Investing in sustainable technologies and green-building certifications such as LEED and Energy Star can increase a building’s market value, according to Dutch economist and sustainable-property research expert Nils Kok. An associate professor of finance and real estate at Maastricht University in the Netherlands and a visiting scholar at the Goldman School of Public Policy at the University of California at Berkeley, Kok, 30, has spent the past five years researching the microeconomics of energy efficiency and sustainability in the real estate sector. He has co-authored papers such as “Doing Well by Doing Good: Green Office Buildings” (with Piet Eichholtz and John M. Quigley); “The Economics of Green Building” (with Piet Eichholtz and John M. Quigley); and “Supply, Demand, and the Value of Green Buildings” (with Andrea Chegut and Piet Eichholtz). In 2011, he co-founded the Global Real Estate Sustainability Benchmark to track and catalog the environmental performance of property funds around the world.
What motivated you to start this research in 2007?
Energy prices started to rise. Before 2007, when markets were bullish, energy wasn’t really on the radar screen. In 2007, oil prices started to rise at the same time that the brands of LEED and Energy Star started gaining traction, and you saw an increase in the number of certified buildings. I work mostly with institutional real estate investors—managers and owners—and they have always been interested in investing in a way that gets the highest risk-adjusted return. At some point, they said that if we can invest in properties that are more efficient and save on operational costs, then that might be a good proposition. The capital market became curious as to whether good environmental performance would hurt financial performance, would benefit it, or wouldn’t do anything to it.
So simply looking at whether it was worth the up-front investment?
Exactly. Leaving all emotions aside—whether you think there is climate change or that greens are crazy—and just looking at the financial implications of energy-efficient buildings.
As a starting point for our chat, you passed along several charts tracking the rise of square footage of LEED- and Energy Star–certified space from 1995 to 2009 (see figures in the slide show).
You can see this interesting growth in the number of certified buildings. One line is the fraction of certified office stock in terms of buildings, and the other is the fraction in terms of square footage. If you look at the percentages, you see that in some cities, the fraction of LEED- and Energy Star–rated buildings is more than 15 percent. In every major commercial real estate market, you basically see this trend.
When you think about why green buildings are picked up in the market, or why landlords adopt LEED certifications or go for Energy Star for existing buildings, it has to do with a few factors, which I wrote about in “The Diffusion of Energy Efficiency in Buildings” [with Marquise McGraw and John M. Quigley].
One is that investment is driven by the state of the property market. So, if a market is depressed, you don’t see a lot of green buildings because there’s no development, and no existing buildings are transformed because there’s no liquidity in the market. The rental premium that you might be able to obtain is going to be lower. Some people say that even in a depressed market you can set your building apart from others by investing in your building, but that’s easier said than done. In places like Detroit, you see a slower diffusion of retrofitting of the existing stock.
Another factor is energy prices. In areas where energy prices are higher, it would make sense to build more efficiently, as well as in areas where the climate is harsh and you have to heat and cool space more. There are soft factors that determine the rate of energy-efficiency diffusion, but in some cities, you’re now seeing a tipping point, where a very large number of downtown-office tenant spaces are Energy Star or LEED certified. A lot of tenants require certified properties.
When I first started this research in 2007, we scrambled and found about 700 commercial properties, along with their rents and transaction prices, and found premiums for the buildings. During that time, which produced “Doing Well by Doing Good,” you could see these buildings were special and were being recognized by the market. But at the end of 2009, when we did [research for] “The Economics of Green Building,” the situation had changed in many ways. The economy, and the property market, had collapsed. But we still saw growth in both Energy Star and LEED certifications.
At the end of 2009, the premium we had documented earlier remained. To us, that was an indication that there is more to LEED or Energy Star than a warm glow. There are real operational benefits from being in a building, such as lower energy and water costs. At the same time, tenant demand for these buildings holds up. As more tenants go into these buildings, you see other tenants doing the same. It’s first and foremost an efficient building, but with that comes other benefits that are intangible to an economist, such as indoor air quality.
“The Economics of Green Building” focuses specifically on Energy Star– and LEED-certified buildings in the U.S. and how they compare to non-rated properties in the real estate market. What are the main effects on rental and sales prices?
In the second part of the paper, we look at the premiums, and ultimately we found that, yes, there’s a rent premium. We also looked at effective cash flows that take the occupancy rate into account. With this, we found three results. The first is that there’s a rental premium of about 2.5 percent. Second, there’s an effective cash-flow premium of 8 percent. Third, there’s a sales premium of about 13 percent. Ultimately, there is variation in the premium across individual properties. For one building, the premium might be 5 percent, for another it might be 4 percent, and for another there might not be a premium. But, on average, the premium is significant.
Does this apply to LEED-certified buildings or Energy Star–certified buildings individually, or only to buildings that have both certifications?
We found that the rent premium is slightly higher for LEED-certified buildings as compared to Energy Star–certified buildings. But when we look at effective rents, you can see that because some LEED buildings came on the market in 2008 and 2009 (a time when it was most difficult to lease up), the occupancy rates of these properties are not as high. As for sales price, there is no significant difference between Energy Star and LEED.
One more thing we found in 2009 is that the greener the building and the higher the LEED score, the higher the premium up until LEED Gold certification. For LEED Platinum certification, the premium was not higher than that for LEED Gold. This was at the end of 2009, and if you think about it, it makes sense. At that time, to go from Gold to Platinum was an expensive exercise and there probably were not a lot of investors who would go that extra step. Things might have changed.
Some LEED-certified buildings were difficult to lease up in 2008–2009, but so were non-rated buildings. Are there still any advantages to a LEED- or Energy Star–certified building in a recession?
During the recession, there was no change in the performance differences between LEED- and Energy Star–certified buildings on the one hand, and non-certified buildings on the other. Premiums did not go away, but they also didn’t grow. They held stable. To me, that’s a surprise, because at the same time, we saw a massive increase in the number of certified properties coming on the market. So that in itself is an indication that there is still demand for these types of buildings and the demand is not satisfied. We don’t have an oversupply of green buildings yet.
It seems to be becoming more of the norm.
I think that we’re heading toward a situation in some downtown office spaces, where you will have to have a certificate, and if you don’t, you’re the outlier. From an economic perspective, there will be a gap between your [non-certified] building and the [certified] building next door—where tenants prefer the building next door. At some point, that gap will become so large that it will be better to invest in the building and upgrade it.