Nils Kok

Value Added From Money Managers in Private Markets? An Examination of Pension Fund Investments in Real Estate

with Aleksandar Andonov and Piet Eichholtz (2012)

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Real estate is the most important alternative asset class for pension funds and represents on average more than five percent of their total holdings. We employ a previously unexplored international database to examine the investments of some 880 pension funds in direct real estate and REITs over the 1990-2009 period. We document that larger funds are more likely to invest in real estate internally, have lower costs, and higher returns. Smaller funds are more likely to invest in direct real estate, through external managers and fund-of-funds, but largely ignore REITs. This significantly increases their costs and reduces their returns. Moreover, U.S. pension funds’ investment costs are twice as high as those of their foreign peers, and their gross and net performance is lower. The underperformance of U.S. pension funds in real estate investments is most striking in the last two years of the sample period, which may be due to opportunistic investment behavior pre-crisis.

After the silence: new research on energy literacy and green building competition

In the posts below, there are two new working papers -- just in time to allow for killing some time during the food-filled Christmas days (I know, this year Christman is just like a regular weekend, but...Europe not only celebrates Dec 24 and 25, but also SECOND Christmas Day, the 26th. Well, we better enjoy it as long as these perks last...). The first paper is a long-awaited piece on the "value of green" in the UK, using BREEAM certification as a proxy for environmental performance. To be honest: all such studies outside of the US suffer from the crappy data syndrome, including this paper. It's incredible, but we could not find a consistent, widespread indicator of building quality in the UK. Yes, there is the anecdotal "prime," "institutional," or "Grade A," but there is no such quality rating as BOMA's standard in the US and Canada. As a result, we end up comparing apples to oranges, even though we try hard to make the green buildings as non-green as possible (think: propensity score weights, an overload of locational and hedonic controls, and decent models). We end up with a "green premium" that's a bit too high to my taste, but I'm hoping the reader takes away more than just that: we also find that green buildings lead to gentrification of neighbourhoods, raising locational value for all surrounding properties. That's quite a novel result. We also document that once the number of certified buildings in an area increases, the "green premium" becomes smaller, and zero once the number of green buildings in an area is larger than eight or nine (remember: this is statistics, so it's just an average). Worth reading (comments welcome).

The second paper is with Dirk Brounen (Tilburg University) and extends our work on residential energy consumption, energy labels, and capitalization of energy efficiency by private homeowners. In this (slightly premature) paper, we explore the results of a large survey that we sent to homeowners, asking them nasty questions about their energy consumption, their ideology and attitudes towards the environment, lifestyle, and their ability to make rational decisions when it comes to investments in energy efficiency. We dub awareness and ability: "energy literacy." Not surprising, but only fifty percent of our respondents has some idea about their energy bill -- and the variation is unrelated to education. Intelligence does not increase awareness of residential energy consumption. But, lifestyle and attitude does: well-organized, older people tend to score better on energy literacy. We then study the behavior of households as it relates to thermal comfort, i.e., their thermostat setting during the evening and at night. Our study is executed in Holland, and remember: in Northwestern Europe it's cold in winter, so heating  matters! Our results show that older respondents with higher incomes choose higher comfort levels, and age is negatively related to lowering the temperature at night. We also find that setting the evening temperature higher than average increases the gas bill quite substantially. The behavior of the household in “turning the knob” results in statistically significant effects. We then add a night switching dummy that indicates whether the household lowers the home temperature at night. The results confirm that switching to lower night temperatures significantly lowers the gas bill. Household behavior matters strongly for residential energy consumption, but a large group of households doesn't seem to care (or is rather unaware). We refer to this group of consumers as “sleepers,” comparable to the “woodheads” of Quigley and Deng (2002) that just forego substantial savings on mortgage payments through refinancing. Many households forego savings on energy payments through ignoring temperature control: a clear case for switching to a default that installs pre-programmed smart meters that safe energy at night. Using this "opt-out" approach would swiftly reduce the energy bill without the explicit consent of the household. (Sounds familiar? Think about "opt-out" pension saving schemes or "opt-out" organ donation systems. These nudges have been shown to be quite effective and I assume you've read Thaler and Sunstein's classic on this topic.)

Ok, on a lighter topic: I've been on a road show for the Global Real Estate Sustainability Benchmark during the past month(s), visiting for example Australia. I keep on being impressed by the state of sustainability Down Under, with all market participants striving to be the environmental leader. The most recent recognition was for Stockland, the 2011 Sector Leader in the DJSI Index, which, arguably, is mostly about organizational sustainability. Colonial First State topped the Carbon Disclosure Project. Etc.

