Thursday, April 30, 2009

Green Building Economics 102: Affordable Green Housing

The key takeaways from my last post on green economics is that green building is more valuable and many people are willing to pay more for green buildings. This is great for the high-end of the market, but what does this mean for affordable housing? Obviously if green housing is more valuable, i.e. more expensive, this means green housing might be less affordable for potential buyers. How can we balance the need to keep green housing affordable with the green economics I presented last time? That is the focus of my post today.

(In this post, I will make the assumption that affordable housing is owned by the occupant. Of course, this is not always the case, but this simplifying assumption doesn’t actually change the underlying economics and makes it easier to write this post. If you are interested in how this would apply to renters, please email me and I would be happy to talk with you.)

Affordable housing in China
In China, as elsewhere, “affordable housing” usually means keeping upfront cost as low as possible. A pillar of China’s affordable housing program has been government subsidized development of affordable housing under the 经济适用房 or “Economical and Comfortable Housing” program. This program consists of a combination of subsidies in the form of land grants and reduced taxes and caps on developer profits to keep upfront prices low. For more info on this policy, see this Harvard Joint Center on Housing Study report (PDF). Although I am not an affordable housing expert, this program seems to have been pretty effective in creating affordable housing: in 2003, for example, Economical and Comfortable Housing accounted for nearly a quarter of all housing units sold in Beijing. Despite these successes, China still does not have enough affordable housing to satisfy its lower- and middle-class populations and the government is trying hard to fix this situation. The government is embarking on the construction of 7.5 million affordable urban homes between now and 2011, and an additional 2.4 million affordable rural homes.

On the surface, this approach of minimizing upfront costs makes sense. Certainly, those less well-off will have less ability to save and purchase homes. So subsidization means that more families are able to afford the down payments needed for these home. However, this narrow focus on upfront cost ignores any element of lifecycle costs. In many cases, the cheaper upfront option is actually much more expensive over its lifecycle, and in some cases, significantly more expensive.

In the case of this affordable housing program, I suspect that something like this happens: the developer designs the building one way and convinces the authorities to allocate his pre-determined profit margin based on those estimated costs. When it comes time for construction, the developer then has an incentive to cut as many corners as possible in order to reduce costs and max out profit. This is certainly a skeptical view, but given the compliance rates I showed in a recent post, this is unfortunately a likely reality.

The result? In most cases, the developer uses cheaper insulation and poorer insulating materials. The developer then sells off the property and washes his hands of any responsibility for the long-term operating costs of the building. The new owners, who were ostensibly buying this home because it was affordable, are now saddled with an energy inefficient home. Every year for the life of the building, the new owners will have to pay more in utility costs. Moreover, when it comes time to sell, what do you think will happen to the value of this home? That’s right, it will have depreciated greatly thanks to poor quality and high energy bills. So as we can see, even though this home was cheaper upfront, it carries a much larger lifetime cost. Who could call this affordable?

What does affordable really mean?

In order to properly define affordable, we must move beyond this narrow definition of affordability and consider total cost of ownership (TCO). TCO measures how much it costs to occupy a house or apartment annually, and includes everything from rent (or mortgage) to utilities, maintenance and taxes and can even include transit fees related to daily commute. Using this definition, homes with lower TCO are affordable, while homes with high TCO are not. After all, an avoided expense is just as good as money in the bank, in the sense that both increase a citizens ability to save and spend.

Total cost of ownership for green homes is lower

As I said in my post on green economics last week, it’s obvious that operating costs for green buildings are lower than comparable buildings. Therefore, it also makes sense that TCO for green homes should be lower than their energy-guzzling brown counterparts.

A recent study by Michelle Kuafmann, a green home guru in Northern California, confirms that TCO is lower for green homes. Even with a 3% cost premium for green features and the larger resulting mortgage, green homes still cost less, thanks to lower utility bills. Unfortunately, the increase in mortgage costs due to the green premium drowns out a lot of the utility bill savings, resulting in a pretty meager $2 in gross savings over the conventional building. (Note: Unlike the US, China does not have tax deductibility of mortgage interest, so ignore the net calculation here.)

But in fact, Kaufmann’s analysis understates the case for green building, at least in the US. As I mentioned before, insurance companies are offering lower insurance rates for green homes and some banks are offering lower interest rates. Most green homes focus on proximity to public transit, which means shorter commute times and less commuting expense compared to their sprawling brown counterparts. Furthermore, as energy and water prices rise in the future, this TCO case for green buildings will get even better.

