Environmentally sensitive or “green” buildings have become a key component of many development projects in recent years, and the growing popularity of green buildings is driving an area of significant growth in commercial real estate finance. In this article, we will explore the lending community’s reaction to green development, construction and renovation projects.
An increasing number of institutional lenders are developing commercial lending programs that provide access to capital to develop green buildings or to retrofit existing buildings with green upgrades. Developing an expertise in underwriting green projects, valuing the unique nature of such projects and integrating environmental considerations into their traditional lending practices are some of the ways lenders are approaching “green lending.” Some lenders have even lowered the cost of credit to borrowers who are developing green projects.
What is Green Lending? There is no universally-accepted definition of “green lending.” The term “green lending” generally refers to financing the design and construction of green buildings or retrofitting existing buildings to incorporate “green,” or environmentally responsible, features. A so-called green building is a “high performance property that considers and reduces its impact on the environment and human health.”1 Green buildings are typically designed to use less energy and water, minimize waste, utilize renewable resources and, in general, reduce the impact of the physical facility on the environment.2
Valuing Green. The development and implementation of underwriting standards for green buildings represent a significant challenge for lenders financing green projects. Originators and underwriters, as well as those real estate professionals who contribute to the underwriting process, such as appraisers and insurance consultants, consider the unique features of green buildings in order to attribute value accurately in the context of a financing. For projects with an associated cost premium for green features, a borrower may be best-served working with a lender that has green building expertise and therefore is more likely to acknowledge the value which the green features contribute to the building and incorporate the higher values of such features into the overall value of the building. This higher attributed value may support higher construction costs, in which case, the lender may be in a position to approve increased loan amounts to the developer or owner. Conversely, a lender that is not focused on the economics of green buildings may effectively discount the value of a green building by applying standard market averages for rents, occupancies, expenses and values in its analysis, thus effectively giving the green project’s value a “haircut” and lowering loan amounts.3 We think it is a safe bet that, in the not too distant future, most, if not all, major lenders will focus on the effect of a green project on property value and related cost factors.
There are national, regional and local rating standards available to lenders for the evaluation of a green building. The most widely used set of standards is known as Leadership in Energy and Environmental Design (LEED), which was promulgated in 1999 by the U.S. Green Building Council, a non-profit organization based in Washington, D.C. The LEED rating system is voluntary, consensus- based, and assigns points for meeting certain objective, green standards. The particular level of LEED certification achieved is determined by the total number of LEED points accumulated. Basic certification under the LEED system is known as “Certified,” and as a project accumulates further LEED points, the certification is elevated to “Silver,” then “Gold,” and ultimately, “Platinum.”4 The LEED rating system attempts to address all major factors influencing the sustainability of a building,5 and the list of issues addressed varies by type of construction.6 Other standards, such as Green Globes,7 are available to assist lenders in evaluating a green building. Many cities across the country have green building mandates. Although such requirements and related programs differ somewhat, many have settled upon the LEED rating process as their standard.8
Although many lenders, most notably community and boutique banks, rely to a significant extent on rating standards, such as LEED, to evaluate the degree to which a project qualifies as a green, or “sustainable,” project, they generally still consider the individual factors underlying a LEED certification in order to value the property and size the mortgage loan. Some national banks have developed in-house expertise to analyze the green attributes of a building rather than relying exclusively on third party ratings. An example is Wells Fargo Bank. Paul Brumbaum, Senior Vice President in environmental finance at Wells Fargo, notes that although the bank is very supportive of LEED and considers it an important benchmark, the bank does not rely heavily on a LEED or other third party rating when it comes to underwriting a mortgage loan. Instead, it looks behind the rating to determine what factors went into earning the rating and attributes value accordingly.
Green Banks. There are a growing number of banks, typically community and boutique banks, specializing in financing so-called “sustainable,” or green, projects. These niche banks, including, among others, Green Bank (Houston, Texas); New Resource Bank (San Francisco, California); One Earth Bank (Austin, Texas); and ShoreBank Pacific (Ilwaco, Washington), are committed to promoting and supporting green initiatives by seeking out green projects and offering financial incentives to borrowers, possibly including discounted interest rates and higher loan-to-value ratios. CEO David C.E. Williams of ShoreBank Pacific, which represents that it has an on-staff scientist to help clients increase energy-efficiency and utilize renewable resources, summarizes the bank’s philosophy and values as follows: “Making the commitment to green building translates into long-term economic and social benefits— from reduced operation costs to improved occupant productivity —that we believe are worth funding.”9
One newly-formed banking organization, e3bank, is a self-proclaimed green bank headquartered in San Francisco. Sandy Wiggins, Chairman and co-founder of e3bank, and the immediate past Chairman of the U.S. Green Building Council, and fellow co-founder, President and CEO, Frank J. Baldassarre, Jr., propose that social responsibility and economic success do not have to be mutually exclusive. According to Wiggins, the bank intends to offer its customers an incremental discount in their interest rate which is tied to each step up in the particular project’s LEED certification rating, both at the initial closing and during the term of the loan.
