Thursday, December 3, 2009

Return on Investment for Green / LEED projects

Above: PNC Bank Headquarters in Washington, D.C. slated to be completed in 2010. The Gensler designed building is currently aiming for LEED-NC Platinum rating. Copyright: Gensler and PNC Bank

By Ed LeBard, Associate AIA | LEED AP

Green development is becoming more business-savvy. Many developers and building owners consider it a smart business decision to invest a down payment of 1 to 2 percent of project cost to lock down long-term savings. It is based on a framework of several rewards and benefits but the two most obvious benefits are long-term financial savings and returns on investments (ROI). Keep in mind that benefits and rewards for constructing green/LEED buildings vary by type of ownership, type of use, owner's and project team's level of investment and the team's drive to build a sustainable building.

Regardless of variations, according to the U.S. Green Building Council (USGBC), projects that achieved LEED and Energy Star status normally garner an internal rate of return of 20% or more. This is achieved by increased annual energy savings (think of rising oil and natural gas prices for the foreseeable future). Many more LEED buildings are specified to use 30 to 50 percent less water and energy use than current codes.

For instance, compare a 100,000 square foot LEED building that saves $1.50 per square foot in energy costs to a similar building built to code - resulting in savings of $150,000 per year. In order to get $1.50 in energy savings, the building owner had to invest $400,000 on green / LEED related items; in other words, put down a $4.00 per square foot premium. As a result, it would take a little over 2.5 years to receive your investment back and then some.

In the world of commercial real estate, commercial properties are normally valued as a multiple of "net operating income", which is determined by dividing the income by the capitalization rate of roughly 6 percent. Capitalization rate is expressed as a percentage - similar to corporate bonds. If the building reduced annual energy and water costs by $150,000, the capitalized rate of 6 percent would result in an incremental increase of property value by $150,000 divided by 6% = $2.5 million.

The result of investing $400,000 in annual savings of $150,000 would be to yield a return on investment of 625% - more than a "six-bagger" in the investing world!

Another way of looking at it, would be to give the 100,000 square foot building costs of $275 per square foot (industry average is between $150 to $300 per square foot). Multiply $275 per square foot by 100,000 square feet and you end up with $27.5 million in overall construction costs. The savings of $150,000 may appear diminutive compared to the cost of $27.5 million to build the project - but it's a savings nevertheless.

As previously stated, with the going rate of roughly 6 percent annual capitalization rate, the green / LEED investments made by the owner and project team would add $2.5 million to the value of the building ($150,000 savings divided by 6% rate) - an increase of $25.00 per square foot compared to a investment of $4.00 per square foot. That's a net increase value of $21.00 per square foot. The value of the LEED project when completed would increase from $27.5 million to $30 million.

In the end, when the building owner or developer arrive at the decision to sell their LEED building on the market, it is the norm for green buildings to command 30% premium price over similar non-LEED buildings due to the economic benefits they offer. It's a matter of time before Class A office buildings that do not attain LEED certification see their property value decline as LEED is becoming the de facto benchmark in measuring quality in construction. This is an example of true value of green/LEED buildings by long-term savings and solid returns on investments. Indeed, less is more.

Citations: U.S. Green Building Council, Making the Business Case for High-Performance Green Buildings (Washington, D.C.: U.S. Green Building Council, 2002); Green Building Through Integrated Design (Jerry Yudelson, Green Source / McGraw-Hill Construction, 2009)

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