greenness  Two channels  Benefits at property level  Benefits from making CSR investments  Causality issues

Green buildings in the portfolios of US REITs increasing number of green properties LEED

Model  We estimate the following set of equations: where i stands for REIT i, and t stands for year t.  Greenness stands for Number of Certified and Sqft of Certified properties for both LEED and Energy Star certifications.  2 instruments in the first stage:  The weighted locational greenness (WLG)  The weighted locational green policy (WLGPL)  Financial Performance stands for ROA, ROE, Funds from Operations (FFO)/Total Revenue, Alpha and Beta

Operating performance – ROA (1)(2)(3)(4) VARIABLESLEED Energy Star Number_Certified 3.42*** 0.90 (Predicted) [1.26] [0.61] Sqft_Certified 3.46* 0.31* (Predicted) [1.78] [0.18] Total Assets -0.33**-0.95**-0.73*-0.73 (in log) [0.15][0.46][0.40][0.45] Price-Book Ratio [0.01] RE Investment Growth 0.01*** 0.01** [0.00] Age 0.06***0.05**0.07***0.06*** (years, in log) [0.02] [0.01] Year-Fixed EffectsYYYY Property TypeYYYY ConstantYYYY Observations

Operating performance – ROE (1)(2)(3)(4) VARIABLESLEED Energy Star Number_Certified 7.92*** 2.05 (Predicted) [2.99] [1.40] Sqft_Certified 7.39* 0.66* (Predicted) [3.83] [0.35] Total Assets (in log) [0.53][0.72][1.02][0.62] Price-Book Ratio [0.03] RE Investment Growth 0.02***0.03***0.04***0.03*** [0.01] Age 0.09* **0.08** (years, in log) [0.05][0.06][0.04] Year-Fixed EffectsYYYY Property TypeYYYY ConstantYYYY Observations

Stock performance – Alpha (1)(2)(3)(4) VARIABLESLEED Energy Star Number_Certified (Predicted) [0.095] [0.028] Sqft_Certified (Predicted) [0.144] [0.010] Total Assets *-0.046*-0.049*-0.035** (in log) [0.012][0.027][0.026][0.017] Price-Book Ratio **0.001*0.001** [0.000] [0.001] RE Investment Growth 0.001*** [0.000] Age (years, in log) [0.001][0.002][0.001] Year-Fixed EffectsYYYY Property TypeYYYY ConstantYYYY Observations

Stock performance – Beta (1)(2)(3)(4) VARIABLESLEED Energy Star Number_Certified ** * (Predicted) [0.063] [0.019] Sqft_Certified ** (Predicted) [0.111] [0.006] Total Assets 0.194***0.207***0.217***0.189*** (in log) [0.009][0.019][0.018][0.009] Price-Book Ratio **-0.001*** [0.000] RE Investment Growth 0.000*** *** [0.000] Age (years, in log) [0.001][0.002][0.001] Year-Fixed EffectsYYYY Property TypeYYYY ConstantYYYY Observations

Main Findings  1% and 6% of the REIT property portfolios are green-certified in 2010 for LEED and Energy Star, respectively.  Portfolio greenness enhances operating performance proxied by ROA, ROE and FFO/Total Revenue.  Different from analysis of financial performance of green properties, these measures are net of costs.  No effect of greenness on abnormal stock returns, indicating that market already corrects for portfolio greenness.  Portfolio greenness decreases market risk.  More, and more stable, occupancy of green buildings  Green properties less exposed to energy price fluctuations

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