Some national banks have either developed green lending programs or announced commitments to do so. For example, in 2005, Wells Fargo announced its commitment to green building and has provided more than $2 billion in financing for building projects that are designed to earn LEED certification.10 Likewise, Bank of America announced in 2007 that it would commit a portion of an $18 billion environmentally sensitive and innovative program for new products, services and technologies to financing real estate projects with LEED certification.11 The creation of high-profile green lending programs at national banks provides an important credibility boost to this relatively new industry.
In-house expertise at banks with sophisticated green lending programs is charged with recognizing and capturing the value of green building features during the underwriting process and, ultimately, tailoring the loan to the correct amount. While the financing terms and underwriting process at these banks are not significantly different from that which is available in conventional, non-green financed projects, according to Marc Heisterkamp of the U.S. Green Building Council, “their models can and should capture the benefit [of green features] and possibly result in better financial terms for the borrower.”12
The Business Case. The business case for financing green projects will include a wide variety of benefits associated with green buildings including the positive economic effect, the aspirational productivity boost to the building’s occupants, and the positive impact on risk management, health of the occupants, public relations, marketing based on environmental responsibility, recruitment with respect to environmentally conscious employees and retention of appreciative inhabitants of the project.13 However, the success of green lending will ultimately rely on its profitability. Many supporters of green lending argue that green buildings are more valuable than their non-green counterparts, all other factors being equal. This claimed increase in value is attributed, at least in part, to the proposition that green buildings will generate greater consumer demand and command higher appraised values, higher sales prices, greater occupancy and higher rents.14 These assertions are supported by the results of a recent survey of executives commissioned by Turner Construction Company showing that (a) roughly 75 percent of the executives said green buildings have higher building values than similar non-green buildings, (b) roughly 65 percent of the executives said such green buildings command higher asking rents, and (c) roughly 50 percent of the executives said green buildings provide a greater return on investment and higher occupancy rates.15 It remains to be seen whether these observations will be sustained by market data.
Just a few short years ago, the premium associated with the construction of LEED certified buildings was prohibitive, making the financing of these projects difficult to secure. More recently, with advances in technology and pressure from and on end users to reduce production costs, this construction premium is shrinking. According to Michael Dean, Chief Sustainability Officer of Turner Construction Company, green buildings should not necessarily cost more than their non-green counterparts. Dean approximates that, typically, LEED Silver can be achieved with a 0-2 percent construction premium over comparable non-green buildings, whereas LEED Gold can carry a 1-4 percent construction premium over comparable non-green buildings. New projects, according to Dean, are demonstrating that certain of the benefits of green building systems can be achieved without significant (or any) increase in construction costs.
The increasing support for green building practices at the federal, state and local levels of government is another factor which augments the business case for green lending.16 In recent years, federal and several state governments have enacted legislation providing tax benefits for the development of green buildings.17 For example, the federal Energy Improvement and Extension Act of 2008 extended for five years the provision allowing immediate deduction (rather than capitalization) of the cost of qualifying energysaving improvements to commercial buildings.18 Maryland allows counties and municipal corporations to grant certain property tax credits to buildings that have LEED certification.19 New York State’s Green Building Tax Credit, enacted in 2000, allows developers who meet certain eligibility criteria to claim a credit on their state tax bills of up to $3.75 per square foot for certain tenant space work and $7.50 per square foot for certain base building work for constructing green buildings.20 Oregon provides a Business Energy Tax Credit based upon the building’s size and its LEED rating.21 In order to qualify for the credit a building must receive at least a Silver rating. A LEED Platinum rated building with an area in excess of 50,000 square feet can expect to receive a tax credit of up to $4 per square foot for certain core and shell work, while a LEED Gold rated building with an area in excess of 50,000 square feet can expect to receive up to $2 per square foot for such work. Nevada rewards developers with a property tax abatement of up to 25 percent per year for LEED Silver rated buildings, 30 percent per year for LEED Gold rated buildings, and 35 percent per year for LEED Platinum rated buildings.22 As a result, a large number of projects in Nevada are pursuing LEED certifications.
