Commercial Appraiser - Appraisal Blog, APPRAISAL/CONSULTING SERVICES: LA, Los Angeles, 310.337.1973

Many companies are taking the plunge and deciding to build green LEED-certified buildings (LEED is the U.S. Green Building Council’s Leader­ship in Energy and Environmental Design green building rating system). They’re not just for granola-crunching tree huggers who appreciated Al Gore’s dramatic use of a cherry picker when discussing greenhouse gasses.

Indeed, the checkbook greenies are rejoicing in LEED-certified buildings because they save money. Recent studies show that efficiency pays off start-up costs, especially since energy prices have mushroomed in recent years. For example, contractor Robert Mader suggests that a mechanical contractor can save an owner 36 cents per square foot per year by reducing energy costs by 20 percent^.1

Furthermore, with a healthier, more pleasant interior environment, LEED-certified buildings can improve personnel returns by improving productivity, reduc­ing illness, bolstering recruitment and raising reten­tion.² Labor is a huge expense in the United States, averaging about $150 per square foot per year.3 One study suggests a 1 percent improvement in worker productivity saves $1.30 per square foot per year.⁴

LEED buildings generate not only energy savings and enhanced employee productivity, they also reduce stormwater runoff, increase groundwater recharge, utilize sustainable transportation systems and support other societal benefits. All told, one study shows that an investment of $4 per square foot in LEED building features adds about 50 cents per square foot to the annual rent.⁵ As a high-performance product, LEED buildings can generate a 7 to 12 percent increase in net operating income by reducing operating costs.6 Also, an initial invest­ment of 2 percent in green design can benefit the owner tenfold in savings.⁷ It’s no wonder the U.S. Green Building Council expects that in the future LEED buildings will constitute at least $200 billion of the real estate industry.⁸

As these buildings hit the market, they will have to be bought, sold and insured; but for how much? Companies with green buildings will merge and will need to know who has what, what to keep and what to sell; but for how much? Companies with LEED buildings will go bankrupt (though hopefully not because of their buildings!) and will have to liquidate their assets, including their real estate; but for how much? Inevitably, these buildings will need to be appraised, but the appraiser might not know how to do it correctly.

If the appraisal industry were a high school student, he would like math more than theater. He would prefer the safe, predictable and calculated laws over the new, daring and startling theories. And because currently accepted appraisal principles were built in the past, it takes some finesse for the appraiser’s methodologies to mesh with LEED-certified build­ings of the future.

Long before anyone knew what a graywater system or green roof system was, the appraisal industry developed three sources to support their value opin­ions: 1) analyzing and adjusting recent sales of com­parable buildings (the sales comparison approach); 2) estimating the price of building components and accrued depreciation (the cost approach); and 3) using potential revenue and expenses to calculate an expected income and investment payback (the income capitalization approach).

To be fair, these systems are very appropriate for con­ventional building valuation, not to mention required under industry guidelines. Current appraisal standards were made to protect clients from wildly variable opin­ions and make sure everyone in the industry was using a properly sized yardstick. But when a LEED-certified building, a new type of product, enters into the ap­praisal equation, it can make the sales comparison and cost approach difficult to apply.

For the sales comparison approach, if there are no comparable buildings because no other LEED-certified buildings were bought, sold, listed or even built within a reasonable distance of the subject property, the quality of the appraisal may be low if proper adjustments are not made. When using the sales comparison approach, the appraiser should employ ways to quantify the premium characteristics and price for a LEED-certified building.

Also, the cost approach would have to be carefully applied to LEED-certified buildings. The appraiser would be wise to use actual construction costs instead of building cost averages from sources such as the Marshall and Swift Building Cost Index, as some LEED features are quite different from the industry standard. Furthermore, unlike conventional buildings, LEED-certified buildings push forward costs in equipment and technology to save on utility bills and replacement in the long run. Many LEED features, particularly those that have been commis­sioned by a third party to verify proper installation and maintenance, should have lower depreciation rates than standard features.9 The cost approach would be particularly tricky to apply to a LEED-certified building as it gets older.

Since the LEED program has only recently been put into place, de­preciation rates for LEED-certified building features are not widely available beyond anecdotal evidence. Further, using the cost approach for an older build­ing of any type with a large amount of depreciation adds uncertainty. To reliably use the cost approach for an existing building, a prudent appraiser should accurately calculate a LEED-certified feature’s ef­fective age, which measures overall condition and utility, as opposed to its actual age.

The income capitalization approach is the LEED-certified building appraiser’s best line of attack, as it includes the building’s lower operations costs. The appraiser would have to evaluate the degree of acceptance and understanding the local real estate market would have for LEED features. Next, the appraiser would have to evaluate how much tenants would be willing to pay in additional rent for those improvements.

