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REITs lead in mainstreaming green building

By Susan Persin, managing director, Trepp
Green building has become more widespread as people recognize that the positive financial implications of “going green” extend beyond environmental stewardship.

During the recession, demand for green buildings stayed strong. Many large corporations have sustainability initiatives that lead them to favor green buildings. Additionally, green-lease policies have been adopted by federal, state, and local governments in the United States and internationally.

The lower operating costs associated with energy efficient green buildings are attractive to both investors and tenants.
Government regulation, which can affect anything from preferential treatment for entitlements to requirements to disclose information about building efficiency, provides further incentive for green building.

REITs and other large institutional owners are at the forefront of the movement toward green buildings.

Academics have had some success quantifying the extent to which commercial properties with LEED or Energy Star certification outperform conventional buildings. These buildings achieve higher rents and sales prices and have lower operating expenses.

A 2010 study called “The Economics of Green Buildings” analyzed the significance of green building trends on the commercial office market and noted lower utility bills and higher employee productivity, as well as higher rents and sales prices.

The study also noted a significant increase in EnergyStar and LEED certified buildings even during the 2007 to 2009 economic downturn.

Additionally, a 2012 University of Notre Dame study that focused on PNC bank branches found that businesses perform better when operating in LEED rated buildings.

In an effort to quantify the impact of green buildings, NAREIT, the FTSE Group, and the U.S. Green Building Council announced last November the joint development of a Green Property Index that will enable investment in REITs based on objective sustainability rankings.

The family of green property indexes will be based on the FTSE NAREIT Index Series, using data from the U.S. Green Building Council. The new indices will help rate these REITs according to how green their overall portfolios really are.

The indices will enable REITs to target specific green property types, and help analysts and investors compare REITs based on objective sustainability rankings.
Brad Case, senior vice president, Research and Industry Information at NAREIT, recently confirmed that work on the new indices is ongoing as they try to make it representative of all green commercial real estate, without overweighing any particular sector.

The indices could help REITs attract some of the growing pool of socially responsible investment money slated for green investments.

Most REITs have green buildings in their portfolios, and have moved toward green building for new construction. REITs have been slower to take on large-scale retrofit projects because they disrupt existing tenants and revenue flows.

They can also be expensive (e.g., existing roofs may not support the weight of solar panels) and difficult to finance. The adoption of green building is occurring among REITs in all real estate property sectors.

Office REITs have been leaders in adding sustainability options to their properties; because many tenants demand green buildings, they are a competitive advantage for office owners. Owners also benefit from cost savings, because many office leases include expenses like utilities and janitorial.

Prologis, the largest industrial REIT, is also a leader on sustainability with a program called Green Path.  Among its green measures are solar rooftops on large warehouse buildings.

Retail REITs are also increasingly adopting sustainability platforms that include measures to increase energy efficiency, as well as to reduce landscaping irrigation costs. Because most of their expenses are passed onto tenants that have NNN leases and because they have limited input in the design of stores, retail owners have less incentive and ability to make their properties green.

However, larger retailers like WalMart are pushing retail REITs toward greater sustainability.

Healthcare REITs have been among the most active sectors undertaking green initiatives, seeing an advantage in reducing the high cost of operating health care-related facilities.

The ongoing importance of green building to both building owners and tenants through the recession indicates that the movement has become ingrained in the way businesses operate. The movement faces challenges, such as defining what makes a building green, how to make existing properties more green, and how to incentivize building owners and tenants to adopt sustainability measures.

REITs will continue to play an important role in the widespread adoption of green building measures, which benefits REIT investors, as well as the environment.

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