The Case for More Energy Efficiency in Commercial Real Estate

Nobody embodies ‘you’ve got to spend money to make money’ quite like LEED.”

By Eduard Batash

Why go Green?

     Commercial Real Estate development, investment, and management firms have strong incentives to encourage the expansion and development of the current green-design building market over the next 15-20 years. Although only relevant since 2000, the green design market has expanded rapidly in the last 17 years and has provided green firms with competitive advantages over non-green ones. Energy efficiency is one element of green design that offers immediate benefits such as lower operating expenses, increased cash flows and rental premiums, and higher perceived utility values among consumers. Additionally, because the CRE sector accounts for a large portion of domestic energy consumption, public policy makers may consider prioritizing green development in the combat against climate change.

What is Green Design in CRE?

        The Leadership in Energy & Environmental Design, or LEED, as of 2017, is the most prominent baseline of green building and design standards in the United States CRE market. It is a voluntary, third party green-buildings ratings system developed in 2000 by the U.S. Green Building Council , a non-profit and private membership-based organization. Typical LEED certification processes, or voluntary-eco certifications, require individual firms to model their green building designs around LEED’s criteria, and then compensate LEED for inspection of the firm’s properties. Before 2000, minimal consensus existed among CRE industry experts on a “green building’s” specific features. LEED subsequently, was the first program to create such sets of comprehensive green building design guidelines. Some standard and fundamental LEED criteria for green building sustainable sites include water efficiency, renewable energy and atmosphere efficiency, resources and materials and indoor air quality. Certifications levels of green design are based on correlating points-to-ratings systems.

        According to 2013 data from the U.S Green Building Council,  the rating system had accumulated 44,270 projects and certifications in North America, by far its largest market. From 2000-2007, LEED initially experienced minimal growth in North America relative to its exponential growth in this same market from 2008-2013, and only grossed 5,000 projects and certifications by the end of 2007.  But by 2008 it had finished developing its current core ratings systems such as Operations and Maintenance, Core and Shell and Commercial Interiors, and saw a large spike in registrations and certifications from 2009 onwards. By January 2017, it has accumulated a total of 89,600 commercial projects and certification in North America.

     Projects and certifications have also grown at increasing rates in other parts of the world since 2009. The U.S. Green Building Council reported that Latin America, the Caribbean islands, Middle East, North Africa, Europe and East Asia had each surpassed 1,000 projects and certifications as of May 2013. By January 2017, LEED registrations have accounted for more than 17.1 billion global commercial square feet, and have certified more than 5.5 billion global commercial square feet.

Comparing Energy Consumptions before and after LEED:

      Energy consumption, and subsequent operating energy costs are vital metrics used to determine a commercial building’s value, rent premiums, net operating incomes and cash flows.

     Therefore, the fluctuations in domestic energy usage help reflect CRE firms’ efforts to increase energy efficiency, and are good determinants of the effectiveness of LEED’s overall green building standards. The U.S Energy Information Administration designated the U.S. as the 2nd largest primary energy consumer in the world in base year 2012. U.S. primary energy consumption (non-renewable) amounted to 94.3 quadrillion British Thermal Units, a decrease of 4 quadrillion units from 2000. Additional data from the World Bank indicated that the U.S also concurrently increased its renewable energy consumption as a percentage of total consumption from 5.43% in 2000 to approximately 8% by 2012.

        The most recent Commercial Buildings Energy Consumption Survey also from base year 2012,  quantified total U.S. commercial buildings’ energy consumption at approximately 7 quadrillion British Thermal Units, or 18% of total U.S energy consumption. Food service and hospital buildings were the largest commercial building energy consumers per square foot. Moreover, the two largest overall energy uses in commercial buildings, heating and lighting, amounted to 25% and 10% of total energy uses, respectively. But both these overall energy uses decreased substantially from the last survey in 2003 to the 2012 base year survey. The decrease in energy usage and the increase of renewable energy output during this period was concurrent with the emergence of LEED during the mid 2000’s.

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Benefits to Domestic Firms associated with LEED Design:

        A property’s net operating income represents its cash flow, and is the primary measurement in a property’s valuation and its profitability. The Light House Building Centre Society cited a 2013 survey of 718 American executives from CRE-oriented firms of which, 84%  stated that ongoing operations and maintenance costs were “extremely important” to them as opposed to other factors such as building values, occupancy rates and asking rents. These executives might have been relieved to observe further data from the U.S Green Building Council, which showed that its LEED-certified buildings exhibited 13.6% overall decreases in operating costs for new constructions, and 8.5% decreases overall in operating costs for existing building projects. And it’s due to these lower ongoing maintenance costs that property owners’ net operating income rose in their green buildings.  

     Firms are also hesitant about green design because they fear’ initial investments into sustainable energy projects carry additional risks due to higher construction costs in new developments, and expensive capital expenditures in existing buildings. However, according to a Henely University study, new construction premiums only increased 2% for sustainable designs, while existing constructions did not show consistent patterns of abnormal capital expenditures. LEED buildings, in specific, experienced 6% rent premiums and 31% sales increases primarily due to higher demand among potential tenants and buyers. It is significant to note that the rent and sales premiums were not due to a ‘cost plus basis’ given the above-mentioned insignificant cost premium of building green; rather, were genuinely due to higher market demand for green, LEED buildings.

        Eco-voluntary certifications also have positive effects on commercial real estate’s utility value among consumers. In a 2014 study, Notre Dame University sampled PNC Bank’s 52 LEED-certified branches against the bank’s other 452 non-LEED certified branches throughout the United States with controls for market demographics and facilities’ ages and square footages. The study concluded that the LEED, or “green,” facilities opened more consumer deposits and increased consumer loans at a greater rate than the non-LEED certified facilities.

Where does it all lead to?

     Given commercial buildings sizable impact on U.S’s energy output and the financial incentives firms can expect, future cooperation between local and federal governments, and the CRE sector from now until the mid-2030’s is crucial in curbing CO2 emissions, and establishing a reliable and plausible climate change policy. The federal government may consider further incentivizing green building through subsidies and federal grants to encourage an unintuitive blend of outcomes: more energy efficiency, more corporate profits and less climate change.

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