How to get from here to there?

It’s clear that green homes have much lower TCO than their brown counterparts. But unfortunately, this doesn’t change the fact that green homes often cost more upfront. And although we should focus on TCO when analyzing affordability, this doesn’t mean we can totally ignore upfront cost. So how can we minimize TCO while keeping upfront cost low?

We can use two primary policy tools: incentive alignment and green financing.

First, government could and should require developers of affordable housing to have a long-term stake in the operating cost of the buildings. Government could set up a scheme whereby developers guaranteed some sort of typical level of energy costs for the residents. Any costs above this amount would be borne by the developer, and any savings below this amount would be split between the developer and the tenant. This would give the developer a big incentive not to cut corners and save energy over time. If government is interested in lowering TCO as they should be, this policy would be a useful lever to align the incentives of both developer and tenant.

Second, government should encourage banks to step up their green financing programs for customers to purchase green homes. Banks should offer a mix of lower interest rate “green loans” that will lower TCO further and also larger loans that will help reduce the upfront cost to purchasers. The mortgage is almost always the largest expense on a home and lower interest rates would further lower TCO. For example, let’s take another look at Michelle Kaufmann’s numbers. In the analysis below, I used the same figures but assumed the bank offered a 0.25% interest rate reduction for green homes. As you can see, this frees up significant savings, bringing the cost advantage for green from around $2 to nearly $87.

This type of green financing program is not unprecedented in China. The Chinese government has been using green loans to encourage other sectors to go green, but hasn’t done much for green financing of buildings, and nothing for green financing of affordable housing. Hopefully Chinese banks will expand this to individual customers, particular those in the lower- and middle-income brackets.

The future

Eventually, I think building a green home will actually cost less than building a conventional home. Zeta Communities, for example, is working on making pre-fabricated net-zero housing that costs less than standard brown housing. But until these cost breakthroughs occur and green buildings are superior on both total cost of ownership and upfront costs, government policy will have to help drive adoption.

Wednesday, April 22, 2009

Green Building Economics 101

As promised, today’s post will describe the economics of green building and why green buildings are so much more valuable than their brown counterparts. I will follow this up with a post describing how developers can use these economics to make affordable green housing work financially.

How to value real estate- DCF basics
The Discounted Cash Flow method and the Direct Capitalization method are the fundamental tools for valuing real estate investments and I will use that to inform the discussion today.

The Discounted Cash Flow (DCF) valuation method attempts to account for all future cash flows from an investment and discount them to a present value. So to make that more concrete, let’s say I buy a building today. I can assume I will get rent every year for the life of the building, and also assume that I will have to pay expenses over the same period. The difference of the rent income and the expenses is my profit. But as everyone knows, a dollar of profit today is a lot more valuable than a dollar of profit in the future, so we have to discount the future cash flows to today’s value using the time value of money. We also can’t be certain that we will continue to receive rent in the future, so we should also discount the future cash flows to reflect this uncertainty.

The DCF is the best theoretical way to value real estate, but it is somewhat more complex than the direct capitalization method I will focus on today. Direct capitalization generally captures nearly all of the important nuance of DCF, but does so in a much easier-to-understand formula. Therefore, I will focus on capitalization today. But if you want to understand more about the differences between capitalization and DCF, please see this article or email me.

The direct capitalization method involves taking the current net operating income (NOI) of a building and capitalizing (multiplying it by a large number- generally between 10 and 20) to reflect the face that this income will continue into the future
So the direct capialization valuation method works like this:

  1. To calculate NOI, we simply add up all of the revenues (rent and other revenue) and then subtract all of the operating expenses (management fee, utilities, etc). It’s important to note that we only subtract operating expenses, so we don’t subtract things like taxes or interest payments. Although obviously important, these expenses don’t factor into NOI.

  2. We then take the NOI and divide it by a capitalization rate. The capitalization rate is a percentage that takes into account 3 things: NOI will continue indefinitely into the future and in many cases grow over time; future NOI needs to be discounted to today’s value; future NOIs need to be discounted for risk and uncertainty. Capitalization rates are generally between 5 and 10%, but can be lower or higher depending on circumstances.