Many state and local governments support green building practices by reducing the time and expense of the permitting process or mandating that new buildings and renovations are either LEED certified or certifiable. For example, San Francisco provides expedited permit review for projects committing to LEED Gold or Platinum Certification, and Chicago’s “green projects administrator” allows certain green projects to receive priority processing.23 Other localities, such as Gainesville, Florida and Mecklenburg County, North Carolina reward developers of certain green projects with reduced or, in certain cases, waived permitting fees.24 In Massachusetts, an Executive Order put the Governor’s authority behind The Commonwealth’s Green Building standard—Mass. LEED Plus; the Order requires that all new state buildings larger than 20,000 square feet must be LEED certified and have 20 percent better energy performance than current standards.25 And Massachusetts is not alone. In San Francisco, an ordinance amending the building code was passed in 2008 which requires that certain new buildings and renovations, including residential and commercial buildings of various sizes, but excluding laboratory space, be LEED certifiable or LEED certified, depending on the size and use of building.26 Under the San Francisco ordinance, owners of new large commercial buildings (25,000 or more square feet or which meet the definition of a “high-rise” under the building code) must submit documentation, along with their permit applications, relating to achieving a LEED Gold rating by January 1, 2012.27 According to Jerry Yudelson, author of The Green Building Revolution and founder and principal of Yudelson Associates, a consulting firm dedicated to the growth of the green building business, 900 mayors have signed the U.S. Conference of Mayors Climate Change Commitment to build green within their own cities.28
This recent confluence of new governmental laws and regulations29 encouraging or requiring LEED certified construction will likely result in an increase in green building construction and renovation in the coming years, which, in turn, should create significant new opportunities for the lending community. Lenders underwriting green projects may attribute value to such projects as a result of these laws and regulations. For instance, expedited permitting or special permit assistance may help to facilitate on-time projects, thereby reducing the exposure to the project’s lender.
Looking Forward. Green lending appears to be on an upward trajectory. The approximate $12 billion in green construction projects built in 2008 is predicted to balloon to $60 billion in 2010.30 At the end of 2007, there were fewer than 100 LEED EB (existing building)-certified buildings in the United States.31 That number is expected to increase to approximately 12,000 by the end of 2010.32 The question remains, as the momentum for green building mounts: will lenders stay ahead of the curve, or will they be playing catch-up?
Some industry insiders speculate that green projects will not be as hard hit in today’s harsh lending environment as non-green projects. Glenn Fydenkevez, President of MasterPlan Capital LLC, a privately held commercial investment bank, goes so far as to say, “I can attest to the fact that developers who choose designs that are not green will find it very difficult to raise capital or secure loan approvals for their projects. …[I]n the midst of [this] severe liquidity crisis, construction money is in short supply. Lenders are giving priority to green development...”33
While new building starts remain low, it appears that the recent credit crisis has not significantly dampened enthusiasm for green construction. In a 2008 survey of 754 executives, conducted in August through September, by Bayer Consulting for Turner Construction Company,34 executives were asked whether they agreed or disagreed that recent developments in the credit markets would make their company and its clients “less likely to construct buildings with green features.” Only one-quarter of these executives agreed that the credit crisis would discourage their company and its clients from building green. This is good news for the green lending industry where support for green projects translates into opportunity for the green lending programs. According to Yudelson, green building enjoyed 80 percent growth in 2008 and this growth is expected to continue. Furthermore, public and private financial support of banks with green lending programs remains strong during these uncertain economic times. For instance, San Francisco-based New Resource Bank, one of the nation’s first banks established for the purpose of financing green projects, received a $10 million deposit from the State of California in the Fall of 2007, and in the Fall of 2008 was able to raise nearly $14 million in its second stock offering.35
Conclusion. The approach to green lending by publicly-traded banks will undoubtedly be influenced by their responsibility to shareholders. Lenders’ efforts to incorporate social responsibility into their lending practices are and will be coordinated with the obligation to maximize profits for shareholders. Over time, green lending programs with financial incentives will undoubtedly be shown to be economically viable.
There is no doubt that developers, owners, investors and lenders are becoming more focused on green construction and lending. “Five years ago,” according to Ron Hubert, a researcher at the Center for Sustainable Environments at North Arizona University, “you had to justify why you were building green. These days, you have to justify why you’re not.” The industry as a whole is evolving and, as construction costs come down and political pressure and social momentum increase, the case for going green gains strength. Additionally, as both the government and private companies begin to establish requirements for LEED certified or other “green” facilities, green building will continue to gain traction, thus expanding the volume of opportunity for green lenders. Before long, “green” may very well become a new standard for commercial real estate finance.