Environmentally friendly building practices slash operating costs, increase ROI and boost asset values.

By Michael Fickes

Recycled carpet. Fluorescent light bulbs. Monitored lights. These features are coming to a building near you, now that the REIT industry is going green.

Many of the most common challenges faced by REIT executives, such as lowering expenses, meeting tenant demands and satisfying shareholders, can be advanced using sustainable solutions. New initiatives, such as energy-efficient heating, ventilating and air-conditioning systems (HVAC), will assist REIT executives in lowering operating expenses and raise net operating income (NOI).

Liberty Property Trust (NYSE: LRY), ProLogis (NYSE: PLD) and Simon Property Group (NYSE: SPG) are among the REITs leading the charge into the world of sustainable property. In fact, Simon Property was honored with NAREIT’s Gold Leader in the Light Award in November 2006 for its superior sustained energy use practices. ProLogis was awarded the Bronze.

ProLogis’ headquarters uses special lighting controls that cut electrical usage by 30 percent.

Green retrofits made since 2003 will enable Simon Property to save more than $15 million in energy costs during 2007. Next year, Simon Property’s savings will increase as the company retrofits more systems within its 300-mall network and as energy costs continue to rise.

Energy efficient lighting designs are helping ProLogis cut utility costs for its tenants by 25 percent to 35 percent. Although industrial landlords like ProLogis execute triple net leases with tenants, ProLogis still earns returns from the practice. “By reducing tenant utility costs, we make our buildings more competitive,” says Jack Rizzo, managing director of global development for ProLogis.

As for Liberty Property Trust, its renovated green buildings can cut water consumption by 30 percent as well as HVAC costs by 30 percent to 40 percent, says Liberty’s Chairman, President and CEO William P. Hankowsky.

		From Sea to Shining Sea Many local U.S. governments are using a new building code that adheres to Leadership in Energy and Environmental Design (LEED) standards set out by the U.S. Green Building Council (USGBC). Costs and Returns for Green Building Practices Experienced developers say the cost of designing and constructing green buildings from scratch is only nominally more than a conventional building.

Investors Are Turning Green

REITs can attract a whole new type of investor by being energy efficient and embracing other environmental initiatives. According to ProLogis, today’s investors may express a preference for investing in companies with sustainable initiatives.

“We’re seeing more interest from institutional investors with funds focused on socially responsible investing,” says Melissa Marsden, senior vice president of investor relations with ProLogis.

It is becoming more difficult for real estate companies to avoid environmental issues, adds Marc Brammer, director of research with Innovest Strategic Value Advisors, and investment research and advisory firm. “As energy costs continue to grow, they will hit the bottom line.”

In other words, rising energy costs will rise too high to pass through the tenants. At that point, energy costs will begin cutting into NOI. The only solution will be to renovate with energy efficient systems. Just as tenants have begun to expect energy efficiency, so have investors.

According to Bruce M. Kahn, financial advisor with Citigroup Smith Barney, $1 of every $12 invested today goes toward a company that has been screened for some form of social responsibility. “Within this area, we evaluate REITs by how well they manage their social and environmental footprints,” he says. “This area has been growing by about 18 percent per year.”

Energy Efficient Steps Here are recommended first steps in the conservation process: Install ultra-low flow toilets, or adjust flush valves or install dams on existing toilets Install faucet aerators and high efficiency shower heads Install monitors that turn off lights when no one is using a room Install T-8 or T-5 fluorescent lamps Use water-conserving ice makers As appliances and equipment wear out, replace them with water-saving and energy-saving models Eliminate “once-through” cooling of equipment with municipal water by recycling water flow to cooling tower or replacing with air-cooled equipment Rehabilitate an existing building instead of demolishing and rebuilding Reuse salvaged materials and use materials with high recycled content Develop a construction waste management plan Source: U.S. Environmental Protection Agency

Going Green Saves Green

According to the U.S. Environmental Protection Agency (EPA), utility or energy costs account for one-third of the operating expenses of a typical office building. “Those costs are very controllable,” says Stuart Brodsky, national program manager for EPA’s commercial real estate sector in Washington, D.C.

For that reason, Simon Property has decided to focus its efforts on energy costs. “Energy accounts for a high percentage of costs that we can actually control,” says George Caraghiaur, vice president of energy services with Simon Property. “We’ve been managing energy costs without affecting safety or the shopping experiences of our tenants’ customers.”

Tenants Lean Toward Green

Tenants with sustainable initiatives are expecting sustainable, energy efficient systems in the buildings that they lease, says Rizzo of ProLogis. “Most of our tenants have corporate sustainable initiatives,” he says. “We want our warehouses to be a vehicle that helps those companies achieve their green objectives.”

Office and retail tenants also are bringing sustainable issues to their landlords. “Very often, a tenant might lease 500,000 square feet from a publicly traded company,” says John Fleming, director of commercial real estate with Johnson Controls, Inc., a provider of building system controls. “As part of the tenant’s corporate sustainability initiative, they may ask a landlord to reduce energy use in that 500,000 square feet by 20 percent.”

To promote green building practices among landlords, the EPA’s Energy Star program has introduced a free software tool called Portfolio Manager. “Portfolio Manager helps property owners understand how lower energy costs reduce operating costs,” says the EPA’s Brodsky. “Landlords can share that information with prospective tenants to prove that a building with energy efficient systems will cost less to rent than another building with the same base rent but conventional heating, ventilating and air-conditioning systems.”

Brodsky also points out that energy efficient systems can raise building values. “Our research shows that $1 per square foot invested in energy efficiency has the potential to increase the market value of a building by $2 to $3 per square foot,” he says.

Energy Prices Fuel Trend

Surging energy prices also have added fuel to the trend toward sustainable buildings. “One thing that moved the green building trend was the rise in energy prices,” Hankowsky says. “Energy has become so expensive that everyone focuses on the importance of operating expenses as well as old-fashioned rent.”

Rizzo agrees and surmises that the trend will endure, despite previous energy efficient building trends that tapered off when energy prices went into decline. “The reason sustainable initiatives have become important is that oil costs $75 per barrel,” he says. “If you look back to the oil shortages of the 1970s and 1980s, people got serious about conservation for a year or so, but then went back to driving big cars again. This time, corporate citizens believe that it is time to get our environmental priorities in order.”

Sustainable practices have longer-range effects as well, notes Tom Hicks, vice president, Leadership in Energy and Environmental Design (LEED), with the U.S. Green Building Council (USGBC). “In addition to saving money for tenants and raising NOI for owners, a number of studies are showing that sustainable environments improve employee productivity, while working to attract and retain top talent,” he says.

Whatever the cause, energy conservation is well on the way to becoming a hard-nosed business objective for property owners as well as tenants. “The benefits will make green ubiquitous over the next two years,” Caraghiaur says. “We’re happy to have caught this trend at the beginning when it is just getting started.”