Mixed Greens: Is Sustainability Sound?

Does investment in green building pay?

Apart from the evidence, to suggest otherwise would put us on the wrong side of history. Our collective intuition, however unscientific it generally proves itself, points to a future where we shall use our resources more efficiently and where technological advances will make that efficiency more cost effective to implement.

blitt chandan1 Mixed Greens: Is Sustainability Sound?

Sam Chandan.

If not because of economics, and certainly not because of investors’ love for the environment, regulation may hasten the adoption of higher standards for building materials and energy performance. San Francisco is a case in point. In less progressive markets, the expectation that what is voluntary today will be the norm tomorrow (or the next day) is supporting the tradability of certified properties.

At least on an anecdotal basis, buyers will opt unequivocally for the green building when choosing between two properties that are otherwise undifferentiated. In an environment where liquidity remains off-kilter, that tradability commands a premium in the valuation. Borrowing a phrase from Professor Norm Miller, who has been among the most active researchers investigating the issue, the green premium may be accompanied by a brown discount.

The green ideology is not equivalent to hard analysis. The latter evaluates the cost of investment in materials and technologies, either for new properties or refurbishments and retrofits, against the cash-flow benefits. Apart from lower operating costs, the environmental benefits of green—such as cleaner air—may be internalized by tenants in higher productivity and captured in upside revenue.

From a practical perspective, quantifying the return on green investment is difficult. Because LEED-certified assets are generally newer or recently renovated, higher valuations for these properties may reflect the correlation of green status with other desirable property characteristics.

The findings of the research are mixed, in part because some investments are far more costly than the operational benefits while the balance is reversed for investments that are chosen with a stronger eye for fundamentals. In at least one case, Dwight Jaffee, Richard Stanton and Nancy Wallace determine that Energy Star certification may not enhance value once robust controls are introduced for a property’s cash flow and capitalization characteristics.

It is important to state that green and green-certified are not equivalent, even though they may be bandied as such. Why certify? The quality of properties’ energy-use characteristics is not directly and easily observable. If buyers value green but are not able to discern the green status of their various acquisition targets, information asymmetries will interfere with the efficient functioning of the marketplace. To correct for potential or realized market failures, certification allows for a reliable signal of quality and becomes valuable in itself.

Research by Charles Corbett and Suresh Muthulingam, undertaken at UCLA, evaluates LEED certification, not simply as a binary function, but in terms of the gradations facilitated by the certification process. They assess whether “signaling or the pursuit of intrinsic benefits dominates organizations’ decisions to adopt the LEED standard,” but find that neither one has explanatory value in isolation. Testing alternative model specifications, they ultimately suggest “a significant part of LEED certification behavior is driven by signaling considerations.”

The results of the Corbett and Muthulingam analysis may be impacted by the vintage of their study, which was undertaken in 2007. In a more recent analysis, Prasant Das, Alan Tidwell and Alan Ziobrowski show that the value of green is dynamic rather than constant. While they do find that green properties command rent premiums over their comparables, they also find that the premium changes over time, concluding that “green property rents may provide a hedge in down markets.” With that in mind, data from the downturn and current recovery should feed increasingly robust analysis to support our notions of green’s value as we move forward.


Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.

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