So then, the value of a building is roughly equal to:

Other valuation methods

Of course, DCF and direct capitalization are not the only valuation methodologies. Another extremely useful type of valuation tool is comparables. Comparables involves taking two or more similar assets and comparing their values. If, for example, we wanted to value Prosper Center, we could use the value of the neighboring Kerry Center as a proxy. For example, Prosper Center and Kerry Center should have similar capitalization rates. Of course we’d have to do slight tweaks to account for variations, for example, but their valuation should be in the same ballpark (although as I will show Prosper should have a lower cap rate since it's green and Kerry is not).
Comparables is a very good way of valuing marketable assets, but I will leave this valuation method aside and focus primarily on DCF today.

Another valuation method often used by real estate developers is simple payback period. Simple payback period measures how many years it takes to recoup an investment. One knock on many green systems is that they have a long payback period. Since many developers usually have a limit on their desired payback period, say 5 years, they often will not make investments that have longer investments.

While it may be true that some green building systems have long payback periods, this totally misses the point in my mind. Simple payback period makes no sense as a rigorous valuation tool for several reasons. First and most importantly, payback period has no concept of revenues. For example, imagine an investment that required $1 today, and then made no revenues for the first 5 years, but made $1,000,000 in the 6th year. If a developer were to strictly use the simple payback period with a 5 year limit, they would miss this clearly profitable investment. This may be an extreme example, but captures a serious flaw in the simple payback period method of valuation. For this reason, I do not consider the simple payback method to be a useful method of valuation. While it generally is true that investments with short paybacks have good returns, it is not necessarily true that investments with longer payback periods do not have good returns.
Therefore I will ignore simple payback entirely and focus instead on direct capitalization today.

How green building drives increased building value
One more time, direct capitalization works like this:

As we can see from this equation, in order to maximize value, we need to maximize revenue, minimize costs, and minimize the cap rate. Green building helps do all three of these things, and in turn increases building value.

(Note: for this discussion, I will assume that we are talking about an office building, where tenants rent the building on a gross lease, i.e. one monthly payment from the tenant to the landlord that covers utilities, maintenance, insurance, and taxes in addition to rent. Other lease structures, such as triple net, are more common, but the green valuation issues remain the same. Please email me or use the comments box for any questions that relate to different lease structures and I will be happy to respond.)

Reduced costs
The first way green buildings increase building value is through lower operating costs.
Obviously, a green building that uses less energy will have lower utility bills. Since LEED rated buildings on average use 33% less energy than regular buildings, this means utility costs are about 33% lower. Since utilities account for ~25 to 30% of an office building’s operating expenses, this adds up to big value. Smaller water and waste bills also make for better economics.

Green buildings can also lower other less-obvious expenses. For example, the Fireman’s Fund, a leading insurance company, offers lower insurance rates for LEED certified buildings. Other possible cost saving measures for green buildings include lower interest rates through green banks (although again this doesn’t affect NOI, only returns to the owner) and lower maintenance costs thanks to smaller systems and better commissioning processes.

The result is less operating expenses for green real estate, which means higher building value.

Increased revenues
Green buildings also benefit from higher revenue, primarily through increased rents.

Several recent surveys and studies show that green buildings command higher rents. A study by economists for the Berkeley Program on Housing and Urban Policy showed that green buildings on average rent for 2-6% more than their non-green counterparts, after controlling for other variables like location and building age. This green premium even exists in China, where a recent JLL report shows that nearly 70% of high-end real estate tenants are willing to pay more for green real estate.

Why do green buildings command these premium rents? Two reasons primarily. First, workers in green buildings are more productive than workers in brown buildings. Thanks to more daylighting, higher air ventilation rates, improved indoor air quality, and other attributes of green real estate, occupants of green buildings tend to be more comfortable and more productive. The US Green Building Council website links to numerous studies showing that productivity in green buildings is higher. Since green real estate space is more productive than regular brown space, tenants are willing to pay more for the productivity benefits. This productivity-driven rent premium for green buildings will continue, as brown buildings just cannot match the many productivity-boosting benefits of green buildings.

Second, the supply of green buildings is low relative to demand, meaning the large and growing number of companies who want to occupy green space need to pay a premium to get access to the limited supply. This likely will not persist much longer, since the supply of green buildings will expand dramatically. However, what we will see then is a switch, whereby brown buildings actually require a rent discount in order to lure tenants away from the abundant supply of green buildings. So this will also guarantee continuing premium rents over brown buildings.