I also visited a slightly less sustainable area: the Emirates. I was hosted by Carrier (a United Technologies company) and we visited Oman, Abu Dhabi and Dubai (in 2.5 days, that is). In a climate where the temperature reaches 50 Celsius (approximately 130F) for a large part of the year, combined with a high humidity, HVAC energy consumption should be a big issue. Alas, when energy is cheap and (otherwise expensive, desalinated) water is subsidized, nobody cares. But that has started to change: district cooling is integrated in most new developments, and these outfits are commercial enterprises, charging market prices. Landlords have already started to complain that operating costs in their buildings are getting out of hand. That's what happens when you build fancy-looking office/residential towers and fill them with crappy equipment. I see business opportunities...

Supply, Demand, and the Value of Green Buildings

with Andrea Chegut and Piet Eichholtz (2011)

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Attention to “sustainability” and energy efficiency rating schemes in the commercial property market has increased rapidly during the past decade. In the UK, commercial properties have been certified under the BREEAM rating scheme since 1999, offering fertile ground to investigate the economic dynamics of “green” certification on the commercial real estate sector. In this paper, we document that over the 2000-2009 period, the expanding supply of “green” buildings within a given London neighborhood had a positive impact on rents and prices in general, but reduced rents and prices for environmentally-certified real estate. The results suggest that there is a gentrification effect from “green” buildings. However, each additional “green” building decreases premiums for a certified building in the rental and transaction markets by one percent and four percent, respectively. In addition, controls for lease contract features like contract length and rent-free period have a modifying impact a certified rental premiums and should be taken into consideration in further research.

Residential Energy Literacy and Capitalization

with Dirk Brounen (2011)

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With the residential sector accounting for some one-fifth of global energy consumption -- resulting from the requirements to heat, cool, and light residential dwellings -- energy efficiency in private dwellings has again gained interest in recent years. In this paper, we examine the importance of awareness and behavior of households with respect to their residential energy use. Using a detailed survey across 1,721 households, we measure the extent to which consumers are aware of their energy consumption and whether they have taken measures to reduce their energy bill. Our results show that “energy literacy” among respondents is low: just 56 percent of the respondents are aware of their monthly charges for energy consumption, and 60 percent appropriately evaluate investment decisions in energy efficient equipment. We document that energy literacy, consumer ideology and attitude towards energy conservation have a direct effect on behavior regarding heating and cooling of the home. The impact of the moderating factor, measured by thermostat settings, ultimately results in strong variation in the energy consumption of private consumers. Slideshow on this paper:  My colleague Dirk Brounen on this paper:

Electricity consumption and commercial buildings (and some non-related news from Amsterdam)

I'm currently in Berkeley, working hard on new papers. (You can't make the same jokes forever.) I just posted a working paper on the financial implications of "greenness" in US REITs. Preliminary, but some interesting results (the fraction of Energy Star and LEED-rated buildings in a REIT portfolio is positively related to operating performance and market risk, but not to alpha).

In another paper, Matt Kahn, John Quigley and I have been able to get monthly energy data (bills and usage) for some 5,000 commercial building in Califonia. Merged with building-specific information from CoStar, we're looking at energy consumption dynamics in commercial buildings, distinguishing between the building, the tenants and the building manager ("human capital"). In the current debate on energy efficiency in buildings, not much attention is given to commercial buildings. Presumably, the sector will cure itself. However, out of the 74 percent of total US electricity consumption that is used in buildings, commercial space soaks up exactely half. So, all policies, subsidies, weatherization programs, etc. aimed at private homeowners are great, but what about starting with rational investors owning large swats of space first?



My hope is to expand our sample beyond northern California, to create our own CBECS. (Our current sample, at 5,000 buildings is already multiple times the size of CBECS.) Using our, pretty basic, building stats (occupancy, size, renovation, type of tenant, amenities, presence of on-site building manager, etc) we can already explain the variation in energy consumption better than EPAs Energy Star program...

Time for something not related to energy or "green" stuff. Well, there are some statistics in this absolutely great compilation of FOX's O'Reilly coverage of sin-city Amsterdam. I mentioned those stats after the state elections here last year (The US Elections: Cannabis and Climate Change.

Portfolio Greenness and the Financial Performance of REITs

with Erkan Yonder and Piet Eichholtz (2011)

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There is an increasing body of evidence on the financial performance of “green” commercial properties, but not much is known about the implications of investments in such buildings for property companies. This paper investigates the effects of the energy efficiency and sustainability of commercial properties on the operating and stock performance of a sample of US REITs, providing insight into the net benefits of “green” buildings. We match data on LEED and Energy Star certified buildings with detailed information on REIT portfolios and calculate the share of “green” properties for each REIT over the 2000-2011 period. In order to control for the endogeneity between environmental and financial performance, we use two instrumental variables – locational greenness and local environmental government policies. We estimate a two-stage regression model and document that the greenness of REITs is positively related to three measures of operating performance – return on assets, return on equity and the ratio of funds from operations to total revenue. We also document that there is no significant relationship between the greenness of the property portfolio and abnormal stock returns, suggesting that stock prices already reflect the higher cash flows deriving from investments in more efficient properties. However, REITs with a higher fraction of “green” properties have lower market betas, which may be related to their reduced exposure to shocks in energy prices and environmental legislation.

