Commercial buildings in the United States
are estimated by the U.S. Green Building Council to account for 71
percent of all electric usage and nearly 50 percent of all energy
usage. Further, they contribute 39 percent of greenhouse gas, compared
to only 32 percent for transportation and 25 percent for industry. U.S.
office buildings alone are responsible for more carbon dioxide
emissions than those in any other country in the world, except for
China. Thus, improving the environmental performance of a property may
not be a choice for building owners in the future.
As a result,
the government's role in this issue is being gradually stepped up. The
Energy Independence and Security Act of 2007 requires federal buildings
to have more specific and ambitious green building requirements,
including a goal of zero net energy buildings by 2030. The beneficial
impact of this legislation is mitigated when you factor in that
government buildings require congressional approval and funding in
future budget cycles, thereby creating lag times in embracing new
technologies. That being said, there is still an opportunity for the
private sector to provide green leases to government to fill the gap.
Is This Downturn Different?
are many indicators that this downturn, while significant, has the
potential to be materially different than the last two. Torto Wheaton
Research (TWR) data through the first part of 2008 provides a great
First, according to TWR, the overall state of the
office market has not substantially deteriorated. The market is far
from overbuilt (this is the key difference between the 1990 and 2001
recessions), and job losses which drove the severe fallout in the
office market in those downturns were far more significant than we are
experiencing today. Second, even in the current downturn, rent growth
has continued, albeit not at the historic pace of 2006-2007. Key to
this is that overbuilding does not appear to be a major exposure in
this cycle. The pipeline shut down quickly, and, in the midst of the
commercial mortgage-backed securities debacle, it's hard to say that
markets have financial discipline.
Clearly the difficulty in
financing new projects as a result of the mortgage meltdown will
further moderate supply, which is anticipated to catch up with demand
by 2010. Although rent growth slowed in the first half of 2008 and
concessions are back, this has not yet resulted in rent declines. While
2009 looks challenging, with greater vacancies and real rent declines
expected of between 0.5 and 1 percent, these are much lower than the 7
percent decline at the bottom of the last real estate cycle in 2003.
key insight is the nature of rent and inflation. In past cycles, rent
growth raced ahead of inflation, thereby creating a more severe
correction. Since 2003, rent growth has occurred hand in hand with
inflation, and in adjusted terms, rents remain below their previous
peak; thus no major correction is required.
Out With the Old
most significant driver for keeping sustainability at the forefront is
the long-term impact of our current energy crisis. Bubble or no bubble,
resource scarcity is driving cost. Energy and water will cost more, and
costs will rise at an accelerating rate. High-performance buildings
will redefine the market.
The very nature of the constrained
amount of new office development in this last cycle underscores one
critical data point: the U.S. office inventory is aging, with most
major markets defined by Class A buildings that are 10 to 20 years old.
The U.S. office inventory has nearly doubled in 20 years from 1.27
billion square feet in 1988 to 2.1 billion square feet in 2008; 92
percent of that inventory is more than five years old, and 78 percent
is more than 10 years old.
Most developers are calculating that
modern, high-performance office buildings can use 30 to 50 percent less
energy than last-generation buildings, and consume as much as two
million gallons less of potable water per year, while boosting the
health and productivity of tenants by 5 to 10 percent. The energy
crisis is making payback analysis more rudimentary, where the
investment in performance is no longer optional, but mandatory.
is expected that new office deliveries will redefine the Class A market
in the coming cycle, and the entire product previously considered Class
A - that cannot be materially retrofitted to higher performance
standards - will be relegated to a lower status. As metrics from
Corporate America become more available on productivity and health
improvements, tenants will embrace the moderate rent increases needed
to enjoy these benefits. Demand is forecasted to return in 2010 and
2011; while we know it takes two years to deliver new product, the
question is, when will market fundamentals provide debt vehicles that
allow the pipeline to fill again to meet this demand?
should benefit from this downturn, driven by the energy crisis,
buttressed by corporate responsibility, and anchored by future
regulation. Yes, the wheels could still fall off the sustainability
bus, but at least it will likely be electric-powered.