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By Brandon Lorenz, Senior Editor
September 2007 -
When the levies in New Orleans were breached by Hurricane Katrina’s flooding in August 2005, the disaster set in motion a domino effect that left buildings smashed and infrastructure ruined. Other effects were less immediate.
Six months after Katrina struck, executives at CB Richard Ellis were getting nervous. Crude oil prices had surged to more than $65 a barrel. Estimates of insured losses from the storm ranged as high as $60 billion, pushing up insurance costs.
The tandem of growing energy and insurance expenses were putting pressure on the net operating income (NOI) of investors. NOI is a key metric used by real estate firms to calculate the cap rate, which determines a property’s value.
“Energy volatility had everyone focused on operating expenses,” says Ron Herbst, global director of energy and sustainability for CB Richard Ellis. “When people miss budgets, they pay attention. Especially if they miss their budgets by a factor of two.”
Charged with managing more than 1.7 billion square feet of property, executives at the world’s largest real estate
services firm knew the company needed to respond to increasingly volatile energy prices. The company tasked more than 30 of its market leaders to come up with a solution. Dubbed “the green knights” internally, the group decided that launching a robust sustainability policy was the best response.
More than a year in the making, the group’s work culminated in May with the announcement that CB Richard Ellis would promote energy efficiency to tenants and owners in the space it manages and go carbon neutral in its own space by 2010. The decision is another sign that the slow-changing commercial real estate industry is taking energy efficiency seriously. “In the past year or two environmental awareness has passed a tipping point,” says Adam Hinge, principal at Sustainable Energy Partnerships. “There has been more recognition that if you are concerned about carbon emissions, buildings are a very large part of that picture.”
A key part of the company’s plan to improve energy efficiency in its space involves using the ENERGY STAR benchmarking tool. To begin, all office buildings larger than 100,000 square feet will be benchmarked; a second round for smaller buildings will follow. “We wanted to take the biggest piece, the place where we could have the biggest impact first,” says Dave Pogue, senior managing director for the western region of CB Richard Ellis’ asset services division. “Ultimately we will engage every client in every building at some level.”
The ENERGY STAR rating system is based on a 100-point scale. Buildings must earn at least a 75 using the online portfolio manager to earn an ENERGY STAR label, which is valid for one year. CB Richard Ellis already has 350 buildings using the program, with facility managers creating individual building plans to improve performance.
Part of the early effort is focusing on retrocommissioning. Benchmarking the buildings using ENERGY STAR followed by retrocommissioning gives the company a solid starting point for making improvement without having to rely on capital expenditures.
“We are finding that there is opportunity for improvement almost across the board,” says Pogue. “We’re focusing on the low-hanging fruit. There are so many places where buildings have gotten lax over the years. ENERGY STAR helps us focus our efforts.”
To help train employees, CB Richard Ellis has adopted the BEEP program from the Building Owners and Managers Association (BOMA) International. Launched last year, the program aims to show facility executives how to improve energy efficiency using low- and no-cost methods. “Our primary goal is to do everything we possibly can with a payback of one year or less before we go to capital spending,” says Pogue.
Skeptics might question how much room there is for trimming energy use without resorting to capital improvements. The answer: plenty. “On average, a building can achieve a 20 to 30 percent improvement in energy efficiency where the majority of improvement doesn’t require capital expenditures for new equipment,” says Stuart Brodsky, ENERGY STAR’s national program manager, commercial properties.
Starting with operational improvements has two advantages, Brodsky says. First, savings generated by operational improvements can finance capital improvements with longer paybacks. And a staff that is already paying attention to making operational improvements will be better able to handle capital improvements, such as in a new energy management system, which can be challenging to integrate into an existing building.
Pogue doesn’t expect every building the company manages to earn an ENERGY STAR plaque. Some occupancy types will make that impossible. Instead, the goal is simple: continuous improvement against the benchmark score. “We don’t want management to be discouraged if they get a lower score,” he says. “We know not everyone will be in the top 25 percentile. We want sensible sustainability.”
CB Richard Ellis’ announcement that it would go carbon neutral by 2010 in it’s own space was a first for a major real estate services firm. The company plans to eliminate carbon emissions by cutting energy and purchasing carbon offsets.
While CB Richard Ellis’ decision to go carbon neutral is significant, the biggest potential environmental impact lies with the company’s ability to reduce energy use in the 1.7 billion square feet of space it manages.
“Nothing compares to the scale of the CB Richard Ellis effort,” says Ashok Gupta, director of the Natural Resources Defense Council Air and Energy Program.
Company officials stress that the efficiency program isn’t meant to generate extra revenue. There are no plans to seek a portion of the energy savings for doing the work, for example. “Being an expert in this field is a differentiator,” says CEO Brett White.
Though not all of the company’s green initiatives are new, it’s clear the company’s decision to go green has sparked a cultural change. “For this year, all office managers in charge of buildings over 100,000 square feet will have a portion of their bonuses based on their engagement with the program,” says Pogue.
Early evidence is that employees throughout the company are buying into the program. When Pogue decided to draft a training document listing 50 best energy internal efficiency practices, he had to expand it to 101 after getting flooded with suggestions from field employees. (See “Strategies for Energy Efficiency.”) The company is also on track to have 100 employees certified as LEED Accredited Professionals by December.
“You’re more inclined to have success if it’s embraced at the grass roots,” says Pogue.