A popular appraisal analogy goes: A swimming pool installer adds a beautiful pool worth what she would consider $15,000 in her backyard in a mid- to low-income neighborhood. She is quite surprised when she decides to sell her house and finds that the appraiser did not deem her house worth $15,000 more than her neighbor’s nearly identical house. An individual component of a home does not neces­sarily contribute an equal incremental value to the house, as it depends on the local market’s demand, willingness to pay and acceptance of such a feature. An appraiser should consider that tenants may enjoy a LEED feature such as a rooftop garden that filters water and helps control erosion, but they may not be willing to pay the full cost of this feature.10 Yet, LEED-certified buildings are also an enigma in that the converse of this example could be true for some components. If an energy-efficient device is installed in a LEED-certified building, the savings on that fea­ture could potentially translate into financial benefits that exceed the cost of the product.

Just as developers, architects and owners who adopt LEED standards before the pack will reap the benefits of offering a new and novel product before the mar­ket is flooded with late adopters, so too will the real estate appraisers who, early on, develop a high-level understanding of LEED. Golf courses and hotels have their own appraisal categories, so why should not LEED buildings – a highly specialized “Super Class A” – have their own valuation approach?11 Green build­ers will be frustrated and discouraged if the valuation profession naively applies a one-size-fits-all approach to what should be a discerning, tailored fit.

By becoming a LEED Accredited Professional (LEED AP), appraisers announce to their clients that they know the features necessary to certify a green build­ing and that those efforts will not be overlooked. A qualified appraiser must be able to identify building features that add value and those that do not. For example, it is fairly straightforward to do a calculation proving that increased energy efficiency will lead to a higher net operating income, which would increase a building’s value. But what about a do-gooder component, such as providing an alterna­tive fueling station before the market demands one?

Another difficult-to-navigate component of a LEED building appraisal could also be the value of the land if it is thought to be contaminated (a brownfield). Some developers would see a net financial benefit with brownfields, due to low purchase prices and incentives such as tax increment financing. However, these remunerations are often localized and only available for a limited number of years. Furthermore, there is a great deal of risk with taking on a clean-up project, especially if local governance requires a strict standard of revitalization. If necessary, both the appraiser and owner should investigate the costs and benefits of a brownfield site.

Besides becoming a LEED AP, valuation profession­als have other sources to strengthen their credibility as strong LEED building appraisers.12 The Appraisal Institute and the U.S. Green Building Council have teamed up to offer one-day seminars titled “An Introduction to Valuing Green Buildings.”13 Costar is offering comp searches for ENERGY STAR® and LEED-certified buildings.14 A particularly exciting development is the creation of the Vancouver Valu­ation Accord, an agreement between valuation pro­fessionals to promote and share valuation practices that take sustainability into account. Participants will meet in 2010 to collaborate and write up agreed practices and standards.15

Appraisal clients should also take heed and educate themselves about potential valuation issues when planning a building project. Building industry profes­sionals should proceed with caution when choosing not to LEED-certify a building to avoid certification costs, then claiming the building is “able to be LEED-certified” at some level. Most appraisers are not engineers, inspectors or architects, so their ap­praisal clients should not expect them to verify any level of LEED readiness. Appraisers are able to add a caveat to an appraisal, saying they assume a build­ing meets LEED certification requirements. However, this practice could be littered with red flags. Just as you would not want someone to perform surgery on you who claims he could pass the medical boards but hasn’t done so because it’s expensive, it’s hard to assume that a non-certified building fully performs at LEED standards. It would be irresponsible for an appraiser to present an equivalent LEED-certified building value for a structure that has not gone through the certification process.

The LEED system does include many other third-party certification programs, including Forest Stewardship Council wood, ISO recycling content standards, Green Seal paints, etc. Furthermore, third-party commissioning of systems is encouraged as a way to achieve LEED certification and to verify that expensive equipment and building components function as planned. To the degree that a non-certified building follows these other standards, it will perform more akin to a LEED-certified building.

Although LEED-certified buildings are inconvenient to appraise for many valuation professionals, this difficulty offers an incredible opportunity for apprais­ers to specialize and differentiate themselves in the market. Further, there is a change in climate looming, and you do not have to believe in global warming to believe it is coming. Green buildings may become the standard instead of the outlier. Both real estate practitioners and their analyses have communicated that there is only a short window of time before incentives and rebates for green buildings transform into requirements and penalties for noncompliance,16 so appraisers should update their training before the real estate market outpaces their skill set. It seems quite certain that LEED-certified buildings will equal green for knowledgeable appraisers.