Scott Muldavin is showing bankers how to be green…sort of.
Many true things have been written about money, but the lies are more interesting. For instance, it’s been called “Long Green,” though it’s been my experience that isn’t the case if we measure the time it stays in my pocket. It’s hard to argue with Woody Allen’s observation, “Money is better than poverty if only for financial reasons.” But one-time Marin denizen Van Morrison once wrote a song celebrating the spending of cash called “Blue Money.” San Rafael Real estate consultant Scott Muldavin might quibble with the songsmith.
Get off Highway 101 at Lucas Valley Road, as if you’re taking a run back to Skywalker Ranch. At the Big Rock Deli, hang a right like you’re heading to Marin’s Juvenile Hall (a place I avoided as a child for the simple reason I didn’t live in Marin). Pushed back off the street a bit is a brown, two-story office building with a wealth of trees surrounding it like old friends. Around the corner, in a hidden courtyard, is the office where Muldavin is inventing something. Hint: It’s not a computer add-on nor something Billy Mays will soon be hawking on late night TV along with Mighty Putty.
No, Muldavin is working on something much more important. He’s developing a methods for investors and lenders to better understand and finance “green” construction and retrofitting. Muldavin founded the Green Building Finance Consortium, a nonprofit research project backed by the National Association of Realtors, the Mortgage Bankers Association, Urban Land Institute, Pension Real Estate Association, the Building Owners and Managers Association and select other industry players. (Muldavin won’t let green trade groups or product companies chip in, because he wants the end result to be free of any influence from green advocates).
The purpose of the Consortium is to create standardized tools for underwriting sustainable building projects so that previously discovered benefits and pitfalls can be expressed in black and white terms. In the past, developers and environmentalists, for example, have pointed to greener projects and said that the operation of such buildings would mean lower energy use—and thus a savings—to the building operator and, by extension, to society. But other benefits, such as worker productivity and health, increased tenant demand for green space, and protection against future government regulation or ability to use government incentives are harder for lenders to gauge and underwrite. It’s in these and other areas where Muldavin and the Consortium are seeking to lay a foundation for easier lending and investment by providing more accurate measurements of risk and reward.
Growing green buildings
What is green building? Well to begin with, it isn’t a category of building unto itself. “An office building can be considered green with only a minor part of it being sustainable,” says Muldavin.
Though a number of rating systems have evolved in the last few years to help define green or sustainable building, the real estate industry has begun leaning primarily on two different systems. The Environmental Protection Agency has the Energy Star program, which can help assess a property’s energy efficiency. And the United States Green Building Council has the Leadership in Energy and Environmental Design program (LEED). With LEED, a project can attain different levels of “green-ness” based on its use of recycled materials, energy efficiency and a host of other factors.
Here’s the thing: Green building is getting huge. Developers and builders have fallen in love with Mother Earth, wanting to build projects that are good for the old girl as well as for their bottom line. In 2006, the green niche of the construction industry was worth $11 billion. That number will climb to $60 billion by 2010, according to this year’s McGraw Hill Construction Analytics Smart Market Trends Report.
And it isn’t just the guys putting up large buildings in downtowns across America. City hall types have also figured out that structures that use recycled materials, less energy and are built closer to mass transit are more desirable and leave a smaller footprint than traditional construction projects. Whereas, two years ago, there were no local governments that regulated private building sustainability, today there are hundreds—if not thousands—of cities with such regulations and related incentives driving future value and risk of property investment. Even if a city doesn’t have such regulations yet, the risk that they’ll eventually be put in place is so high, it has a major impact on investment. These regulations aren’t just affecting new buildings, but also existing buildings. The federal government now has regulations in place that specify that new and existing federal buildings set to house federal programs must meet green specifications. Having the feds on board the green train is significant when you realize the government owns three billion square feet of commercial real estate and leases another 57 million square feet of space—and, despite the Bush administration’s boasts about smaller government, that number has grown during the last eight years.
