Doing Well by Doing Good:

Green Office Buildings

Nils Kok UC Berkeley

Maastricht University John M. Quigley

UC Berkeley Piet Eichholtz Maastricht University

San Diego February 2010

Climate change and the built environment The macro and micro economic perspective 1.  Climate change and its consequences are a global (economic) threat

  Carbon emissions and buildings are closely related   At least 30 percent of global greenhouse gas emissions stem from

buildings (construction and subsequent economic life)   Built environment offers largest potential for greenhouse gas abatement

  McKinsey cost abatement curve

2.  Energy costs are single largest expense in provision of office space   30 percent of operating expenses   10 percent of total housing costs   Salience can only increase with rising energy prices

3.  Awareness is growing and the importance of “green building” practices has increased…

Usage of “green building” in the popular press…

…and visitors to the “Greenbuild” conference

What about the importance in the marketplace?Top-25 “green” commercial office markets

The value case for eco-efficiency in real estate Costs versus revenues in ‘green’ buildings A higher initial outlay…

  Not clear how much higher (0 – 20%)   ‘Smarter’ building managers/software

… may be compensated by ‘green’ value drivers   Cost savings

  Energy savings (up to 35%)   Emission reduction

  Increased rents   Reputation effects   Improved indoor air quality

  Increased economic lives, reduced depreciation lower risk (e.g. less variation in occupancy)

  Case studies on the economic implications   Focus often on new buildings, but annual new construction is only

1%-3% of total stock   Results are hard to generalize

This study: economic effects of ‘green’ label U.S. property sector offers laboratory

“Green” buildings Two programs: Energy Star (EPA) and LEED (USGBC)   Dataset of existing sustainable office properties (U.S.)

  EPAs Energy Star for Commercial Buildings (1995)   Efficiency in source energy use is in top quarter relative to CBECS   Standardized for building use (occupancy, hours) and climate   Certified by professional engineer   Based on real energy consumption (at least one year of bills)

  Our sample: 2,759 Energy Star-certified buildings

  USGBCs Leadership in Energy and Environmental Design (1999)   Scoring systems based on 6 components of “sustainability”   Energy efficiency one component   Various systems and versions (eg. NC, EB, O&M, ...)   Based on design stage (and now verified after construction)

  Our sample: 716 LEED-certified buildings

Defining conventional comparables Systematic match on location   Based upon longitude and latitude, we use GIS to identify all

conventional office buildings in a 0.25 mile radius

Example: 401 W A Street, San Diego Energy Star certified (‘01, ‘02, ‘04, ‘08, ‘09), LEED Gold 401 W A St

Columbia Center

This copyrighted report contains research licensed to Maastricht University - 382753.

Example: 50 Hurt Plaza, Atlanta Energy Star certified, LEED Gold

Clusters of green and control buildings Minimum of one control building per cluster

Chicago, IL Houston, TX Columbus, OH

Defining conventional comparables Systematic match on location   Final sample

  Rental sample   1,943 green buildings   21,395 control buildings

  Transaction sample   744 green buildings   6,065 control buildings

  To further control for differences in quality, we estimate a propensity score for each building (Rosenbaum and Rubin, 1983)   Logit model including all hedonic characteristics

Descriptives: green sample vs. control sample Green buildings are larger and younger Propensity score weighting substantially reduces differences

Methodology How to correct for differences in location and quality?   Methodology: standard valuation framework

  Rin is the rent, effective rent or transaction price per sq.ft.

