VGVALUINGGREENHow green buildingsaffect property valuesand getting the valuationmethod right.VALUING GREEN1

THE GREEN BUILDING COUNCIL OF AUSTRALIA WISHESTO THANK THE VICTORIAN BUILDING COMMISSION ANDSUSTAINABILITY VICTORIA FOR PROVIDING THE FUNDINGREQUIRED TO RESEARCH, WRITE, DESIGN AND PUBLISHTHIS PAPER.The Green Building Council of Australia also wishes to thank the authors of the report:Mr Richard BowmanAAPI, PRINCIPLE AND REPRESENTATIVE, REAL ESTATE ADVISORY SERVICES, ERNST & YOUNGMr John WillsMIMC, AAPI, AIMM, DIRECTOR, THE PROPERTY LABIn addition the Green Building Council of Australia thanks the many other individualswho contributed to the production of the paper. A complete list of participants can befound in Appendix 1.Special thanks to the Australian Property Institute and the Royal Institute of CharteredSurveyors for reviewing this document in draft. Copyright Green Building Council of Australia 2008.On the front cover: MFB Burnley (VIC) – 5 Star Green Star – Office Design v1.VALUING GREEN2

CONTENTSFOREWORD I1.2.EXECUTIVE .48999Putting a value on greenStakeholdersWhat are Green Star buildings?Market Growth of Green Buildings3. PROPERTY VALUATION3. ComparisonIncome CapitalisationDiscounted Cash Flow (DCF)111212RESEARCH AND dologyKey Findings from the Literature SearchSurvey of commercial property industry stakeholdersCase Study FindingsIMPLICATIONS FOR VALUATION5.122A Discounted Cash Flow Valuationmethodology for Green Buildings236. SENSITIVITY MODELLING6.16.224Base CaseSensitivities24257. CONCLUSIONS AND RECOMMENDATIONS268.APPENDIX29Appendix 1: AcknowledgementsAppendix 2: Case StudiesAppendix 3: Green Initiatives Incorporated to Achieve BenefitsAppendix 4: Financing the Green Building IndustryAppendix 5: Productivity and Green Buildings2931727579TABLE OF CONTENTS // VALUING GREEN3

FOREWORDTHE GREEN BUILDING COUNCIL’S MISSION IS TO DEVELOPA SUSTAINABLE PROPERTY INDUSTRY FOR AUSTRALIAAND DRIVE THE ADOPTION OF GREEN BUILDING PRACTICESTHROUGH MARKET-BASED SOLUTIONS.Recent feedback from industry indicates that the valuation of green buildings is anarea where there has been little research and analysis to date, and there is much workto be done. This paper is intended as a contribution to advancing the debate on thisimportant issue, both in Australia and internationally. The Green Building Councilof Australia looks forward to being a part of the discussion.Romilly MadewCHIEF EXECUTIVEFOREWORD // VALUING GREEN4

1IN ONLY A FEW SHORTYEARS, GREEN STARBUILDINGS HAVECAPTURED SERIOUSATTENTION, NOWACCOUNTING FORAS MUCH AS 30%OF THE NEWBUILDING MARKET.EXECUTIVESUMMARYINVESTORS, OWNERS, MANAGERSAND DEVELOPERS IN AUSTRALIAOVERWHELMINGLY CONFIRM THAT‘GREEN VALUE’ IS STARTING TO HAVEAN IMPACT ON PROPERTY VALUATIONSTHROUGH LOWER BUILDING OPERATINGCOSTS, EASE OF SALE AND RENT, TENANTRETENTION AND IMPROVED OVERALLOCCUPANCY RATES. THERE IS A STRONGINDUSTRY CONSENSUS THAT GREENSTAR BUILDINGS WILL OUTPERFORMCONVENTIONAL BUILDINGSIN COMING YEARS.In only a few short years, Green Starbuildings have captured serious attention,now accounting for as much as 30%of the new building market. Such rapidshifts in market sentiment are difficult forprofessional valuers to incorporate intotraditional models, which rely on tangibleevidence from sales and/or leasing frommultiple properties. That evidence iscoming, but with many Green Starbuildings still under construction,the data base remains limited. In theinterim, valuers will need use theirexpertise to assess the extent of theadvantage Green Star buildings will enjoy.Ignoring the likely impact of thisadvantage is not an option: this reporthas found Green Star buildings arealready having a market impact. At thevery least, non-Green Star buildings faceaccelerated value depreciation.To be able to make informed judgementswith limited information, valuers will needto share knowledge in order to keep pacewith the marketplace. By surveying andinterviewing industry leaders, this reportaims to contribute to this knowledgesharing and pave the way for furtherexchange and learning. It is based onan extensive literature search, case studiesof eight recently completed Green Starbuildings and interviews with some 50of Australian property owners, valuersand developers, responsible for some30% of total property fund assetswithin Australia, with a combinedvalue of 85 billion.The majority of investors indicatedthat they would pay more for a GreenStar building. The improved marketabilityof Green Star buildings is their maincurrent competitive advantage: they areeasier to sell and lease, which reducesvacancy times and hence income losses.While some tenants are willing to pay therental cost of achieving Green Star, a rental premium is not yet proven in all cases.Corporate and government demandfor improved lifecycle economic andenvironmental performance are keydrivers of green, but these tenantscan negotiate green as a bonus forlong rentals with predeterminedreview patterns, rather than payingan up front direct premium.EXECUTIVE SUMMARY // VALUING GREEN5