Since higher rents means more NOI, higher rents therefore drive higher value for green buildings.

Lower cap rate
The capitalization rate is essentially a measure of the future outlook of the property. This includes both expected growth in NOI as well as the perceived risk of future NOI. On both accounts, green buildings do better and therefore should receive lower cap rates.

Let’s first look at expected growth of NOI. As more and more companies demand green real estate and are willing to pay more for the productivity benefits, I think it’s safe to say that we can expect rents and NOI at green buildings to grow faster than those at brown buildings. Or conversely, when green building becomes the norm, very few tenants will be willing to pay the same price for brown real estate, meaning negative rent growth for many brown properties. The result is still faster NOI growth for green buildings, and therefore lower cap rates.

Green buildings are also less risky than their brown counterparts. Since green buildings use more advanced building techniques and are more likely to satisfy the needs of tomorrow’s tenants, there is less risk of functional obsolescence for green buildings. Moreover, thanks to lower environmental impact, green buildings also face less regulatory risk. The result? Again, lower cap rates for green buildings.

Green buildings have higher value
So let’s take these results and run through a quick thought experiment. Let’s start with a hypothetical building with rent of $1,500,000, expenses of $500,000 and a cap rate of 10%. Now what happens when we take the same building but assume it’s green? Well now rents will be 2-6% higher, utilities will be 33% lower, and I'll assume the cap rate will be lower by 0.5 - 1%. As we can see from my calculations below, we get a big value increase.

At the low end, we should expect green buildings to be worth 12% more, and at the high end, green buildings could be worth as much as 25% more than their brown counterparts. Of course this is just a hypothetical example, but the takeaway is clear nonetheless: green buildings are more valuable.

What does this mean for developers and owners?
For developers, I think this means build green from the start. Even for developers who build to sell immediately upon completion, green building is still compelling. The purchaser of the building will have an interest in owning for the longer-term, and should be willing to pay more for green. So even if developers don’t believe the 12% valuation premium example that I laid out above, it seems they can easily get 5+% for all of the reasons I described. This means as long as that developers can hold the cost premium for green below this 5%, they will be making more money than they otherwise would by building brown. If a developer can build green at 5% but get a 10+% valuation increase, well, now the developer is really doing well financially (not to mention socially and environmentally). As more developers start to understand green building economics, I think building green will become increasingly more profitable and eventually become the only way to build.

For owners, I think this means retrofitting to green standards right now. As my hypothetical calculations showed, the benefits of retrofitting and getting green certification are huge. Not only will the building benefit from higher rent, lower operating costs, better corporate image, less risk, etc etc, but it will most likely pay for itself through immediately increased building value. For example, if a building owner could perform a large retrofit on a building for 10% of the building value, the investment would immediately pay for itself thanks to higher post-retrofit building value. Although increased building value isn’t exactly the same as cash in hand for the building owner, the increased building value provides significant security for this investment in energy efficiency and green features.

The bottom line is that green building makes sense for the bottom line. As more and more developers, owners and tenants realize this, I expect to see green building become the norm for those who can afford to pay for the green benefits, particularly those in Class A office buildings, luxury apartments and international quality industrial facilities. The trick then will be to figure out how to make green building economics translate into something that works for those other sectors of the market that I’ve been talking about so much recently. Stay tuned for my next post for some initial ideas on how to use these green building economics to make green building affordable- and widespread.

Upcoming green building events

Dear China Green Building watchers-

I just want to quickly alert to you a few great green building events that are taking place over the next few months.

First up is Scaling Up: From Green Buildings to Green Cities in the U.S. and China.
The event will be held on Friday, May 1st in San Francisco and is being sponsored by the Asia Society, who incidentally has been really making a move into the green China arena with their recent reports on climate change and water security.

Second is Green Building Summit: Greentech Media's Forum on the Future of Building. The event will be held on Thursday, June 11th in Menlo Park. Greentech Media is a great source of info for all news related to cleantech, and does some great coverage of Serious Materials and the other emerging green building cleantech companies.

Next is the China Eco-Expo, held June 18-20 in Beijing and sponsored by the Ministry of Construction (although it's interesting to note that the MoC no longer exists, having recently changed names to MOHURD- Ministry of Housing and Urban Rural Development.)

Last, but certainly not least, is GreenBuild Asia 2009. This event will be held July 7-9 in Hong Kong.