  Xi 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 cn dummies to control for location – 1,943 (744) separate dummies in the rental (transaction) sample

Results: rents, prices, and green ratings Green premium ranges from 2% – 13%

Substantial variation in label increment Expensive location: green label less important

What explains the green premium? Signalling value…or a better building   The variation in the premium for green buildings:

  Energy characteristics of the building   Sustainability characteristics of the buildings   “Label premium”

  For 209 LEED-rated buildings, we have information on:   Registration versus certification   Standardized numerical rating (37 – 100)   Score achieved in six components of LEED evaluation

  For 1,719 Energy Star-rated buildings, we have information on:   Source/site energy consumption   Energy bill   Local climate (heating and cooling degree days)

Detailed information on LEED-rated buildings Standardized indices of buildings’ sustainability

Explaining the premium for LEED rated buildings Certification score is important determinant of rent increment

  LEED-certified, score 40: effective rent of 2 percent higher than otherwise identical, registered building

  LEED-certified, score 60: effective rent of 20 percent higher

Information on Energy Star-rated buildings Emissions of efficient buildings are still substantial…

  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

Explaining the Energy Star increment Energy efficiency is reflected in “green” price increment

  A $1 saving in energy costs is associated with a 4 percent premium in market capitalization

  At the point of means ($245/sq.ft.), this implies a cap rate of 10 percent

Some first conclusions Eco-investment real estate sector is not only ‘doing good’

  Ceteris paribus, green buildings 1.  Have higher rents by 2% 2.  Have higher effective rents by 6% 3.  Have higher selling prices by 13%

  The green increment is systematically related to the underlying characteristics of energy efficiency or “sustainability”   Market seems to be relatively efficient in pricing these aspect

  LEED and Energy Star measure somewhat different aspects of “sustainability” and complement each other

Market dynamics and green buildings (I) 2007 – 2009 was a painful period…

Office rents –30%

Vacancy rate +40%

Unemployment +115%

Market dynamics and green buildings (II) 2007 – 2009 was a painful period…

Office rents –29%

Vacancy rate +50%

Unemployment +111%

But... “green” office space flourished Fraction of certified “green” space in 150 CBSAs

Dynamics of green building Substantial increase in rated space in a contracting economy   We investigate the differences in rental developments in rated space

and otherwise comparable space

  8,182 observations as of September 2007   694 rated buildings and 7,488 nearby control buildings   Rents, occupancy rates, effective rents

  Same sample as of October 2009   Some control buildings were converted to “green” during the sample

period   Developments in rents, occupancy rate, effective rents

The returns to green buildings “Brown-green” is the biggest loser…

Regression results effective rent …controlling for differences in quality and location

€

logRinT − logRinτ[ ] = αT −ατ( ) + βi XiT − Xiτ( ) + δT giT −δT giτ + εinT −εinτ( )

Conclusions and implications “Green” is getting mainstream   Increased awareness of global warming and the role of the real

estate sector have increased attention upon “green building”   Demand-pull is necessary to reduce carbon impact of built environment

  Voluntary labels can help in creating transparency in energy efficiency and sustainability   Energy efficient and sustainable office space is getting mainstream   This may have economic implications for investors, tenants, and

policymakers

  Buildings certified by Energy Star or LEED command higher rents and prices in the marketplace…   The “green premium” has slightly decreased during the crisis

  Private market incorporates signal of energy efficiency and/or sustainability

Global green building certification A label jungle

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Does this evidence hold for Europe as well…? Tentative evidence points in a similar direction

  UK study   BREEAM-labeled offices (1,000 buildings)   IPD financial data   Outcome: 88 matches…

  Institutional property investors have not (yet) embraced BREEAM

  First results   Difficult to control for quality differences   Similar economic implications for rent and value   Cap rates for BREEAM-labeled buildings seem to be lower

  More later this year…

…but what about other labeling systems?

EU Energy Performance of Buildings Directive Originated January 2003, revised December 2009

“Member states shall ensure that, when buildings are constructed, sold or rented out, an energy performance certificate is made available by the owner to the prospective buyer or tenant”

Study value of EPCs in Dutch housing market The “greener” the better…

The EPC seems to be effective: we document a price premium that varies with the label outcome, which is driven for a large part by future energy savings

Questions? Remarks?

kok@haas.berkeley.edu