In the longer term, however, the industryexpectation is that rental growth, tenantretention and operating cost savings willbecome the key drivers for the marketvalue of Green Star buildings, relativeto non-Green Star buildings. Green Starbuildings also claim improvements inproductivity; wellbeing; and occupationalhealth and safety, but market acceptanceof these intangible values is limited.It is highly likely that a two-tiered marketwill emerge, with Green Star buildingsattracting premiums and/or existingassets being discounted. Non-Green Starbuildings may suffer from lower rentalrates, rental growth and higher longterm risk with greater potential capitalexpenditure requirements resulting indecreasing value. Many investors andowners/managers believe Green Starbuildings are ‘future proofed’ againstthe risk of rising energy costs, marketrejection of non-Green Star buildingsand tightening regulations on buildingsustainability performance. Non-GreenStar buildings may face the prospectof major capital works to meet futureperformance standards, which currentlyappears omitted from contemporaryvaluation consideration.Subject to the availability of adequatecomparable rental and sales evidence,each of the conventional market-basedmethods of valuation could beadopted for green buildings.However, the Discounted Cash Flow(DCF) valuation methodology, allowsthe valuer to more explicitly reflect thevarious aspects of comparable rentaland sales evidence in the valuationprocess. The DCF method facilitatestransparency in the various rental rates,outgoings rates, growth rates and capitalexpenditure allowances adopted,enabling the valuer to more fully reflectall aspects of the comparable evidence.Sensitivity modelling, via movementin key valuation factors, shows valueis most sensitive to movements inrental growth. Thus, if non-Green Starbuildings fail to maintain rental growthin the face of tenant preference forgreen, owners of such buildings willbe confronted with a significant lossof value – modelling shows that a fallfrom 3.5% rental growth to 2%rental growth would wipe off almost 13 million from the value ofa 100 million property.The potential upsides for Green Starbuildings are in increased renewalprobabilities, decreased downtimesand lower terminal yields. Valuers needto make clients aware of the potentialimpact of Green Star buildingson future values.IT IS HIGHLY LIKELYTHAT A TWO-TIEREDMARKET WILL EMERGE,WITH GREEN STARBUILDINGS ATTRACTINGPREMIUMS AND/OREXISTING ASSETSBEING DISCOUNTED.EXECUTIVE SUMMARY // VALUING GREEN6

1.1 RECOMMENDATIONSGiven the state of the market for GreenStar buildings and the challenges thisposes to the valuation profession, thefollowing recommendations are made:1. The valuation profession shouldcontinue to assist its members byproviding professional educationon how to incorporate the emergingmarket value for green buildings,specifically highlighting: the inclusion of DCF valuationmethod for green buildings as oneof the optional methods used underthe IVSC or Red Book standards; the need to advise clients of thesensitivity of building values to theemerging market value attached toGreen Star buildings and the potentialimpacts on tenant retention,downtime and terminal yield as wellas the possible value loss and capitalcosts facing non-green buildings; and the inclusion of a sustainabilitysection in valuation reports .4. The valuation profession shouldcontinue to foster discussions aboutGreen Star buildings within thevaluation industry and with keystakeholders from the wider propertyindustry and from government.This should include conferencesand academic papers.5. The valuation profession should alsoshare information globally with otherprofessional bodies, given the growthof green buildings in overseas markets.6. Asset and fund managers shouldalso investigate means of improvingunderstanding of how sustainabilitycan be incorporated into assetmanagement plans.THE VALUATION PROFESSION SHOULDCONTINUE TO ASSIST IT MEMBERSBY PROVIDING PROFESSIONAL EDUCATIONON HOW TO INCORPORATE THE EMERGING MARKETVALUE FOR GREEN BUILDING.2. Property professionals should beencouraged to undertake Life LongLearning in sustainability issues suchas the Green Building Councilof Australia’s Green Star AccreditedProfessional course to improve theirunderstanding of Green Starbuildings and their economicand environmental performance.3. Regulators, policymakersand professional associationsshould investigate ways to improveawareness of the impactof sustainability features on specificmarket transactions so that valuerscan more quickly detect and assesssustainability market trends.Investa at 26 Phillip Street, NSW – 5 Star Green Star – Office Interiors v1EXECUTIVE SUMMARY // VALUING GREEN7

