Citi report on new buildings: the financial story, Part II
21 August 2010
FAVOURITES [REPORTS ]- 3 February 2010 – Following is a second extract from ASX-Listed Office Trusts: Does “Green” Pay? a definitive new study of green buildings by Citigroup Global Markets’ Elaine Prior and Felipe Faria, with Adrian Dark, Laurence Parisi and Jackie Tin.
-Studies Into “Does Green Pay?”
In theory, higher rental income, lower vacancy rates, and lower outgoings (such as energy costs) would combine to yield a positive return on the incremental capital investment needed to build (or refurbish) to “green” standards. Over time, we expect that tenant demand and higher energy prices will combine to increasingly support the economics of “green” buildings.
Various studies have sought to assess the impact of “green” initiatives on returns and valuations. “Green” buildings will tend to be newer buildings, so comparability can be challenging.
At this stage of industry development, actual data is limited. Some studies are based on surveys of attitudes, perceptions, stated intentions, or hypothetical buildings, whilst few studies are based on “hard” market data.
There is the possibility of study bias, since those who conduct such studies, or participate most actively in study surveys, may include the strongest proponents of “green” buildings.
Costs and benefits of new and upgraded green Australian office buildings
A 2007 Davis Langdon Australian-focused study investigated the cost and benefit of new green buildings, with results incorporated into a 2008 presentation. The study looked at incremental cost and benefits of building 5-star and 6-star Green Star, versus 4-star. (Key conclusions are shown in Figure 47 of the report).
The analysis indicated that:
- Many measures that contribute to a “green” building are integrated into design, so separate financial assessment is difficult. It indicated that key features are building geometry (form, orientation, passive ventilation strategy, daylight strategy, exposed mass), and that these features are more important to energy/emissions efficiency than façade (such as lighting controls, shading devices, glazing, insulation) and technology (such as solar hot water, combined heat and power, wind, hydro and solar PV) attributes.
- For the Australian market, it estimated extra costs of 0-5 per cent ($98 a sq m) for a 5-star building, compared with 4-star, and 9-11 per cent ($203 a square metre) for 6-star compared with 4-star, based on overseas experience.
- Additional gross annual rental required for an 11 per cent IRR was estimated at $19 a sq m for 5-star, and $40 a sq m for 6-star, both relative to 4-star. However, this increment would be reduced with carbon costs and with re-prioritised (reduced) construction costs.
- After estimating potential productivity gains at 1 per cent or $40 a sq m, the study indicated that a net breakeven (or even positive) result might be achieved. The study concluded that productivity must be considered to achieve reasonable payback.
Industry feedback suggests that building 5-star Green Star is becoming the “norm”, with minimal additional construction costs, but that building 6-star is a bigger step involving extra costs.]
Upgrading Existing Buildings
A 2009 report by ARUP, the Property Council of Australia and Davis Langdon assessed the cost and benefits of various levels of upgrade to existing Grade C office buildings (with pre-upgrade NABERS ratings of 2.0 or 2.5 for energy and water).
While every project will be different, and the results will depend on numerous assumptions, some key conclusions were:
- The best payback was where the upgrade was sufficient to reduce the risk of obsolescence by giving tenants a green office space, and bringing the building up to new-building standard. For the CBD office studied, this resulted in an upgrade cost of $980 a sq m to achieve a Grade B building with NABERS energy and water ratings of 4.5 and 4.0 respectively. Internal rates of returns of 10-11 per cent were estimated, on the basis of rental uplift, lower vacancies and lower utility outgoings, though offset by higher costs of maintenance and building staffing.
- A further upgrade to Grade A had a slightly lower payback, and may have to be evaluated against undertaking a new build entirely.
- Much smaller upgrades that included NABERS energy upgrades to 3.0-3.5 and water to 2.5-3.0 showed much lower IRRs. These would not reposition the asset higher in the market, so the risk of obsolescence remains.
Industry feedback suggests that the financials may be better than indicated in this study, with lower project capex, as plant such as chillers, motors and cooling towers is replaced on an ongoing basis (perhaps every 10-20 years). More efficient plant would naturally be installed as part of this normal capex (capital expenditure) cycle.
“Doing Well by Doing Good?” – US-Based Study on Actual Buildings
A study into the financial performance of green office buildings (Nils Kok, Piet Eichholtz, John Quigley, 2009), covered 694 “green buildings” and a control sample of 7488 buildings across the US. Clusters of buildings within a quarter mile radius were compared. Rents, vacancies and market values were investigated.
The study found:
- an effective “green” rent premium of about 6 per cent
- that the increment in selling price may be as much as 16 per cent, but that the value increment was less in an expensive location
- that the market value incorporates part, but not all, of the energy savings benefits.
It may be difficult to isolate benefits of “green” compared with benefits of newer buildings in general, so we are not clear how definitive these results are.
“Do Green Buildings Make Dollars and Sense?”
Results of a US study by the University of San Diego and CB Richard Ellis were published in November 2009. The study covered 154 buildings under CBRE’s management in ten markets across the US.
The study found that:
- more intensive management of green buildings made overall operating expenses equivalent to non-green buildings, despite lower energy costs
- occupancy rates and rental rates were higher than market
- survey respondents felt that sustainable buildings provide a healthier indoor environment, improved staff retention and improved employee productivity,with fewer sick days
- metrics included 2.88 fewer sick days, a 3.5 per cent lower vacancy rate, and 13 per cent higher rental rates than market.
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