UPDATE: China Sustainable Building Summit 2009 to be held June 29- July 1 in Shanghai.

If there are any other green building events in Asia or the US, please let me know and I will be happy to add them to this blog post. Thanks!

Tuesday, April 14, 2009

Two Pronged Approach: Top Down

This is the last of a three part post on my two-pronged approach for greening China’s buildings. The two-pronged approach consists of both a bottom up and a top down strategy for transforming the market for green buildings in China. The first post focused on how China achieved its success with LEED buildings thus far and what this says about market dynamics. The second post described the need for bottom up green leadership by real estate developers and some policy steps to encourage this. The third post will make the case that particularly in China, this bottom up approach is not nearly enough and introduce a top down approach to supplement the bottom up approach.

In last week’s post, I described the power of the bottom up approach to transform the Chinese real estate market and make building green standard. This assertion rested on two main ideas, or feedback cycles as I referred to them. First, as the building industry develops the capacity to build green, costs will come down to the point where there is no perceived cost premium for green. Second, as tenants become aware of the benefits of occupying green buildings, they will demand green buildings in large quantities. I really believe this framework will transform the market for green buildings in China. However, even if this bottom up effect works exactly as well as I describe, there is still an unfortunately large minority of builders who will refuse to adopt green building practices until they are forced to by policy. The top down approach, therefore, focuses on ensuring that green is adopted by all, even those who otherwise wouldn’t want to adopt green methods.

The Laggards
Laggards are those who lag behind in adopting new practice. Everett Rogers first created this theory in his seminal work Diffusion of Innovations, which Malcolm Gladwell then popularized in The Tipping Point. In this case, I refer to the laggards as those who won’t adopt green building practices even after the market has been transformed and green buildings are the norm.

Unfortunately, the real estate is particularly noteworthy for having laggards. The World Business Council for Sustainable Development recently conducted a survey of over 1400 building professionals (developers, architects, engineers, building owners and corporate tenants) in eight countries, including China. This chart below shows the responses to the question: What do you as see the role of your company in the adoption of sustainable building practices?

This data provides a useful reality check for my bottom up approach. First, it shows that innovative developers are out there. Second, more than 25% of building professionals adopt practices as soon as they are tried and tested. A further 25% of building professionals then adopt practices incrementally. This is an extremely large nascent base of buildings who will adopt green building practices as soon as leading edge developers prove them. This data matches well with the trend lines that Rogers’ described above- with the first group as the innovators, the second group as the early adopters, and the third group the early majority. Moreover, significant adoption of green building by the first two groups has a strong chance of influencing the behavior of tenants and activating the “demand side” feedback loop that I mentioned in my first post. As this demand side snowball is activated, clients are likely to demand green features in many of their projects. This makes it likely that the “late majority” of those who only adopt practices as clients require it will adopt green building practices relatively soon after the early majority.

The real problem though is the embarrassingly large group of laggards: nearly a quarter of global building professionals adopt innovations (and presumably green building practices) only as required by policy! It’s sort of sad because this group of laggards is larger even than Rogers predicts (he predicts 16%). But it’s really sad because, absent good policy, these laggards are allowed to build polluting, energy hogging buildings that will last for decades.

Application to China
As bad as the WBCSD chart makes it look for laggards globally, builders in China can be even worse. To get a realistic look, we should probably add even another line to the bottom of that chart: Not even adopting practices as regulations require. This is an allusion to the extremely poor building energy code compliance in Chinese buildings.

As the data shows (PDF), compliance with energy codes in China is poor throughout the country. The disparity between design and construction compliance also shows the willingness of developers to “cheat” when faced with the perception of increased costs. Given that many Chinese building dont even currently comply with mandatory building energy codes, it seems unlikely that these developers and owners will be willing to voluntarily take the jump to green buildings.

The need for policy with teeth
Therefore, the Chinese government must step in and force these laggard developers to improve their energy efficiency. The current mandatory building energy code, which mandates 50% savings over 1980 levels for new buildings, is a good start. But now the hard work of actually enforcing this code must begin. Several US groups, including NRDC and the US DOE Pacific Northwest National Laboratory,are working with Chinese government to help them develop the capacity needed to enforce the codes.

