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
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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!

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

Source

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.

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.

Retrofits
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.

Two-Pronged Approach for Greening China’s Buildings, Part 1: The LEED Snowball

This is the first 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 will focus on how China has achieved its success with LEED buildings thus far and what this says about market transformation. The 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.

LEED in it’s current incarnation is most certainly not the end goal of the green building movement. LEED doesn’t go nearly far enough: even if every building globally achieved the 33% energy savings common in LEED buildings, the world would still be far from achieving the CO2 emission reductions needed to forestall the worst effects of global warming. However, LEED has been an important stepping stone in the journey toward a green built environment. Importantly, LEED has provided a good real world case study in how to successfully transform parts of the real estate market. By studying how LEED transformed the US real estate market and parts of the Chinese real estate market, we can better design a plan for transforming the rest of the Chinese market and achieving the vision of green buildings for everyone, everywhere.

The LEED snowball
LEED has seen massive growth in the US and globally. LEED registrations, i.e. projects committing to seek LEED certification (and paying money to say so), grew from 1000 in 2006 to over 20,000 in 2009. The Green Building Impact Report estimates that "new construction sector penetrations [are] approaching a whopping 40%." This seemingly unstoppable growth is a lot like a snowball rolling down a hill. MIT’s Peter Senge describes the snowball concept in his recent book The Necessary Revolution:

Snowballs arise from an underlying system structure where change feeds on itself to produce more of the same, and soon it snowballs into a pattern of self-reinforcing growth.

The underlying system structure of the market for LEED-rated green buildings is a snowball with two parallel and complementary feedback cycles that drive growth.

The first cycle is the demand side. As more green buildings are built, tenants begin to occupy that space and benefit from the green features. As these benefits become publicized and more widely understood, more tenants demand green buildings. Thanks to increased demand, developers build more green buildings. The cycle builds on itself, and the result is more green building.
At the same time, there is a parallel supply side cycle. As more green buildings are built, developers and builders begin to learn how to make green buildings better and more cheaply. As a result, more tenants can afford green buildings and therefore demand for green buildings increases. This cycle also builds on itself, and the result is more green building.
More importantly, these two cycles reinforce each other and will eventually result in green building becoming the standard in the market place. The result of this snowballing growth then is nothing less market transformation. The snowball feedback loop helps explain the explosive growth in LEED building. In other words, once the snowball gets big enough, nothing is going to stop it from rolling down the hill. This holds true not only in the US, but also in Tier 1 Chinese Class A markets like Beijing and Shanghai. The same dynamics even seemed to be at work in Dubai before its real estate market collapsed.


The need for snowballs
Interestingly, LEED has achieved this snowballing growth from the bottom up. LEED filled an unmet need in the market place and was able to tap a nascent demand for better, healthier and greener office space. Although the federal and state governments certainly played a role in helping LEED along in the US, the heavy lifting was really done from the bottom up. And in China, besides the Ministry of Science and Technology’s role in Accord 21, almost nothing was done on the part of the government to promote LEED, which illustrates just how thoroughly bottom up LEED’s growth has been in China.

In my next post, I will build on these principles of snowballs market transformation to introduce the “bottom up” approach to achieve snowballing growth in the Chinese building markets that are currently being left untransformed.

Green Buildings for Everyone, Everywhere: How China Can Achieve This Vision

I was recently in Hong Kong and Macau at the Fulbright midterm research conference. When talking with my fellow Fulbrighters, I was often asked to describe my research findings about green buildings thus far. This event was a great chance for me to reflect upon what I’ve learned about green buildings during my time in China. Sometimes in the course of focusing on specific topics on my blog, I lose track of the bigger picture. This post will describe the key findings from my research so far: while China has made progress with green buildings, it hasn’t gone nearly far enough. I will focus the rest of my time here on finding solutions to how China can realistically tackle the many barriers to green buildings and achieve a vision of green buildings for everyone, everywhere.

Buildings are huge polluters
When people imagine the chief causes of greenhouse gas emissions in China, many think of coal power plants. While true on the surface, this popular perception misplaces the real blame. After all, where does that electricity produced by coal power plants ultimately go? To power buildings, primarily. The reality is, the energy used in buildings- both in their operation and construction- represents almost 45 percent of China's total annual energy use and a similar share of China’s greenhouse gases. This means that buildings in China alone account for more greenhouse gas emissions than all of Japan and Russia, combined. In addition to greenhouse gas emissions, buildings also consume large amounts of land, water and material resources.

