Green Building: Great Opp, but Perceived Cost Still a Barrier (Huh?)

Today I was reading the recently released McGraw Hill Construction SmartMarket Report on Global Green Building Trends and found myself again shocked at the massive market opportunity for green buildings in Asia, and even more shocked that more green buildings aren't being provided.

Huge opportunity for profits…
The Asian section of the report starts by noting that Asia is already a $1.4 trillion real estate market, and set to grow as China, Indonesia, Vietnam and the other developing tigers continue to expand rapidly alongside Japan and Korea. Assume 10% of this was green, and we’re talking a $140 billion market…

According to McGraw Hill, most of the growth in green buildings in Asia will be coming from the commercial and residential sectors in the near term, with government, retail and industrial lagging behind but still expanding.

I think this is powerful and shows that tenants and investors are catching on to the imperative to go green. At the US China Greentech Summit last month, Tishman Speyer’s sustainability guy, Steve Latargia, said the credit crunch will not affect Tishman’s drive to go green, saying that if they don’t build green, they wont have any tenants when the recession is over. The same trends are starting now in China and will only deepen as the market matures and more international and leading-end local tenants demand green space.

This demand for green space and a relatively small supply of space in China means that owners of green real estate should start to see a premium for their space. And sure enough, Jones Lang LaSalle reported recently that nearly ~70% of corporate real estate managers are willing to pay more for green real estate in China. This also gels with what Prosper Center has seen, commanding rents 5% above the going CBD rate. And just to drive the point home, 64% of Asian respondents to the McGraw Hill survey expect rapid growth in both sales and profits from green buildings.

…so what’s holding green back?
Higher perceived first costs are the key barrier to green building growth in Asia. In fact, fully 83% of respondents cited this as the key obstacle to further growth of green building. Interestingly, the same percentage of respondents cited higher first costs in America, a market that has much more experience with green construction. So this is a worldwide problem.

I continue to be surprised that the real estate market cannot get over this obsession with first costs, especially because it’s wrong: a recent report by Good Energies (PDF) shows the median cost premium for 150 recently built LEED buildings was a measly 2%, while median annual energy savings were around 30%. That’s a no-brainer investment. Jim Chen of Tishman Speyer China told me they brought in their LEED projects at a 3-5% premium, which is astounding given both the lack of a green product market in China and contractors’ relative lack of experience with green construction.

But second, and most importantly, this green premium is just an amorphous term used by developers and owners to resist change and learning. Most green building professionals now think of the green premium as a “tuition fee”, something a developer has to pay on his or her first few green projects while learning the ropes of green development. I bet that if you were to sift through the Good Energies data, you would find that developers who have done more than 5 LEED projects now pay no premium.

As Scott Muldavin of the Green Building Finance Consortium told me last summer, the green premium is not necessarily an increase in actual hard costs of construction. In most cases, developers have been building buildings the same way for a long time and are loath to change a winning formula. When they do finally begin to build green, they find that to do so successfully requires changing this formula, and they chalk this up to some amorphous, perceived “cost”. And as a result, they don’t do it.

All of this is a huge opportunity for a new type of real estate developer: one who understands integrated design, whole-systems thinking and how to tunnel through the cost barrier and doesn’t just try to tweak the old model to be “green”. With a new model, developers will be able to bring in better buildings at lower cost and outperform the tired, old real estate players who keep talking about upfront costs.