Keep Your Eye on the Green Prize

As green building standards continue to become mainstream and the industry grows to allow more investments, lenders will need to begin to embrace “green” lending. While preferential treatment to lending on energy efficient buildings has not been popular until recent years, lenders need consider “green” lending opportunities moving forward as the market continues to recover. Understanding these lending practices will help lenders strategically keep their finger on the pulse of continuously evolving green building investment opportunities as demand continues to grow.

For today’s Strategic Brief for commercial real estate lenders, EDR Insight is fortunate to have guest author, Stormie Jason Williamson, founder of RainCity Green Consulting, a Seattle-based consulting company that specializes in LEED developments and green commercial real estate. Williamson is a Washington-state-based real estate broker and a Leadership in Energy and Environmental Design Accredited Professional (LEED AP).

Williamson outlines the recent increase in commercial green building interest, along with increased demand for renovation and retrofitting, and details how lenders can embrace green trends through education and implementation of practices that will allow them to effectively capitalize on new lending opportunities. To help lenders stay abreast of this rapidly-changing area of commercial real estate, EDR Insight is pleased to share Williamson’s intell on why it might be a prudent business strategy for lenders to keep “green” lending practices on their radar screens.

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Author: Stormie Jason Williamson, Founder of RainCity Green Consulting

Commercial mortgage brokers should be well aware of the growing market interest in green construction and renovation. In fact, nonresidential green building has increased dramatically in the past few years — from representing a 2 percent market share in 2007 to 38 percent this past year. And it is projected to reach as much as 48 percent by 2015, according to McGraw-Hill Construction data.

There also has been increased demand for retrofitting and renovating existing buildings, particularly through the rating system of the U.S. Green Building Council (USGBC) Leadership in Energy and Environmental Design (LEED). By 2015, the USGBC expects that the green share of the largest nonresidential retrofit and renovation activity will more than triple, growing between 25 percent and 33 percent of activity by value — a $14 billion to $18 billion opportunity in major construction projects alone.

Despite this interest and the returns perceived by investors and developers of green buildings, commercial lenders have lagged behind in responding to market needs with appropriate financing and refinancing products that specifically cater to green makeovers. As a result, many industry professionals are now pushing for a better understanding of green building and more products that take into account the many advantages a sustainable building has, including improved asset value, better occupancy and healthier cash flow.

Many lenders have taken a traditionally conservative stance on green-building valuations, which has led to much confusion among commercial mortgage brokers as to whether they should be seeking out green projects for loans or dragging their feet. In fact, with the exception of a handful of programs mostly affiliated with the U.S. Department of Housing and Urban Development or the government-sponsored enterprises, large commercial lenders have not yet found a way to support developers who would like to build a green project and simultaneously keep an eye on their shareholder responsibilities. It’s not clear if all of these factors have led to missed opportunities for all involved.

GreenPrize---ImageThe market has been moving in the right direction, however. Although some larger lenders are taking incremental steps toward green-lending advances, the insurance industry seems to be more comfortable in embracing the state-of-the-art systems and high-efficiency designs resulting from green practices, particularly the more-demanding LEED rating system. This is evidenced by the increasing number of insurers awarding these developments with higher ratings.

Some community banks also are beginning to buck the large-lender trend. Their financial innovations may one day change the way lenders value a greener product. For example, community lenders like Houston-based Green Bank, to name just one, have begun lending programs with loan products that favor green development projects. These lenders have loan products that provide advantageous terms like interest-rate discounts, longer amortization periods and even preferential reviews.

Despite the innovations of banks like Green Bank, many community banks still are choosing to stay conservative with regard to green lending. A number of reasons are driving this trend, but two clearly stand out:

  1. There is no universal standard when it comes to measuring the exact benefits of green or LEED-built developments.
  2. Different local and state governments have a varied degree of preferential initiatives and diverse values when it comes to sustainability, green building and LEED.

So, where does all this leave commercial mortgage brokers when it comes to green deals? At least for the time being, they may be treading water.

