I met real estate appraiser Tim Runde when we were both speakers at the recent GreenBuildingsNY show at the Javits Center, and I was pleased to learn of his analytical market-based method for establishing the value of green buildings and green improvements to existing buildings. Tim takes the recognition of green building as evidence of a new market force (sustainability) and describes how one can quantify its value impact. He was kind enough to share with me an article that he and Stacey Thoyre wrote for the Journal of Sustainable Real Estate (JOSRE) called "Integrating Sustainability and Green Building into the Appraisal Process." I am briefly summarizing some of the salient points in this blog entry, as well as including a link to the full article below.
Sustainability means many things to many people. Tim and Stacey suggest the following definition of sustainability for applied real estate valuation: "Sustainability is the principal of seeking to avoid, minimize, and/or mitigate adverse current and future social, environmental and economic impacts (externalities)."
The authors emphasize that green buildings and green features are more valuable in areas with sustainable orientations and present a three-step Sustainability Valuation Model that can be used to guide appraisers in valuing real property, both green and brown, now and as market conditions with respect to sustainability change. Such a model can help to (a) identify and measure ways in which sustainability impacts market value, and (b) price the impact.
Assessing the Market Uptake of Sustainability
A not surprising but often overlooked aspect in determining the value of green real estate is location, location, location. The impact of green building on asset value has a direct correlation to whether the market in which it is located is Sustainability-Oriented (SO) or Not Sustainability-Oriented (NSO). Green buildings and green features are worth more in an SO market than in an NSO one. Relating a building's level of greenness to its market's sustainability orientation is important so that the appraiser knows whether to adjust the subject building and its comparables for green (or brown) features.
Key indicators of the degree to which a specific market values and practices sustainable principles include:
- Regulations and incentives, especially at the local level
- Voluntary implementation of green beyond the compliance level by building owners and landlords
- Prevalence of green buildings beyond those that might be mandated (such as government buildings)
- Demand for green buildings by tenants and owner-occupiers
- Active local USGBC chapter and/or other NGO's concerned with sustainable initiatives
- Evidence of community uptake, such as triple waste stream recycling, hybrid cars and farmer's markets
The Green Building Opportunity Index created by Cushman & Wakefield and BetterBricks provides valuable insight into the sustainability orientation of major real estate markets. It focuses on the primary factors that influence successful development, retro-fitting, leasing and sales of investment grade "green" office buildings in the 25 largest U.S. Central Business Districts and compares a market's relative position to its peers in six categories: Office Market Conditions, Investment Outlook, Green Adoption and Implementation, Local Mandates and Incentives, State Energy Initiatives and Green Culture.
Green features that add value in one market might not in another one. Markets can differ in their uptake on specific aspects of sustainable building due to factors such as scarcity of particular resources and differences in operational costs, like utility rates and waste removal. A cutting-edge green building in an SO market might include features that do not increase its asset value, and an otherwise brown building in an NSO market might incorporate certain green features that can increase its assest value.
Assessing the Building
For purposes of valuation, green features must be independently verifiable, and actual results must be consistent with modeled performance. The most commonly occurring categories of green building features are the following:
- Energy Efficiency: Reduction in use of energy, especially non-renewable
- Resource Use Efficiency: Water, materials and waste stream reduction
- Site Efficiency: Location specific characteristics, such as proximity to transit and infill development
- Quality of the Interior Environment: Daylighting, low emitting materials, green cleaning, etc.
Assessing the Risk
Assessing potential risk is an important function of any appraisal. So in addition to the characteristics of the local and the individual building, the appraiser should consider the impact of any specific sustainability-related risks related to Resource Use, Obsolescence, Transparency, Externalities (ROTE) and make any necessary adjustments. ROTE risks like escalating energy costs and materials costs respond to global market forces and will adversely affect all properties, irrespective of the local market's sustainability orientation. Obsolescence risk can arise from outside the local market as well, due to state and federal legislation, and could affect the market by setting a new minimum standard for new construction, thus creating implied obsolescence for the existing building stock.
Valuation of Green Retrofits
Brown buildings in an SO market like New York City risk obsolescence. Tenants and buyers who are unwilling to pay a premium for green might demand a discount for brown. When there is clear evidence that the market is moving in the direction of green, a building might need certain features in order to meet the market standard, and the highest and best use analysis may need to include the financial feasibility of "greening up." The value of green retrofits in an SO market can include differentials in occupancy rates, rental income and sale prices, all of which may present a more compelling argument for green retrofits than the more commonly used method of focusing on ROI and payback periods for such improvements.
Proper Valuation Can be a Moving Target
The sustainability orientation of a market, and the "greenness" of a building's peers, will change over time and require monitoring, along with traditional market fundamentals like supply and demand, occupancy, net absorption, and rent levels. The important difference with sustainability is that the rate of change is rapid and can be sudden and unexpected. Information monitoring can be focused on the "big picture" rather than the primary local market and specific subject property. Examples of larger issues that should be considered are the new real estate sector-specific Global Reporting Initiative reporting requirements and proposed Federal legislation.
For Additional Information
The original article upon which this article is based is in the Journal of Sustainable Real Estate
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