The ever rising cost of energy and water along with the growing concern for the environment is gradually strengthening the need to develop green buildings. However, the concern over the additional capital cost and uncertainty over the return are the daunting the investment sentiments in green buildings. In empirical terms green buildings have been observed to be profitable ventures due to savings in energy and other operational costs. However, most of the benefits are intangible and cannot be translated in terms of cash flow which can be used to assess the value of the buildings or project viability. For example, better working conditions cannot be translated directly into money and so there is always the risk that the green aspects or the sustainability measures will be over or undervalued.
There are various methods of valuing buildings. But every method has its own challenges when it is used to value the green or sustainable aspect of a building. In the following discussion we will talk about the most popular methods of valuation such as the Direct Comparison Method, Rent Cap Method and Discounted Cash Flow (DCF) Method. If we want to use the direct comparison method to value a green building, the challenge is to find a similar building that has been transacted. If we value it against any conventional building the sustainable aspect of the building cannot be valued. If we consider the rent cap method of valuation, which uses the cap rate driven by market dynamics to find the value of a building based on total earned rents that drives the cap rate, it neglects the green aspects of the building. This method can only be successful in valuing a green building if the rent also reflects the sustainable aspects.
The discounted cash flow method, which is one of most accepted methods of valuation, considers the cash inflow and outflow. Thus, for a green building, the sustainable aspects of the building can be considered to a large extent in this method of valuation. There are few standard mechanisms to assess the energy savings and water savings of green buildings. However, DCF method has challenges of translating all benefits in terms of cash flows. For instance, there may not always be a rent premium for green buildings as rents in most cases are driven by demand-supply dynamics.
So there are many uncertainties regarding the valuation of green buildings due to lack of data and information. However, it is just a matter of time before change comes. The growing demand from occupiers, due to increased energy cost is putting pressure on developers to develop green buildings. The increase in numbers of green buildings will automatically increase awareness of them and as the market matures there will be benchmarks, comparables and databases to show the value of the green aspects of buildings. This will bring in more clarity and transparency in valuation of green buildings. Thus the investor’s confidence in green buildings will improve.
About the author
Trivita Roy is the Manager of Research and Real Estate Intelligence Service, for Jones Lang LaSalle in India, based in Hyderabad.