Undefined rewards

Much of the hesitation to develop green loan products emerges from the lack of sufficient data for many lenders to give special treatment to green projects — despite data from the USGBC and other sources that suggest an increase in net operating income (NOI) because of bottom-line savings in energy costs and increased rents.

There also is much reluctance triggered by the dismal amount of green projects in the multifamily sector, where the majority of commercial loans are being made in today’s market. Many community lenders think that until there is more data out of the large multifamily sector, they simply aren’t going to fight against years of tradition. Although this viewpoint is understandable, this may be exactly the crux of the matter concerning green-loan products: There is a lack of data, which, in turn, leads to an overall lack of education about green projects.

Education

Changing the direction of green lending can be done only through education. Commercial mortgage brokers need not wait for lenders to take the lead on developing green loan products; they can start educating themselves and their lenders on the greatest asset of going green — value. This can be done by providing better understanding of how green systems like solar panels, efficient cooling systems, low-flow faucets and rain-water-capture systems result in a more energy-efficient building and hence in a higher NOI.

Although there may not be enough data about green buildings out there to change the way lenders make loans, there is enough data to prove the value added by going green. The USGBC is a great resource to gather information on green buildings’ performance, improved occupancy rates, higher rents and increased marketability.

In addition, many businesses — from law firms to retailers — are beginning to self-implement corporate-policy directives that they will lease only green space to meet two goals:

  1. Corporate social consciousness and
  2. Higher productivity.

Even if lenders choose not to offer special terms for loans on green projects, commercial mortgage brokers can increase their chances of taking advantage of the green-building movement by having personnel who are informed and educated about green-development practices. It is sensible to assume that developers that have made the choice to build green will be more comfortable doing business with someone who understands their business model and environmental concerns.

Considerations

Commercial mortgage brokers also should bring to lenders’ attention how green projects perform versus non-green, or brown projects. This performance should be linked to the loan’s long-term risks. One of developers’ reasons to build sustainable and energy-efficient buildings is that they will remain attractive into a future that likely includes volatile energy costs and increasing energy-performance mandates. Buildings that do not incorporate sustainability or energy-efficient strategies run the risk of accelerated obsolescence.

This sustainability is an issue to which equity investors likely are most sensitive, because they focus on the asset’s long-term value, occupancy and resale value. It also should be a consideration for lenders, because they stand to benefit from higher marginal occupancies in a down market. For this reason, the argument could be made that commercial mortgage brokers are doing their lender partners a disservice if they don’t recommend green projects for loans.

Although many may argue that green practices or a LEED certification alone is not enough to base a lending decision on, the needs of investors and lenders are not all that different. Investors want a return on their initial investment with a profit. Lenders also want a return on their initial investment (the loan) with a profit (the interest plus principal).

Lenders may be able to take the lead from investors when it comes to changing how they evaluate green-building projects in the future. If so, this will give mortgage brokers the freedom to choose more innovative projects with longer term benefits. If green development does impact the bottom line positively, interest rate-discounts, longer amortization periods or preferential reviews may follow.

Although many green building operators see immediate results in terms of savings, the full spectrum of rewards will be seen in the long run. That is why commercial mortgage brokers must keep an eye on the performance of these properties. Once the commercial real estate sector is out of the woods and stabilized, it will be possible to look back and evaluate how green projects performed in a down market compared to their conventional counterparts.

Green buildings likely will be found to have outperformed conventional ones, and preserved their value in the long term, as corporate expectations change about what kind of space they will lease. Those owners of green and LEED certified buildings are likely to find that their modest upfront investment costs associated with going green paid off.

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Commercial mortgage brokers have a role to play in guiding their clients to see how investments in green building can be a discount for brown rather than a premium for green. By taking this role now, mortgage brokers can be sure to lead the pack. Lenders that capitalize on this existing opportunity also will be among the first to innovate — rather than the many that will eventually play catch up.

Hockey great Wayne Gretzky was once asked how he scored so many goals. “I skate to where the puck is going to be, not where it has been,” Gretzky replied. When it comes to going green, this may be infinite wisdom.

NOTE TO READERS: This article originally appeared in Scotsman Guide’s Commercial Edition, August 2012, and is republished by EDR Insight with permission from the publisher and author.