More and more buildings
The environmental impact of buildings is growing rapidly. According to McKinsey, China will have one billion urban residents by 2030. Providing housing and employment for the urban billion will require China to continue its unprecedented construction boom. The result will be an estimated 40 billion square meters of construction between now and 2030, spread over 5 million new buildings.

Although China currently boasts one of the lowest building energy uses per capita, this is quickly changing for two primary reasons. First, as incomes rise, Chinese are demanding more and more floor space per capita. For example, floor area per capita in Beijing doubled from 2001-2006. The result is more buildings and therefore more energy use per capita.

Second, as services like heating, cooling and hot water become more common, each square foot is using more energy. According to Lawrence Berkeley National Labs, only 20% of office buildings nationwide had cooling in 2000. By 2020, this is expected to nearly triple to 55%. The result will be much more energy use per square meter. For example, highly-developed Shanghai’s energy consumption per square meter increased 31% from 1998 to 2005 thanks to a mix of increased energy use for heating, cooling, lighting and water heating. As other cities and provinces catch up with Shanghai and demand similar levels of comfort, this will result in continued increases in energy intensity nationwide.

When this data is coupled with the growth in overall floor area, the energy use and greenhouse gas emissions scenarios for China’s buildings look bad. Add to this mix the fact that inefficient buildings built today will continue to pollute and use energy for 40+ years, and the situation is downright scary.

LEED Silver lining not nearly enough
Despite this dirty and worsening picture of China’s built environment, there is a small bright spot emerging: the number of LEED-certified high performance green buildings in China is growing rapidly.

LEED-rated buildings can save significant energy, water, and materials resources and reduce carbon dioxide emissions. LEED first came to China in 2006 when the Ministry of Science and Technology demonstration building called Accord 21 achieved a LEED Gold rating, using 73% less energy than the average government building in Beijing and 60% less water.

Since Accord 21’s completion, LEED has seen dramatic growth in China. As of February 2009, over 118 Chinese buildings had registered to seek LEED certification, and many more businesses have registered their intent to green their offices according to LEED standards. In fact, Rob Watson, an international green building expert, estimates that over 50% of class A office building coming online in Beijing and Shanghai over the next two years will seek LEED certification. This is fantastic news, almost on par with American cities noted for their greenery, like New York or Portland.


The problem is, this high level of penetration is primarily confined to the tier 1 cities. LEED projects have sprouted up in tier 2 cities like Tianjin and tier 3 cities like Wuhan, but most LEED buildings continue to be in the highly developed areas near Beijing, Shanghai and Shenzhen. This is problematic because the vast majority of building is occurring outside of these tier 1 regions. Moreover, the growth in construction in the tier 2 and 3 cities is actually much faster than that in tier 1 cities, meaning more construction will be in these secondary markets in the future.


More worrisome is the fact that LEED buildings are almost exclusively confined to the high-end of the market: Class A office, luxury apartments, and factories owned by multinational corporations. Unfortunately, this does not even come close to covering the entire market. The urbanization statistics shown earlier imply that a significant amount of space is going to have to be created for people who have yet to be urbanized. This certainly won’t be luxury apartment space. And what about for all those companies not ready or willing to occupy Class A office space? While 100+ LEED buildings is promising, this is nothing compared to the 5 million buildings to be built between now and 2030.

Clearly, LEED alone cannot even begin to stem the tide of increasing greenhouse gas emissions and energy use in Chinese buildings. Unfortunately, while the government continues to show strong interest in building energy efficiency programs, I haven’t seen much happening outside of LEED.

What's next
China should not accept this state of affairs. Much, much more can and must be done to reduce the environmental impact of China’s buildings. Green buildings for everybody, everywhere will have to be the goal for China to reduce greenhouse gas emissions and other environmental impacts while making room for unprecedented urbanization.

But how can China spread green buildings to Tier 2 and 3 cities and the countryside? How can China spread green buildings to all segments of the market? How can they do it within the timeframe needed to avoid locking-in future carbon emissions and prevent catastrophic global warming? Most importantly, how can they transform the market at an acceptable cost, or even at a net benefit?

Trying to answer these questions will be the focus of the rest of my blog posts and my research in China.