Enforcing the existing code is necessary, but not sufficient; the Chinese government will have to do more. They will have to continually raise the bar on this standard, and more importantly, make sure that these codes are enforced. Ideally, government policy will set an ever-increasing minimum standard for environmental performance that looks like this:
This government policy can be complemented by a host of other measures, many of which are described in a terrific recent report by the Renewable Energy and Energy Efficiency Partnership. But the fundamental goal of the top down approach is to force the laggards to improve the environmental performance of the built environment.

The goal
When the bottom up and top down approaches are combined, we will get consistent improvements in environmental performance across the market, from the top end to the bottom end, from innovators to laggards.

Ultimately, some variation of my two pronged approach is necessary to transform the market in China. This will involve leading developers and the government striving for great environmental performance across the market: Class A office, government buildings, workforce housing, etc. This push will eventually lead to snowballs in these markets, causing transformations that result in green building becoming the norm. We must not forget the reality of laggards though, particularly amongst developers in China. The government will have to step in and mandate and ensure compliance with energy and related environmental codes. China is already taking good first steps in this direction with the LEED snowball in the Class A office market and the national building energy code. Let’s hope they now quickly start taking the next steps so sorely needed to transform the market and ensure a green future for the Chinese built environment.

Friday, April 10, 2009

Two Pronged Approach: Bottom Up

This is the second of a three part post on my two-pronged approach for greening China’s buildings. The two-pronged approach consists of both a bottom up and a top down strategy for transforming the market for green buildings in China. The first post focused on how China achieved its success with LEED buildings thus far and what this says about market dynamics. This second post will describe the need for bottom up green leadership by real estate developers and describe some policy steps to encourage this. The third post will make the case that particularly in China, this bottom up approach is not nearly enough and introduce a top down approach to supplement the bottom up approach.

As I argued last week, LEED buildings in China’s Tier 1 Class A office markets are beginning to snowball and will continue on this path thanks to the self-reinforcing nature of this type of growth.

But where are the snowballs in the other parts of the market? Unfortunately, nowhere to be found. It’s possible that the LEED snowball will eventually trickle down from the Class A market to the broader Chinese real estate market, but almost certainly not fast enough to help solve the climate crisis in any meaningful way. So how do we create snowballs in all the other parts of the market today?

The need for demonstration projects
The positive feedback of snowballs means that we can “track” the development of these types of markets. Just as with natural ecological cycles, snowballing systems have growth and expansion. It’s almost as though each LEED building in China has spawned two more. This simple chart tracks LEED development in China, but a similar chart could be built for New York City or Portland, Oregon where LEED has really taken off.

A corollary from the snowball discussion then is that the snowball cannot start until some green projects are built. Demonstration projects like ACCORD 21 are critical to transforming the market because they activate both snowball cycles. As tenants of ACCORD 21 begin to understand the many benefits of green building occupancy, word spreads and demand for green building increases. At the same time, the design, construction and operations teams get hands-on experience with green building and knowledge about green building best practices. As this information is institutionalized and disseminated, the premium for green building comes down, further increasing demand.

The bottom up approach therefore focuses on using targeted demonstration projects to create snowballs in the still untransformed sectors which make up the bulk of China’s real estate market.

Developers must lead the way
The fundamental motive that drives real estate development and investment in China is profits. At the end of the day, most Chinese developers value profits above all, no matter how much their marketing may say otherwise.

This profit motive is one of the main reasons why developers and owners have been reluctant to build green buildings. Since most developers have been making good money building energy inefficient buildings for the past few decades, they are quite competent at making these types of buildings. Therefore, changing the process to build green looks like a needlessly risky and costly process to these developers.

In fact, in many cases, every successful project that a developer builds makes the developer that much less interested in changing their process for the next project. “Hey, I made money last project. Why fix something that ain’t broke?” The best way to make the process of building brown buildings “broke” is for leading developers to make more money by building green. Only when green is seen as the more profitable way to build will it start to snowball. And once it snowballs, it will eventually force all market participants to build green.

Leading green developers, therefore, need to step up and start building green projects across all sectors of the market and show that the economics do work (I’ll do a post on green building economics 101 next week that will show why green buildings are so financially superior to brown buildings). They’ve gotten off to a good start at the high end of the market (Pearl River Tower, Vanke Center, Linked Hybrid, Prosper Center, etc). They now need to move this down-market and expand their reach. At the end of this post, I will describe what sorts of projects should be prioritized.

Will this take a few developers to step up and take a little risk? Yes, absolutely. But the rewards could be huge, especially if they believe my snowball theory of green buildings.