2IF A POSITIVEIMPACT ON BUILDINGVALUATION CAN BEDEMONSTRATED FROMA GREEN STAR RATING,MARKET ADOPTION OFSUSTAINABLE PRACTICESWILL ACCELERATE.INTRODUCTION2.1 PUTTING A VALUE ON GREENTHE POTENTIAL OBSOLESCENCE OFNON-GREEN BUILDINGS AND CONSEQUENTEROSION OF VALUE POSES A MAJORCHALLENGE TO THE PROPERTY VALUATIONSECTOR. VALUERS DON’T HAVE THE TOOLSOR PRACTICE TO MANAGE THE ISSUE.THE SECTOR RECOGNISES THAT“GREEN BUILDING EVOLUTION IS THEINEVITABLE AND RIGHTFUL FUTUREBUT THERE WILL NEED TO BE A MAJORINFORMATION/EDUCATION PROGRAM TOIMPROVE VALUERS’ TECHNICAL SKILLS ONASSESSING THE ESD [ENVIRONMENTALLYSUSTAINABLE DESIGN] PERFORMANCE OFBUILDINGS AND THEIR ECONOMIC IMPACT”(Green Building Workshop 4:Green Valuation, Leases and Productivity– Capturing the Benefits of Green Building,August 2004).The Dollars and Sense of Green Buildingsreport 2006 provided a comprehensivebusiness case for Green Star buildingsthat reflected the rapid growth of theindustry since 2000. It also examineda number of challenges facing marketacceptance of Green Star buildings,among which was the need for improvedvaluation techniques.This report responds to this challenge.It aims to demonstrate how a Green Starrating can affect property value, andto review the techniques available forvaluations of Green Star buildings.If a positive impact on building valuationcan be demonstrated from a Green Starrating, market adoption of sustainablepractices will accelerate.The property industry has spent yearsdeveloping, testing, and re-testingnumerous theories, formulas, and ideasto determine the most accurate way toassess a property’s market value. Theseapproaches have wide application, butmost rely on data from many buildingsover extended periods of time.Case studies and other evidence aboutthe benefits of Green Star buildings todevelopers, occupants and investors arebecoming increasingly available both inAustralia and internationally. Yet, becausethe rise of market interest in Green Starbuildings has been rapid, in-depthanalyses of the impact of this interestbased on rigorous quantitative financialanalyses have been limited.This report seeks to lay the foundation forsuch analyses to take place.The focus is to identify and isolate thekey important variables that valuersshould consider when assessing themarket value of a Green Star building.INTRODUCTION // VALUING GREEN8

2.2 STAKEHOLDERSMany parties are involved in thedevelopment, letting, financing,ownership and management of aproperty asset. The “value drivers”for different participants are shownin Table 1.While this report is primarily aimedat helping professional valuers, it mayalso be of interest to those stakeholdersin the property industry that use theresults of professional valuations.2.3 WHAT ARE GREENSTAR BUILDINGS?The Green Building Councilof Australia defines a Green Star buildingas a property that incorporates design,construction and operational practicesthat significantly reduce or eliminate thenegative impact of development on theenvironment and occupants. Specifically,a Green Star building is any building thatachieves a ‘Green Star’ rating of fouror more stars under the Green BuildingCouncil of Australia’s holistic Green Starrating system. Under the Green Star– Office Existing building rating tool,which in 2008 was still an EXTENDEDPILOT, projects that do not acheivea 4 Star Green Star benchmark canstill achieve a certified rating of betweenone and three stars.The Green Star rating separatelyevaluates the environmental initiativesof projects based on the followingenvironmental impact categories: managementenergy efficiencywater efficiencyIndoor Environment Quality (IEQ)transportTable 1: Property PlayersPARTICIPANTVALUE DRIVERFinancierReturn on capital, development profitability and cash flow,value on completion, marketability, financial banking ratios,ease of letting or sellingDeveloperCompany profile and exposure, return on capital, internalrate of return, development profit, marketing exposureOccupantOrganisational productivity and profitability

Green Star buildings within the valuation industry and with key stakeholders from the wider property industry and from government. This should include conferences and academic papers. 5. The valuation profession should also share information globally with other professional bodies, given the growth of green buildings in overseas markets. 6. Asset and fund managers should