Steven Holl Strikes Again- Shenzhen’s Vanke Center Aiming for LEED Platinum

Steven Holl didn’t stop with the Linked Hybrid in Beijing, he is also the architect for the Vanke Center in Shenzhen, a new mixed-use “horizontal skyscraper” aiming for LEED Platinum. I was lucky enough to visit the construction site last week, and this post will describe the unique concept and display some of my photos.

(Quick caveat: most of this info was provided to me in Chinese... I’m pretty good with the language, but I might have missed something...)

“Horizontal Skyscraper” Maximizes Open Space
The Vanke Center, despite being only 35m tall, is one of the largest skyscrapers in the world. It just happens to be horizontal. In fact, if the Vanke Center were stood up vertically, it would be as tall as the Empire State Building. The building houses apartments, condos, offices, and a hotel, and will be the new headquarters for China Vanke, one of the country's largest real estate developers.


And in addition to just looking cool, this interesting form actual has multiple green functions.

Open space
The building essentially has zero footprint on the ground, which creates more space for social interaction as well as more greenery. Although this landscaping could create additional environmental pressures, the designers have thoughtfully minimized this impact through the use of a rainwater capture system. Shenzhen’s wet, tropical climate provides plenty enough rain to keep the plants green, and rainwater gutters on the roof collect this water and use it for irrigation and filling the several fountains throughout the grounds. Moreover, the additional green space means there is more opportunity for rain water to percolate into the ground before running off into local sewers, lessening the strain on municipal water infrastructure.

rain water collection

Second, the raised building creates a cool microclimate beneath it. The building is sited at the foot of a fairly large hill, and the raised structure allows cool breezes from the hill to pass through the open area. This cools the building and reduces the need for air conditioning during the hot Shenzhen summers. It also creates for a more comfortable outdoor experience, encouraging more occupants and visitors to take advantage of the extra open space.


Third, the raised structure creates the largest possible number of views. Since the building’s lowest floor is at the same height as an average building’s third floor, more occupants have views to the outside. When coupled with daylight sensors, this means less energy used for lighting the indoor spaces. Moreover, the raised structure also creates “floorlights” on the first floor, whereby light bounces up from the open space below to provide additional natural light. Significant skylighting on the roof provides additional light, and louvered windows and double-paned glass allow in maximum light while minimizing glare. The result is a highly productive and comfortable space that uses less energy and is better connected with it’s outdoor environment.

"floorlights" to be

windows with louvers shown blocking out glare

skylighting on the roof can replace significant indoor lighting

Fourth, the horizontal design creates much more rooftop space. Holl takes advantage of this roof space in two ways. First, the building has a significant rooftop solar panel installation. These PV panels provide 12% of the power for Vanke’s offices. And where PV panels aren’t installed, the rest of the roof sports a roof garden. This green roof will reduce the building’s cooling load and keep additional rainwater from entering the sewers.

Housing for solar panels

All these green features that flow from the building’s interesting design, as well as a few more interior features like underfloor air distribution and thermal energy storage, contribute to the building’s lofty green goal: LEED platinum. (Note: the building is actually split into 4 different buildings, and only Vanke’s offices will be going for LEED platinum. I’m a bit confused about the split and will try to find out more.) The building was originally scheduled to be completed in mid-2009, but has been pushed back to late 2009 or early 2010. I guess that means the race between the Vanke Center and Parkview Green is on to be the first LEED Platinum building in China.

Vanke Center

Link to full photo slideshow of my site tour

Vanke
This building represents another step forward for Vanke, one of the biggest developers in China. Vanke was the second company to list on the Shenzhen stock exchange in 1991, and was the most valuable company on the exchange in 2006. It develops residential real estate all over China, accounting for about 2% of China’s residential real estate market. That may not sound like much, but is huge for a market as fragmented as Chinese real estate. As a result, what Vanke does sets a tone for the entire market.

This is not Vanke’s first green project. Vanke has been exploring prefabricated housing to cut down on materials waste, and received an Architectural Record Best Client award in 2008 for their commitment to good design. This makes sense, since Vanke manages all its properties, which gives them incentive to make their properties profitable over the long-run.

Vanke is an established leader in the real estate market, and I think the cutting-edge Vanke Center will really get other developers thinking about how they can implement green principles into their own projects. Cheers to Vanke for pushing the envelope. Let's hope other developers follow suit.