Just because it’s “bottom up” doesn’t mean the government has no role to play
Government as occupant
The Chinese government must also make the commitment to greening their own buildings.The government owns and occupies a significant amount of real estate in China. Think of the many buildings occupied by central, provincial and local authorities throughout the country. Although hard statistics are not available, this has to account for a significant portion of total building energy use.

The Chinese government, through their role as an occupier of building space, should “walk the walk” and start demanding green space. ACCORD 21 was a good start, and the government should extend this target for all government buildings, both new and existing. This would have a significant effect on the green building market in China and push the private markets to start snowballing. The building professionals who green the Chinese government buildings will get hands-on experience that can be institutionalized and disseminated, lowering the costs of green building for everyone and bringing the market closer to snowball.

Ideally, the Chinese government would seek Three Star ratings and help drive the uptake of the locally-made rating system. This type of action has international precedent: the General Services Administration, the landlord of the US federal government, played a similar role in pushing LEED by requiring all new buildings to be built to LEED standards. The GSA now occupies 30 LEED certified buildings and has many more registered to seek certification.

Government as policy maker

The Chinese government should encourage their big developers to build the green demonstration projects I argued for earlier in this post. China can do this in two primary ways. The first and more obvious way is through financial incentives. Tax credits, rebates, low-interest loans, and other carrots can be given to developers to lower the cost of these demonstration projects and encourage developers to build them.

The second way is for the Chinese government should also apply subtle (or even not-so-subtle) pressure to developers to start building the demonstration projects that are so sorely needed. In some cases, this type of pressure could be enough for an already forward thinking developer to go ahead and do a cutting-edge demonstration project.

The Chinese government could also apply pressure to large state-owned enterprises to adopt policies that mandate occupying green buildings. This would help activate the tenant demand side of the snowball cycle and encourage more developers to supply green buildings in order to meet the increased demand.

What markets need snowballs?

Green workforce housing
The primary starting point for demonstration projects should be green workforce housing, or affordable housing. Given the intended market, these demonstration projects should focus on minimizing costs by using no- and low-cost green building technologies. These buildings would absolutely use passive solar design techniques, with a focus on high quality insulation, daylighting, and building orientation. These projects would probably use solar hot water heaters and combined heat and power technologies. These types of green housing projects are not meant to be a show of technical or architectural wizardry, but instead should focus on showcasing how cheap and efficient green buildings can be.

These projects will resonate with middle class Chinese consumers who appreciate the energy saving cost benefits of green buildings as well as the health and environmental benefits of green buildings. As understanding of the benefits spreads, the demand side of the snowball will be activated. Simultaneously, the building professionals responsible for putting the building together will learn low-cost green building techniques, activating the supply side of the snowball.

Sustainable communities
Given the massive rural-to-urban migration currently underway in China, sustainability will have to eventually move beyond just greening single buildings and eventually focus on delivering sustainable communities. It is therefore extremely encouraging to see projects like Dongtan Ecocity and the Tianjian eco-cities, but these projects still need to be completed and proven. Hopefully many of the other eco-cities that are currently on the drawing board (EcoBlocks, for example) will also move from plan to reality.

And we shouldn’t forget that although most Chinese will be urban residents by 2030, many will still live in the countryside. Healthy and efficient green rural housing should be pursued.

And last but certainly not least, China must start retrofitting its existing buildings. I’ve mentioned before how poor insulation is in Chinese buildings. Upgrading this insulation and performing related retrofits is a win-win-win-... strategy that provides more of what’s good and less of what’s bad. More comfort. More jobs. Less energy waste. Less coal power plants. Less air quality problems. Where does this start? Well, again, government as occupier will play a big role here. The governments existing space footprint is huge, and they should take the commitment to upgrading their buildings and using less energy. Big real estate owners should also upgrade their holdings. I recently blogged about how owners like CapitaLand and Soho could even try to pursue CDM credits to sweeten these retrofit investments. ESCOs will also play a role here.

The payoff

What will be the result? Hopefully, green snowballs in each and every real estate market in China. As leading developers and occupiers start to transform the market and increase overall environmental performance, the targets will just keep getting higher and higher.
The goal now is retrofits and green workforce housing, but if and when green eventually becomes the norm in China, these goals will ramp up further. The Chinese government and China’s leading developers should step up to the plate and take the first steps needed to make this green vision a reality.