Investing green
Equity folks, those who make a living being the money end of partnerships that build skyscrapers, warehouses, malls and apartment houses, know the future belongs to those who invest and build green. The largest pension fund in the United States, the California Public Employees Retirement System, has committed to reducing energy use in its real estate portfolio by 20 percent over the next five years. It’s also invested with Texas real estate investment trust Hines in the Hines Calpers Green Development Fund, a $120 million vehicle that will invest in $500 million worth of green development. The Rose Smart Growth Investment Fund raised $100 million to focus on greening existing buildings.
The Schuster Group has its $100 million Green Build Investment Fund. Thomas Properties Group out of Los Angeles has raised a $350 million equity fund to invest in green office buildings. Real estate investment trusts (REIT) like ProLogis, Liberty Property Trust and Multi Employer Property Trust are shopping for green properties to add to existing portfolios. And Green Realty Trust became the first all-green REIT earlier this year with its IPO and a focus on building only green properties.
The environmental community has had its influence, of course, and it’s hard to argue with the data. Buildings consume 70 percent of the electricity generated or purchased in the United States. They use 39 percent of the energy and generate 39 percent of all carbon dioxide emissions. Construction consumes 40 percent of the raw materials in the United States, generates 30 percent of the waste and uses 12 percent of potable water.
This leaves us with lenders, who are trailing badly in this green revolution. It isn’t that bankers are unwilling to get green with their green, or that those in the business of making debt available to the construction industry are unwilling to lead the parade… though there’s certainly historic evidence to be considered.
Bankers are known as a conservative lot, given to careful consideration and quiet introspection. Their business is the evaluation and, to a large degree, avoiding risk. And the trouble with green construction is that—aside from the facts that green building is good for the environment and sometimes more expensive in upfront costs—it’s hard to assess the marginal effect of sustainable features on a building’s value.
But what about Bank of America’s pledge to do $20 billion in green lending? What about how Wells Fargo brags about having already closed $1 billion in green loans?
Nobody is casting aspersions on Bank of America’s intentions or scoffing at the guys with the stagecoach for actually closing those deals. In fact, those lenders are to be applauded for making those loans, especially in light of the current financing crisis (that we’ll cover in good time). What I am saying is, the banks and other lenders don’t yet have the tools to really do green loans. Wells Fargo has, in fact, closed construction loans on green projects. But they did it using traditional underwriting procedures that don’t honestly take into account the values green buildings have.
Change is good
Muldavin wants to change all that. The San Rafael native is in a unique position. He owns his own company (called, oddly enough, the Muldavin Company) and cut his teeth working as a consultant for financial ratings giant Standard & Poor’s creating a system to quantify the value of securities and the risk they carried for a thing called Commercial Mortgage Backed Securities (CMBS) back in 1984.
For the uninitiated, CMBS financing revolutionized the commercial real estate industry. It allowed lenders to loan money for acquisitions, then sell those loans to investors, through a process called securitization, and create liquidity in the capital markets. Essentially, the lenders became conduits, the vehicles through which loans were made before being sold. For the most part, these conduit lenders are found on Wall Street through the investment banking arms of Wachovia, Goldman Sachs, Lehman Brothers and Merrill Lynch, to name just a few.
As an example, a lender might originate a $100 million loan to buy a skyscraper in San Francisco. Once the loan was closed and the acquisition made, the lender would then take the loan and dozens of others like it and package them for sale. The loans would be sliced into different sections called tranches, each with a different risk and reward factor that was designated by ratings agencies. The tranches are then sold as bonds to investors, who are paid off via repayment of the underlying mortgages.
The CMBS market has become a very popular source of financing for commercial real estate players, as well as a standard investment for institutional investors like banks, REITs, equity funds and pension funds. Last year, the lenders who feed the CMBS market originated $230 billion in loans—and the market was literally shut down for the last three months of the year.
It’s what’s inside that counts
It’s late on a Monday afternoon, and Muldavin warns he’s on a tight schedule: “I’m doing, like, thousands of pages of writing with this thing, and I just don’t have that much time.” As I walk in, I see what he’s talking about: A huge conference table is holding 18 different piles of documents he’s using for research. The desk in his office has similar piles, a tribute to organization…and a printer working overtime.