Some Greenbuild material (Prezi opening speech and PPT Green Retrofits)

Alright that was a cool first Greenbuild! Friedman's raving speech is still in my head ("...the green revolution will be a success when the word green no longer exists...!" I think he read my previous blogpost...). Here are some materials:

Opening Remarks on International Day (sponsored by Carrier) - Prezi

Education Session - The Economics of Green Retrofits (with Norm Miller and Peter Morris)

 

 

 

Greenbuild and getting over green

I’m currently in Toronto, getting ready for what will be my first appearance at Greenbuild. Admittedly, I have joked about Greenbuild for years, but the scale of the operation dawned on me when I first used this graph:

Yes: more than 30,000 people convene to confer about energy efficiency, sustainability, architecture, construction and investments in commercial and residential buildings. (In a more academic setting, I usually compare this number to the just 10,000 or so economists that gather for the annual finance and economics meetings.) Maybe the word “green” is just not signaling the right message: in the investment community, green is still thought of as out–of–mainstream. And that’s an outdated thought. Talk about “green building” in the popular press may be receding (see graph above), but the number of commercial office buildings now certified by either the EPA (Energy Star) or the USGBC (LEED) is increasing rapidly. (And that’s an understatement.)  For commercial building investors, all elements related to “green” are increasingly important. But let’s just leave out the green. And focus on the aspects that are embedded: energy efficiency, water efficiency, accessibility. And indoor air quality. Whereas most markets are still struggling to come to terms with energy efficiency, advanced places like Australia are increasingly looking at “the next big thing.” Which is buildings and productivity. Not exactly new, but like energy efficiency, getting more mainstream now. For non-Aussies, this video is great:

 

Nice building for sure. But how to price this "exotic" element? Getting energy efficiency into valuation models is difficult enough, what about the productivity of a building? To me, the productivity of a building can only be reflected into prices through tenants. So the question should be: do tenants value the enhanced productivity that a “green” building might offer? Embedded in this question: is productivity really higher in a “green” building? And yes, I’m familiar with the many studies that addressed this topic, but as of yet there is no study that uses a large number of clean experiments (moving a company into a “green” building, measuring productivity pre and post, and that st least 100 times). The next step would then be to relate tenant productivity and satisfaction to rents. That should be feasible. Enough work for the rainy days this fall.

Energy Efficiency Finance 101 - from theory to practice

It’s been quiet for a while, but finally there’s some (good) news from the energy efficiency finance front. The hard-pushed PACE program (what’s in a name, let’s rebrand this tarnished initiative), almost up and running in Los Angeles, San Francisco and some other large cities (Sonoma has continued their residential PACE program, ignoring the heated national debate) forms the basis for a recently announced “deal.” But…don’t open the champagne yet…this is just an announcement. Let’s first explore the details (an open interpretation from this article in the NY Times):

A business consortium that includes Lockheed Martin and Barclays bank plans to invest as much as $650 million over the next few years to slash the energy consumption of buildings. The consortium is led by a company called Ygrene Energy Fund of Santa Rosa, Calif., which has already won an exclusive contract to manage a retrofit program for a half-dozen communities in the Miami area, with the city expected to join in a few weeks. It is in the late stages of completing a contract with Sacramento, and is seeking deals in other cities. Ygrene and its partners will gain exclusive rights for five years to offer this type of energy upgrade to businesses in a particular community. Lockheed Martin is expected to do the engineering work on many larger projects.

The retrofits might include new windows and doors, insulation, and more efficient lights and mechanical systems. In some cases, solar panels or other renewable power might be included. For factories, the retrofits might include new motors or other gear.

Short-term loans provided by Barclays Capital will be used to pay for the upgrades. Contractors will offer a warranty that the utility savings they have promised will actually materialize, and an insurance underwriter, Energi, of Peabody, Mass., will back up that warranty. Those insurance contracts, in turn, will be backed by Hannover Re, one of the world's largest reinsurance companies.