The biggest barrier to success isn’t internal culture, but a problem that has plagued commercial real estate for years. With investors increasingly focused on short-term returns as properties churn faster, and with tenants often paying their own energy costs, many building owners aren’t motivated to consider energy efficiency measures because they don’t believe they will benefit. “It’s really one of the structural problems with the way the market works right now,” says Herbst.
Building owners and investors also remain skeptical of green building initiatives because, even though programs like the U.S. Green Building Council (USGBC) LEED for New Construction rating system have been around for more than five years, data showing that green buildings are worth more than traditional ones has been scarce.
Because the company’s position as a real estate services firm puts it in contact with both tenants and building owners, Pogue believes the company can help show that energy efficiency has the potential to benefit owners as well as tenants. “The bulk of the savings in the near term is going to go to the tenants,” he says. “We need to get an owner to understand the overall economic value of it.”
Pogue and Herbst know that spreading the message will be challenging. One advantage for CB Richard Ellis is that owners appear more receptive to green measures than they have been in the past. “In the near term, this was really driven more by the client side than tenant demand,” Pogue says.
A landmark report on ENERGY STAR released this summer by real estate information firm CoStar Group could aid the company in making the case to owners. The report is the first to show that energy efficiency directly correlates to property value, a game-changing link that may help facility executives get energy efficiency programs approved.
The report compared the occupancy rates, rental rates, cap rates and sale price per square foot of Class A office buildings that received an ENERGY STAR label to those that didn’t. The report found that Energy Star buildings had better occupancy, higher rental rates and higher sales prices than buildings that didn’t have a label.
“Those three numbers shocked us,” says CEO Andy Florence.
Even more revealing is the trend, which shows that ENERGY STAR building consistently score better in key real estate metrics. During the second quarter of 2007, occupancy rates in ENERGY STAR buildings stood at 89.2 percent. Non ENERGY STAR buildings had an occupancy rate of 87.5 percent. The report found ENERGY STAR Buildings had consistently higher occupancy dating back to the fourth quarter of 2004. The report shows a similar story for rental rates and sale prices.
“If you look at the impact, you are getting higher rent, lower energy costs and lower vacancy costs,” says Florence. “You have three things working on the income statement to the positive. You are going to have a much higher valuation of the building.”
How much higher valuation? The report found that an ENERGY STAR building sold for an average of $351.60 per square foot in 2006, 30 percent higher than a non-ENERGY STAR building, which sold for an average of $270.15 per square foot. Since 2003, ENERGY STAR buildings also have been appreciating in value faster than non-ENERGY STAR buildings.
To ensure that fair comparisons were made, the report only looked at Class A properties of at least 200,000 square feet and five stories. The buildings also needed to be built after 1970. That left 223 ENERGY STAR buildings covering 111 million square feet to compare against 2,077 non ENERGY STAR Buildings covering 889 million square feet.
“We used the filter to try to make sure we were looking at buildings on an apples-to-apples basis,” says Jay Spivey, Costar’s senior director of product management. “We didn’t want to build any bias into our numbers.”
The research effort began by chance because brokers wanted to see which buildings in the company’s database had an ENERGY STAR label, says Florence. Much of the information for the analysis had already been gathered by the company’s 1,000 researchers, who track more than 2 million properties across the country using public records.
The report didn’t show a consistent correlation between cap rates and ENERGY STAR buildings, a factor that Spivey attributes to the fact that the company had to use a smaller sample for that calculation. Not every building in the database has enough information to calculate a cap rate.
Regardless, the historical trends show that ENERGY STAR buildings are outperforming their traditional counterparts in key real estate metrics. “It doesn’t really matter if you believe in global warming or not,” says Florence. “You can cut your operating expenses and improve tenancy by using energy more efficiently, and improve your rents.”
As CB Richard Ellis focuses on its new benchmarking effort, it won’t be working alone. In late July, BOMA announced its seven-point challenge, which seeks to reduce energy consumption by 30 percent by 2012. (See “BOMA Launches Energy Efficiency Program.”) Benchmarking with ENERGY STAR is a key part of the program.
Though CB Richard Ellis’ program is still in the initial stages, the potential benefits shouldn’t be underestimated, observers say.
“Having companies like CB Richard Ellis come out with an announcement like this is important,” says Henry Chamberlain, COO of BOMA. “It’s a tangible part of the business saying, ‘We’re going to change.’”
Among the strategies CB Richard Ellis suggests clients consider are these:
— Brandon Lorenz
In announcing it’s green effort, CB Richard Ellis also took the unusual step of partnering with the Natural Resources Defense Council (NRDC), a nonprofit organization dedicated to promoting sustainability.
“We’re not consultants,” says Ashok Gupta, director of the Natural Resources Defense Council Air and Energy Program. “Our role is to be somebody they can share ideas with and check in with. We can share our ideas and see if, in the end, they did follow through with what they said they were going to do.”
Gupta, who is NRDC’s liaison with CB Richard Ellis, says he wants to make sure the firm has a comprehensive sustainability policy in place. The effort will begin with retrocommissioning, Gupta says, but strategies ranging from managing the plug load of tenants to improving building envelopes and evaluating locations based on sustainability should be considered over time as well.
NRDC will also work with CB Richard Ellis to push for changes in the tax code, such as shortening the length of time chillers can be depreciated, which would encourage upgrades to more efficient units.
“Our goal is to help transform markets,” Gupta says. “We look at CB Richard Ellis as being an industry leader, and we hope other companies decide to follow.”