On this day, however, it isn’t the project that has the clock ticking, but rather a tennis game. Muldavin’s hair dips over his forehead as if he is doing a guest shot on “The Andy Griffith Show.” A pair of gold rim glasses perch on his nose, breaking up a face that’s at once intense and yet not far from a smile. A black baseball cap with the ubiquitous Nike swoosh is stationed on his head. He also has an ultra-high tech Nike t-shirt on, which will no doubt wick away moisture and give him an edge on a cross court backhand later. The ensemble is completed with black shorts. He’s the Johnny Cash of tennis.
“Sustainability is really a marginal issue in underwriting a property,” Muldavin offers as he begins to explain how the consortium is tackling the task of breaking down the real life risks and values of green building. Muldavin launches into an explanation of how the underwriting for conventional real estate isn’t that far removed from that of green projects. “The trouble is, so much of what lenders need to understand can’t be empirically proven, in part because there hasn’t been that much green development to examine,” he says.
But it is much more complicated than the single fact that building sustainably is a relatively new approach. The issues facing Muldavin and the commercial real estate finance industry revolve around the age-old concept of how to incorporate new ideas and information into established underwriting and valuation methodologies without reinventing the wheel—especially when the old wheel still has plenty of tread that can help solve the problem.
Another problem is that the real estate capital markets have been in turmoil since September of last year and in transition for five months before that. In April 2007, ratings agencies informed CMBS lenders they were concerned about lax underwriting on loans being placed in packages for sale, and that, in fact, the loans could require more stringent underwriting that, in turn, would affect the pricing and risk on bonds.
Rating agencies and investors were concerned that lenders had become so intent on capturing business that too many loans were being written at too high a leverage (leverage being a measure of the loan amount expressed as a percentage of the property’s appraised value) and that too many loans were including long periods of interest-only payments. By September, the market for CMBS loans had frozen as bond buyers walked away and lenders were forced to the sidelines, unable to see new loans.
Add in the subprime meltdown and a slowing economy, and interest rates rose as banks and lenders repriced risk. With fewer lenders willing to lend money and those who were still in the game charging higher interest rates and offering lower leverage (forcing real estate buyers to come to the table with more equity), buyers backed away from deals that no longer worked. Sellers in turn, retreated to the sidelines, unwilling to sell properties at the lower prices buyers were offering based on higher priced debt.
By the numbers
Today, there’s been an 80 percent drop in deal volume compared to how things were moving last spring. The lack of deals hasn’t helped Muldavin and company, since having more deals and greener building performing would give the consortium more information to work with. But by the end of the year, the Consortium will release a number of reports covering different areas.
The first report will cover underwriting a sustainable property investment. It will include cost-benefit analysis, working definitions of green building and a financial model to move from traditional construction to green.
One of the most widely discussed benefits of sustainable construction is an increased energy efficiency and a decreased carbon footprint. The trouble facing lenders and investors, however, is how to break down the value of the energy issues beyond the decreased energy costs. The second report from Muldavin and the consortium will relate the energy use to increased tenant and investor demand, as well as address the evaluation of the accuracy and reliability of energy forecasts.
The next two reports generated by the Consortium will evaluate the benefits and costs of sustainability as they relate to the health and productivity of green building tenants and how to apply the wealth of scientific studies to real life real estate.
One of the most critical reports developed by Muldavin and the consortium will look at how government regulation and incentives interact with the risk and value of a building. With the federal government not only active as a tenant all over the country but also involved in ratings and incentives, lenders and investors are going to have to learn how to use those elements as tools.
The last report will link green buildings with user demand and link traditional with sustainable measuresto answer the question of what types of tenants are more and less likely to use the buildings. “For instance, our information so far shows that law firms are most likely to want sustainable space, and transportation companies are least likely,” says Muldavin.
In the end, there isn’t much doubt that green building is good for the earth. Muldavin hopes he and the consortium aren’t too far away from being able to explain to lenders and investors that green building will be good for them, as well.
Bill Meagher covers real estate finance for a national publication and is a regular contributor to NorthBay biz. He also pens the Only in Marin column, which can be found on page 33 in this month’s issue.