Of course, this is a great concept. And it resolves the barrier to energy efficiency upgrades posed by the large upfront capital cost. It opens up access to the capital market by not only providing creditworthy tax liens as monthly payments (the default rates on municipal tax payments are extremely low), but also by enhancing this by a warranty from the constructors (basically an ESCO model) AND an insurance from Hannover Re to back up that warranty. Of course, all of this might be quite costly. I’m curious what kind of retrofits will be feasible in the end, i.e., what will the effective rate charged to building owners be? 7%? 9%? If you apply these rates of return to the infamous McKinsey curve (the basis for many statements on the “massive” opportunities for NPV-positive energy efficiency investments), you might end up doing some quick wins (lighting, optimization) and stop there.

But the scheme also ignores a maybe more important issue in commercial and residential building retrofits: the transaction cost for building owners. The problem of construction work in a building while it’s fully occupied, or having contractors in your home for a week or two. It also ignores the fact that only a very small minority of homeowners as well as commercial landlords will go for a building upgrade without directly receiving some of the savings. If the savings-to-cost ratio is exactly one, a building will certainly become more efficient following an upgrade, but the only reason for an owner to upgrade a building would then be to increase its competitiveness. Or maybe to improve indoor air quality. Convincing landlords and homeowners of “the increased attractiveness” of their building is a difficult play. Ultimately, if energy efficiently is appropriately priced in the market (which I strongly believe), a building upgrade that is fully offset by the cost will not increase the value of the building. Unless other factors of “green” are priced (which I, by the way, also believe…) So, savings in the hands of landlords are needed. And then you’ll still have to do substantial marketing. Luckily, “[Ygrene] will market the plan aggressively, helping property owners figure out what kinds of upgrades make sense for them.”

I hope the marketing budget allows for long and aggressive marketing indeed. As Matt Golden of Recurve Inc. recently noted at a conference organized by the Berkeley Program on Housing and Urban Policy, there is sometimes a reality disconnect between what we think building owners should do, and what owners think they should do. In Matt's "sober view" of the residential market for energy efficiency retrofits, "capucinno-sized savings" will be ultimately be reaped in an efficient market, but only if the hurdle is low enough. (Admittedly, I'm currently drowning my energy savings at a Starbucks in Toronto.) The Prius-driving and iPhone-using consumers that value energy efficiency beyond the dollar value makes for a good niche to target first, but for the average consumer to embrace constructors drilling holes in the wall to blow in insulation, we need more!

 

Investors stimulate property sector to disclose environmental performance

The new GRESB Report is out now! View it online here:

 

Or download the report here!

If you have no more than 2 minutes, just scan the press release:

Investors stimulate property sector to disclose environmental performance 

Commercial property sector improves energy efficiency

Amsterdam, September 1, 2011 – At the request of a global consortium of institutional investors, 340 of the world’s largest property funds have disclosed detailed data on the environmental performance of their portfolio. A report launched today shows that reporting on environmental metrics has improved substantially. Frontrunners in the commercial property sector reduced their energy consumption by three percent in 2010.

More than 340 property funds and companies, with real estate assets worth nearly US$1 trillion, have responded to a call for action by the GRESB Foundation, which is backed by US$1.7 trillion in institutional capital, to disclose information on environmental management and performance. The results, presented at a large real estate conference (EPRA) today, show that the respondents used energy worth US$5 billion in 2010, or the equivalent of about 34 million tons in estimated carbon emissions. On average, the funds consumed one percent less energy in 2010 compared to the year before, with Europe trailing Australia and the US. Environmental leaders, dubbed “Green Stars,” reduced energy consumption by as much as three percent.

Investors push for more transparency

Dutch pension giant APG is one of the driving forces behind the initiative. Angelien Kemna, CIO, comments: “The data provided by the GRESB Foundation now forms an integral part of APG’s investment process, assisting us in the due diligence process of new real estate investments and in engaging with our existing property investments. Ultimately, this should reduce the environmental impact of APG's real estate investments and improve the financial risk-return profile of our investments. The ever louder demands from policymakers to reduce emissions will increasingly affect the way the property sector operates.”

PGGM, the leading Dutch pension fund administrator with origins in the care and welfare sector, is the other founding partner of GRESB. Jac Kragt, CIO, comments: “GRESB is the first and only ESG performance benchmark that covers both private and listed real estate, on a global scale. ‘Sustainability pays of’ is one of our investment beliefs. As a responsible investor we have integrated sustainability into our investment process. As a global investor in both private and listed real estate it is important to us and our clients to be able to benchmark ESG performance and compare between funds, companies, regions and listed and private real estate.”

Reporting on environmental metrics improved

According to Nils Kok, Executive Director of the GRESB Foundation, disclosure of environmental performance is improving rapidly in the global property sector, but there is still a long way to go. “More efficient use of energy and other resources by the real estate sector can structurally reduce energy demand. But the data shows that the most fund managers in the commercial property sector are just at the beginning of full integration of environmental management in daily operations. Reporting on energy, carbon, water and waste is still not common.”