Erika Morphy is co-editor of Debt and Equity Journal, from which this article is excerpted.

San Francisco—More than a year after it announced a $1 billion, five year commitment for green building, Wells Fargo & Co. has financed 13 buildings that will undergo the Leadership in Energy Efficiency and Design (LEED) certification program, a voluntary standard developed by the U.S. Green Building Council for high-performance, sustainable buildings. It has financed a total of about 20 to 30 environmentally beneficial buildings or sustainable developments, says Paul Brumbaum, senior vice president and high-performance building advocate at Wells Fargo.

"The program has been very much a success," he says. He attributes its performance to more than just Wells Fargo's efforts. In general, he says, green building is at a tipping point. It is about to become part of mainstream commercial real estate development. With about 5% of commercial development now following green or environmental standards, Brumbaum is likely correct.

Green buildings--that is, buildings that are designed, built, renovated, operated or reused in an ecological and resource-efficient manner--have quickly become an area of intense interest to developers, tenants and investors alike. Green buildings are designed to meet certain objectives such as protecting occupant health; improving employee productivity; using energy, water, and other resources more efficiently and reducing the overall impact to the environment. A green building may cost more up front, but saves through lower operating costs over the life of the building.

For tenants, the main drivers of the demand thus far, there are obvious reasons for their preference. Green buildings are simply more comfortable, and, for people with asthma or other respiratory illnesses, healthier environments. Consequently, green buildings are also thought to lead to more productive workforces, although Brumbaum says that claim has yet to be quantified.

"The whole area of tenant productivity as a benefit of building green is only now becoming more widely understood and appreciated," he says. "There are a lot of studies being done in this area, but since only a few green buildings have been occupied for a significant period, there is not a lot of hard data."

Developers like green building because some tenants are willing to pay a premium to occupy the space, either because they want to make a statement about their commitment to the environment, because the buildings tend to be trophy buildings or because they really do embrace the health and environmental advantages the buildings deliver.

Speaking at the Northern Virginia RealShare Conference in McLean, VA last week, Jon Peterson, head of the Peterson Cos., told the audience that green building is "a tsunami yet to come." It is something that many tenants have expressed interest in, he said.

Greg Kats, a principal with strategic consulting firm Capital E in Washington DC, tells Debt & Equity Journal there are other reasons beyond tenant demand driving developers to embrace green building. "Four years ago, developers could say that green building was too risky because they were not sure of the costs," he explains. Now it has been established that green buildings use one-third less energy. They also reduce liability risk concerning health claims, he says. More recently another reason has surfaced that is prompting more developers to look at green building: fear their properties will become obsolete, says Kats, who also serves as chair of the energy and atmosphere technical advisory group for LEED and the LEED steering committee. Kats also authored a widely cited study on the cost and benefits of green buildings for 40 California state agencies.

"Developers are worried they run the risk of having to retrofit buildings in a few years if demand for green buildings continues to grow," he says. "Over a relatively short time, the risk-return equation of green building has changed dramatically."

That is the upside of green building. There is still a significant downside that could have a detrimental impact on the valuations and ROI calculations lenders and developers are tentatively reaching as they invest in this technology: lack of hard data. Even proponents of green building are frank that these are uncharted waters. "No one knows what the ROI will be. It is still too soon to tell," says Sean Cahill, vice president of development for Washington, DC's Louis Dreyfus Property Group and an advocate of this development.

"If I knew I was getting higher rents or lower operating costs I could give projected ROI to you. Anyone who says they have it is working on data that is a few months old. To do it properly, it needs to be at least five years old," Cahill says.

Then there is the fact that green buildings' costs can, but not always, run about 2% to 8% more to build than traditional buildings. In markets where green building has become common, such as Washington, DC or San Francisco, the costs tend toward the low end, Wells Fargo's Brumbaum says, adding, "There have been cases in other markets where the costs are much higher." Besides the obvious hurdle this presents to developers, the higher costs can throw off underwriting and lenders' estimated valuation of the buildings. In some situations, Brumbaum says, "We have had to struggle with how the higher costs were reflected in the incremental value of the building being built."

For instance, if a project costs 8% to become LEED certified, it will have a higher loan to value ratio. And the data and methodologies to measure and support higher valuations are not readily available yet, he says. Wells Fargo worked its way around this issue by placing greater weight on the project's sponsor, its track record and its ability to support the project.

As more lenders embrace green building, many of these issues are expected to be resolved. Most green building is financed by traditional means, Kats says. "However, we are starting to see more specialized green funding," he adds. Large pension funds have made commitments to green building, he says. Also there is a new pure play fund raising capital to invest in green building. Called Revival, the fund is based in Boulder, CO.

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Green Building Attracting Interest

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