Green Building Regulations: Carrots or Sticks?

Sep 19, 2011, By Susan Piperato, Managing Editor

Are green building regulations providing “carrots” or “sticks” to the commercial real estate sector?

So far this year, the U.S. Green Building Council (USGBC) has tracked more than 400 pieces of state legislation across the country and counted 30 “wins” for green building in 22 states.

But are the regulations incentives that are urging developers to do the right thing? Or are they strictures forcing the hands of owners and developers into doing costly adjustments to their properties?

“What is a win for green building isn’t always a win for the real estate industry,” notes Michael Gottlieb, founder and managing partner of Advanced Green Solutions, a sustainable real estate asset service provider based in Van Nuys, Calif. “Even though analysis shows higher rents occupancy and value for green buildings and lower operating costs.”

According to Gottlieb, the sustainable real estate movement is driven by “cost-benefit analysis and regulation—or carrots and sticks—and the sticks, at least in the minds of many in the real estate industry, outweigh the carrots because the returns of investing in sustainability remain in question due to split incentive, capital costs perception, thin operating margins, market uncertainty, lack of a long-term track record, etc.”

Gottlieb’s comments came during a recent Webinar, “It’s Not Easy Being Green: Sustainable Lessons for Commercial Real Estate,” presented by National Real Estate Investor and Retail Traffic. Other presenters included Bryan Jackson Bryan, founding partner of Allen Matkins Leck Gamble Mallory & Natsis LLP an adjunct professor of green construction at the University of Southern California and Leanne Tobias, the founder and managing principal of Malachite LLC, a green real estate advisory services provider.

Among the federal government’s carrots identified by Gottlieb is the little-known Federal Code Section 179D, which allows deduction of up to $1.80 per square foot for commercial and residential buildings of three stories or more that achieve a 50% reduction in total energy use. It applies to both public agencies and private developers and is currently being rewritten to allow REITs to make better use of it. He also pointed Property Assessed Clean Energy (PACE) programs to fund energy improvements, which have been slowed by opposition from the Federal Housing Finance Agency; and federal incentives, stimulus funds and SBA 504 loans.

Individual states are offering “little financial incentive to meet regulations” to developers aside from California’s CalGreen program, says Gottlieb. In California, ABX13 and ABX14 bills, respectively, streamline the siting and permitting process and offer a clean energy upgrade program to reduce costs for property owners to restore onsite renewable energy technologies. But outside California, “Entitlement benefits for new construction getting underneath the dirt in under five years is a miracle.”

For Gottlieb, there are four sticks:

The Energy Independence and Security Act of 2007 (EISA) established a national goal to achieve zero-net-energy use for all new commercial buildings built after 2025 and to retrofit all pre-2025 buildings to zero-net-energy use by 2050.

The Federal Trade Commission’s new Guides for Environmental Marketing Claims propose tighter standards for environmental claims like “green,” eco-friendly, biodegradable and recyclable.

The 2007 ASHRAE/IESNA Energy Efficiency Standard increases minimum energy-saving potential to 30% and requires states to certify by July 20, 2013 that they have reviewed and updated provisions of their commercial building code for energy efficiency.

And the U.S. Environmental Protection Agency has proposed changes to the way construction contractors manage storm runoff.

Other uncertainties

With “uncertainty coming from Washington” in terms of the economy and the environment, Gottlieb says he sees “Litigation, litigation, litigation” will become green commercial real estate’s new catchphrase. “Green lawsuits are just beginning,” he says, citing a USGBC lawsuit in the works to challenge the claims of LEED benefits.

“Earning carrots is a big concern, but what if a building can’t be certified or loses its certification and has to recertify?” adds Jackson.

In order to minimize the risks of building green, Jackson says there is greater need than ever for developers and property owners to “hire green consultants, measure performance and recommission to protect certification.”

Buildings must be recommissioned regularly, says Jackson, “not just when they’re completed, to make sure they’re really working.” He approves the USGBC’s updated version of LEED, set for 2012, which includes ongoing measuring and “recommission tune-ups.” He cites a school in Oregon that was certified LEED Gold but when checked several years later, “it was actually performing worse than before it was LEED certified.”

The big question, says Jackson, is: “Can developers recapture green and construction costs and make money?”

Some of the benefits of green, such as enhanced health and productivity, lower absenteeism, higher recruitment, and higher test scores for children in green school buildings, are difficult to measure. But several studies conducted between 2003 to 2009 of groups of green commercial buildings ranging in number from 33 to 10,000 show that “there is significant headroom for building green to make economic sense,” says Jackson.

But Tobias says she has already seen a “strong market acceptance with attractive returns and the bulk of technologies in green buildings well understood.”

A study by Piet Eichholtz, Nils Kok and John M. Quigley on sustainability and the dynamics of green building, provides new evidence on the financial performance of green office buildings. The study shows LEED premium direct rental rates for LEED at 5.85% and Energy Star buildings at 2.1%; effective rental rates at 5.9% for LEED and 6.6% for Energy Star; and sales prices at 11.1 for LEED and 13.0 for Energy Star.

“In all markets, in respect to average rent per square foot, energy efficient buildings have performed slightly better than conventional,” Tobias says. “Generally speaking, green buildings are outperforming conventional buildings with regard to rental rates.”

In a February 2011 global study conducted by Jones Lang LaSalle and Corenet, 50% of officers from commercial real estate companies said they would pay a premium for green even without energy cost savings and an additional 23% said they would pay a premium if the rental premium were offset by energy cost reductions.

“In this market, that is a significant advantage,” Tobias says.

Despite the Energy EISA being “somewhat of stick,” Tobias sees it as “also a very vibrant program that covers 75% of a 1.9 billion-square-foot federal domestic portfolio that mandates 30% energy reduction by 2015 which is premised on combining energy conservation measurements to provide positive return outcomes and continue implementing programs for continuous improvement.”

As of August 2011, there is data to show that green real estate and energy-efficiency projects are performing well in the marketplace. “The best national study speaks to the green and energy-efficient asset class as whole,” Tobias says. “And $1 saved in energy cost equals an average of $13 in increased valuation with an 8% cap.”