In this issue of CoStar Green Report, we take a look at a good report card for REITs embracing green development, and an insurance company improves on its pioneer program to insure green builder risk.

UBS Gives Thumbs Up to Public Co. Green Efforts

After absorbing some upfront costs and taking a few halting steps up the learning curve, REITs invested in green development should begin to realize savings and other benefits over time, according to a study by New York securities brokerage UBS.

Of the 300 REITs in the U.S., 41% are actively pursuing energy efficiency and green building upgrades and another 27% plan to do so, said UBS, citing the industry newsletter Progressive Investor.

As the cadence from governments, tenants, customers and the public continues to get louder for green practices, REITs will face increasing pressure to implement sustainable initiatives -- and early adopters such as ProLogis (NYSE: PLD) and AMB Property Corp. (NYSE: AMB) in the industrial sector, Thomas Properties (NYSE: TMPG) in office, Regency (NYSE: REG) and Simon Property Group (NYSE: SPG) in retail and American Campus Communities (NYSE: ACC) in student housing will have an edge.

"We believe the green movement will continue to gain momentum as pressure from governments, tenants, customers, shareholders, and the public continues to grow in the coming years," said the report authored by James Feldman, Alexander Goldfarb, Jeffrey Spector and other analysts for UBS’s REIT team. "We also think the green movement will see significant growth as more companies begin to realize the environmental benefits as well as the long-term cost savings associated with green building."

The REIT industry is catching on not only because green is a socially responsible practice, but because it is an investment opportunity that yields long-term benefits, according to UBS. The office and industrial sectors are the most advanced in greening their development pipeline.

"What we’ve found from the REITs most active in the space isn’t that they wanted to do it because they wanted to be in green construction. They did it because they wanted to make the right business decision, and it just so happens with their tenant base, green happened to be the right move," Feldman told CoStar Group. "Our view is that these buildings should stay occupied better because you now have a tenant base of both those that now require green of their landlords, and those don’t require green but love the idea of lower utility costs. They're all going to flock to the green building first."

Today's warehouse and distribution center, for example, are north of 1 million square and run 24/7, so the better temperature control and lighting efficiency they have, the happier tenants are going to be, Feldman said.

"To be honest, the less [tenants] have to pay in utility costs, the more they can pay in rent," he said.

The UBS report recognizes the obstacles in the road toward green construction. According to McGraw-Hill’s Green Building SmartMarket report in 2005, 64% of 400,000 architects, engineers, and contractors surveyed agreed that higher initial costs are the most common barrier toward green building.

Hard construction costs for Leadership in Energy and Efficiency Design (LEED) certification range from up to 2% for basic level certification, between 4% and 6% for Gold certification, and to above 6% for the highest level certification, platinum, according to research cited in the report by Tucson, AZ-based sustainability consultant Jerry Yudelson, chairman of the U.S. Green Building Council annual conference. Yudelman was most recently named as research scholar for retail sustainability for the International Council of Shopping Centers (ICSC).

Soft costs such as design and certification services can range from up to 10% more expensive for an architect, to $25,000 for a LEED consultant, a minimum of $20,000 for building commissioning and up to $17,500 for actual LEED registration and certification, according to Yudelson’s study, "LEEDing the Retail Sector Green."

Yudelman also notes that developers have found that these costs decline over time as they gain more experience with green projects.

"We think the long-term benefits of incorporating green products will offset the higher initial costs and result in significant expense savings," UBS said in its report.

There are also the well-established benefits of energy savings. Green buildings can reduce energy costs by up to 30% with existing energy-efficient technology, according to the U.S. Department of Energy. The McGraw-Hill study found an average expected decrease in operating costs of 8% to 9% across the industry, a predicted average increase in value of around 7.5%, and average return on investment expected to rise 6.6%.

Meanwhile, with tenant demand for green building at a peak, the occupancy rate is expected to increase by 3.5% and rents in green buildings are expected to increase by an average 3% across the industry, according to the research cited by UBS.

Among the less tangible but no less important benefits of green buildings are their appeal to socially responsible investors: improved sales and lease up of green buildings; enhancement of a company’s image and marketability; improved recruitment and retention of key personnel, and increased workforce satisfaction.

Other incentives range from tax credits for certified buildings to perks from financial institutions and expedited permit processing from state and local governments.

Insurance companies also support green construction, as there is generally less risk in buildings with state-of-the art technology that provide higher appraisal values and a healthier work environment. One company cited by USB as a leader among real estate service providers, Novato, CA-based Fireman’s Fund Insurance Co., has pledged that if there is a fire in a building that has been selling renewable energy back into the grid, the insurer will pay for the loss of income.

Insurer Sweetens Green Policy Benefits

Speaking of Fireman’s Fund, the company this week introduced new green amendments to its "builders' risk" insurance policy. A year ago, the insurance company launched its Green-Gard program, billed as the first insurance product offered for green commercial buildings.

New green buildings undergoing construction and existing buildings undergoing green renovations have unique exposures regarding loss of income and extra expenses that are not covered under traditional builders' risk policies, the company said.

"It may be more expensive and take longer to bring buildings back to peak efficiency and use following a loss when the building is to be green certified," said Mike Halvey, vice president, commercial real estate, Fireman’s Fund. "The green amendments to the builders' risk policy will offer real estate owners protection of their green assets and pay for losses to green streams of income."

The policy amendments guard against specific exposures not typically covered by traditional policies for new green buildings under construction and existing buildings undergoing green renovations, including a broadened definition of loss of earnings to include coverage for losses arising from the inability to feed surplus power back into the grid and receive energy credits, and reimbursement for lost rebates from utilities due to damaged or destroyed alternative power generating equipment.

Fireman's has broadened reimbursement of soft costs to cover reasonable building commissioning expenses and other costs associated with green recertification. The definition of "loss of rental value" was broadened to include the additional time needed to match the level of green certification incorporated into the building design prior to the loss.

"Fireman’s Fund supports building owners who are taking part in green initiatives and understands the complex risks that coincide with sustainable design," Halvey said.

As more building owners move toward green certification, other insurance companies are likely to follow suit in developing products and services, according to a report profiling the Fireman’s Fund’s program by Janice Ochenkowski, managing director, Global Risk Management, for Jones Lang LaSalle.

Determining proper valuation is critical for insuring green or LEED-certified buildings effectively. Any special coverage that is purchased needs to be aligned with property costs and value, according to Ochenkowski's report.

"If coverage limits are higher than necessary, premiums will be unnecessarily high and may impact the investment’s profit margin. Recovery following a loss is limited to the actual loss sustained, so buying a higher-than-necessary limit will not generate a higher claim payment from the insurer."