The effects of eco-certification on office properties: a cap rates-based analysis

Abstract

Though the effects of eco-certification on individual property cash flows and valuations have been addressed in previous literature, the question has remained as to the worth investors place on eco-certification, and whether there is perceived value in the capital outlays often needed in order to achieve eco-certification. This paper is the first to provide credible empirical evidence through the analysis of excess capitalisation rates that investors place on increased value on the property-specific benefits of eco-certification. Based upon a data-set of Leadership in Energy and Environmental Design (LEED) and Energy Star-labelled commercial office properties and their non-certified counterparts, this paper investigates the effects of eco-certification on the excess capitalisation rates of commercial office properties. Hedonic regression analysis is used to determine whether premiums in rent and sales price associated with eco-certified properties translate into lower excess capitalisation rates vs. their non-certified counterparts. The results suggest that overall eco-certified properties have excess capitalisation rates that are 0.364 lower than their non-certified counterparts. Additionally, those properties with only the Energy Star label also exhibit lower average excess capitalisation rates, with properties achieving the Energy Star rating post-sale having lower excess capitalisation rates than those purchased with the Energy Star rating in place. However, due to the small sample size, the results surrounding properties that are LEED-only certified or that possess both the LEED and Energy Star labels are inconclusive.

Keywords:

• sustainability
• green labels
• property investment
• capitalisation rates
• energy efficiency

Notes

1. As classified by CoStar.

2. CoStar Group is the world’s largest provider of information regarding commercial real estate in the USA and the UK (CoStar Group, 2012).

3. The number of properties that fell outside of the used 3.5–10.5% capitalization rate range was nominal in relation to the overall sample. Additionally, the majority of these properties reported issues that would affect the capitalization rate outside of the normal expected parameters including, but not limited to, change of use, below market rents, the capitalisation rate including offsets for loan defeasance, pre-forclosure, forclosure, sale set up as an annuity investment and non-credit tenants.

4. 1031 refers to section 1031 of the US Internal Revenue Code which allows owners of certain kinds of assets, held for business or investment purposes only, to defer capital gains taxes on any exchange of like-kind properties.

5. Five properties were identified in the sample as having been sold with capitalisation rates that were incongruous with their class. Based on transaction notes from CoStar, these properties were specifically identified as refurbishment projects, properties with below market rents, or properties sold under extreme legal duress. Analysis of the sample with these properties removed resulted in the expected sign for class, and the overall results were consistent with those found using the complete sample.