The Practical Side of Sustainability – (Part One)

Many professionals tout sustainability and “green” practices as being here and now.  LEED building certifications seem to gain a lot of press these days, and architects and engineers line up to become LEED-certified professionals.  Webinars, seminars, publications abound with the latest information about green lease provisions, green construction terms, etc.  This author receives, almost daily, emails and flyers with notifications of upcoming events and publications which feature green topics.  But in reality, the number of green/sustainable buildings is relatively very small and not growing at a significant rate.   The U.S. Green Building Council (www.usgbc.org) estimates that 2% of all new building construction projects receive LEED certification.  While there are many good reasons to go green, in the real world – the one in which we all live – there are significant practical reasons why building sustainability is stalling.

Recently, we met with Scott Renaud, a Principal with CNL Commercial Real Estate in Orlando (http://www.cnl.com/commercial), to discuss why sustainability has not caught on faster in the world of commercial leasing, particularly office buildings.  Scott lives, breathes and works in the real world, where tenants negotiate hard for the best price per square foot, where leasable space is plentiful and competition is fierce, and where economic pressure has already squeezed out any opportunity for savings with respect to building operation.  Scott’s company currently manages more than 2.5 million square feet of leasable space, and they employ some of the absolute best tenant brokers in the business.  In short, Scott knows what he is talking about.

When asked why the green/sustainability movement has not caught on in the commercial office world, Scott points to two significant reasons.  In Part One of this post, we’ll discuss his first reason: the need for “green” space simply doesn’t exist yet.  Renaud estimates that the overall demand for “green” space currently represents much less than 20% of the entire commercial leasing market.  He explains that, in big cities like New York City, Chicago and San Francisco (let’s call them “Tier 1 Cities”), there is a greater demand by tenants for sustainable space than there might be in smaller cities such as Orlando, St. Louis, and Phoenix (let’s call them “Tier 2 Cities”).  Why?  Well, the Tier 1 Cities are home to more Fortune 50 companies, many of which have already adopted green and sustainability directives as part of their public relations and marketing efforts.  An example of one such project is the recent “green” renovation of the Empire State Building (Reported in The New York Times: “How to Get Prompt Payback From an Aging Icon That Guzzles Energy” – August 24, 2010).  Consequently, these tenants may be willing to pay more than they would otherwise pay for space, but they also have great negotiating power to move the price point down.  Those tenants aren’t as plentiful in Tier 2 Cities (or the even smaller cities) where most of us live, and where the vast majority of commercial office space is located.  In Tier 2 Cities, tenants are just looking for the best deal, the best price, the most concessions, etc.

Scott says that in the typical market, commercial leasing is driven by a handful of very good tenant brokers who have a reputation for negotiating the absolute best economic deal for their clients.  Tenant brokers are the “driving force” in any leasing market.  They may not be well-versed in the benefits of sustainable space, but they do perceive (and many have discovered) that LEED-certified buildings have a higher per square foot lease rate than their non-LEED counterparts.  When faced with a choice of recommending space in a LEED certified building or cheaper space in another (non-LEED) building, there is no debate – the tenant broker will understandably recommend the cheaper space every time.

Building retrofits present even more unsolved variables to the commercial lease equation.  Consider the owner of a 30 year old office building who is considering a “green” retrofit.  Running the math, the owner figures that his company can recover the entire retrofit expense in three years.  So the retrofit is a no-brainer, right?  Well, there are a few problems.  First, where will the money come from?  Obviously, his tenants aren’t going to cough up the funds in the form of higher rent, even though they may benefit from future reduced energy costs.  Most commercial leases don’t have provisions that require tenants to pay for capital improvements to the landlord’s building.  Secondly, it is unlikely that the owner will convince a bank to loan the money, given lenders’ general desire to avoid real estate security, and further, their lack of knowledge in underwriting “retrofit” loans.    Lastly, in order for the owner to pay for the retrofit himself, his company will not only have to fork out the cash, but will also have to record a present expense on their balance sheet, resulting in a worse current economic year, even if there is a long term payoff.  For those owner companies that have to answer to investors each quarter, that’s a bad, if counterintuitive, result.

Another obstacle to sustainability is, well, ignorance.  Utility companies often offer free or low-cost energy savings analyses, conversion of lighting fixtures, etc., where the utility company offers rebates or, in some cases, permits payback through energy savings (see, e.g. the “Commercial Rebates” section from the Orlando Utilities Commission website).  Renaud pointed to one example of his own, where the local power company installed energy saving lighting in a parking garage which he manages, resulting in a savings of more than $50,000 per year in utility cost to his client.  The project was “financed” by the utility company over a period of a couple years, without capital outlay by the owner.  So why don’t more owners do the same?  Renaud replies, “because most building managers are simply not aware of these incentive programs, nor are they educated on green concepts in general.”  Renaud points to other commercial office buildings in his home town of Orlando, whose owners could vastly improve both the economics and the attractiveness of their holdings, if they only would take advantage of free or low-cost incentives from the utility companies that are “there for the taking”.

So, while there currently exists a number of practical obstacles to sustainable building, some of them are solvable, at least with education and perhaps a better economic market.  But in the current “practical” world in which we live, sustainability has a long way to go.

Scott Renaud oversees asset management services for CNL Commercial Real Estate and brings over 15 years of veteran experience to the team.  Prior to joining CNL, Scott worked for 8 years at Trammell Crow Company, where he had overseen more than 20 million square feet of property.  Previously, Scott served as Controller with Grubb & Ellis in St. Louis, Missiouri, where he oversaw the $90 million renovation of Chase Park Plaza.  He is a Member of CoreNet Global and the United States Green Building Council.  Scott will be a panelist at the 16th Annual FSU Real Estate Trends Networking Conference on November 4-5, 2010 in Tallahassee, Florida, speaking on the topic of “True Sustainability – Creating Value Through Performance” (http://www.fsurealestate.com).

Dale A. Burket is a Florida attorney who is Board Certified in Real Estate by The Florida Bar.  He is a partner with Lowndes Drosdick Doster Kantor & Reed, P.A. (www.lowndes-law.com) in Orlando, Florida.

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Dale Burket is a partner in the Real Estate Transactions, Development and Finance Commercial Leasing, and Environmental Law practices. With over 29 years of experience, Dale focuses his real estate legal practice on multi-site, multi-jurisdictional real estate acquisitions, dispositions, leasing and financing and large, multi-site and multi-state real estate transactions. His hospitality practice concentrates on restaurant leases and financing arrangements. Dale has also represented Real Estate Investment Trusts (REITs) in connections with mergers, securitizations, purchase of income producing properties, and sales of properties by taxable REIT subsidiaries. Dale is Board Certified in Real Estate Law by the Florida Bar Board of Legal Specialization and Education. He has represented local, regional, and national clients in commercial real estate transactions, including CNL Financial Group, Inc., JDS Holdings, LLC., and Northland, A Church Distributed Inc. Dale has also handled purchase and sale transactions in excess of $100 Million, handled real estate aspects of a corporate merger involving more than 2,000 properties, and closed senior credit facilities on behalf of the borrower in excess of $50 Million.

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