Embed Size (px)
Citation preview
Towards a Green Future: Proposal to Securitize Green Building Retrofits at JLL
WI LLIAM SANKEY , LEE D AP B D+C
Associate Project Manager, Jones Lang LaSalle
MUP (Real Estate Development and Ecological Urbanism), Harvard University
INT R ODU CT ION A ND PR OP OSA L SU MMA RY
This memo proposes that Jones Lang LaSalle creates a real estate finance strategy by
which it securitizes the building operational and energy cost savings differential
(between the retrofitted building and the original building operating expenses) as a
way to cover the upfront capital cost needed for retrofit projects. The vertically
integrated business model of JLL will allow multiple business units to increase profits,
revenues, and market share. The most important business units in this proposal
include Project Development Services, Property Management, Energy and
Sustainability, and Capital Markets.
I fundamentally believe the parties that control and combine easy access to capital
and technical management expertise as a consequence will hold a dominant position
in the future $4B annual building retrofit market (Nock & Wheelock, 2010). Through
this proposal, Jones Lang LaSalle will be best positioned to achieve that primacy.
In the past, one of the primary impediments to a major wave of green building and
energy retrofits in the commercial office sector has been the lack of available upfront
capital and other obstacles. In recent years, however, innovative financial techniques
(such as energy performance contracting, property assessed clean energy financing
[PACE], and energy service agreements [ESAs]), technological progress, and the
increasing reliability of measurement and verification methods have reduced
performance risks, technical challenges, and financing hurdles. Pike Research
analysts have highlighted this potential in their report "Energy Efficiency Retrofits for
Commercial and Public Buildings" suggesting that this market [privately owned
commercial space] has "the largest potential for long-term, sustained growth in
commercial building energy retrofits... [with] strong growth through 2014 and
beyond". Even given these improvements in the investment climate, lending
institutions and investors have been slow to provide the necessary capital
commensurate with the potential retrofit opportunities in the private commercial
building sector. Jones Lang LaSalle, through its existing business organization and
innovative methods described in this memo, is uniquely capable, however, of taking
advantage of these opportunities and seizing leadership in this nascent market.
GR EEN RETR OFIT SECU R IT IES: A MORE DETA ILED A NA LYSIS
To start, it is easier to begin a more in-depth explanation at the individual project
level. A significant percentage of the commercial building stock in the United States
pre-dates the era in which more modern, efficient mechanical, electrical and
plumbing systems were available to reduce energy and water consumption, saving
both the environment and money. Data reported by the federal U.S. Energy
Information Administration in their Commercial Building Energy Consumption Survey
(in 2003) described the median year of construction for commercial buildings in the
U.S. as 1973 at the time of publication. In New York City, 43% of current office space
pre-dates 1945 (Jones Lang LaSalle, Inc., 2010). As a result, there exists a tremendous
market opportunity to bring cost-effective retrofits to many of these buildings.
This memo proposes that JLL has the unique capable to leverage its existing business
lines by providing a synergistic product that offers buildings owners the opportunity
to retrofit their building at no upfront out-of-pocket cost, increase their revenue
through reductions in operating expenses, and grow rent income by marketing the
building as "green". In effect, this is a win-win for building owners.
To initiate the plan, JLL's PDS and Property Management units1 would offer a
package to office building owners in which they would retrofit the building at no
upfront cost (hard costs or soft costs) to the building owner, under the condition that
the building owner signed a ten year contract to allow JLL's Property Management
unit to operate the building. Employing existing JLL expertise like its proven
Integrated Energy Retrofit method and industry standards like the International
Performance Measurement and Verification Protocol (IPMVP), these retrofits would
deliver reliable performance and savings.
As part of the contract, JLL's Property Manager would pass through approximately
half of the savings to the building owner in operating expense reductions (that occur
due to the green retrofit) 2. The remainder of the savings in operating expenses
would be used to create a cash flow that would pay into a pool of funds used to
finance the upfront retrofit costs for other buildings.
On the investment side, the fund and its associated cash flows would be securitized
into financial instruments similar to asset-backed securities that could be sold to
investors such as pension funds and insurance companies. There has been a dearth
of liquid, safe "green" investment vehicles to satisfy the demand of institutional
funds that are facing increasing calls for socially responsible investing (SRI). Our
retrofit-cash flow securities would be perfectly aligned to absorb some of this
demand.
1 The JLL Brokerage unit could also be involved given its network of potential clients.
2 Amount determined from a preliminary discounted-cash flow model of a potential project.
The actual savings passed to JLL will be determined by additional and more rigorous analysis
(see Appendix, Exhibit 2).
Overview of the Proposal
Servicing and
Operations
Financial
Investment
Building Green
Retrofit
Private
Commercial
Office Bldgs.
OPEX
savings
created by
retrofit
Tranche B
Tranche C
Green Retrofit
Securities
Capital
investment fund
Institutional funds and
other investors Low risk, sustainable,
and socially
responsible
investments attracts
investors
Upfront retrofit
capital
Cash-flow from
energy savings
Funds from purchase of
securities by investors
Yield to securities
JLL PDS
Energy and
Sustainability
Provides
technical
expertise and
analytic
capability on
performance
risks and
estimated
savings
Manages the
retrofit and
tenant
occupancy
strategy JLL RE Investment
Bank
JLL Capital
Markets
Services the
repayment
of principle
and interest
JLL Loan Servicing
Platform
JLL Property
Management
Ensures
attainment of
retrofitted bldgs.
operations
expense reduction
targets
Prop.
Management unit
uses existing
relationships and
bldg. operations
data to pitch
retrofit projects
Energy and
Sustainability
JLL Capital
Markets
Securitizes cash
flows
Makes
connections
between
investors and
JLL Green
Retrofit bonds
JLL RE Investment
Bank
Outside
Investment Bank
OR
LaSalle
Investments
U.S. Real Estate
Securities Program
A BA SIC EX A MP LE
The following represents a basic stage one financial analysis of a potential office
building retrofit, as well as the analysis for a typical retrofit project and for the
proposed retrofit program.
If Office Building retrofitted (typical method today)
Rent Income $ 4,200,000 assuming rents increase 5%
OPEX $ (1,137,500) assuming OPEX fall 35%
NOI $ 3,062,500
ADS $ (2,120,000 ) increase DS on capital investments
BTCF $ 942,500
In the case of a typical retrofit project, risks and difficulties to the building owner
include:
� Increased debt service to cover capital investment in building retrofit.
� Difficulty in predicting cost savings (performance risk)
� Retrofit and commissioning is divorced from operations and maintenance team
leading to potentially underperformance of energy savings techniques.
� Must find upfront financing; may be difficult with debt already existing on
building. This is particularly true since the senior debt holder on the property will
have to agree; an assessment outside of their typical underwriting expertise.
Existing Office Building
Rent Income $ 4,000,000
OPEX (operating expenses) $ ( 1,750,000)
NOI (net operating income) $ 2,250,000
ADS (after debt service) $ (1,875,000)
BTCF (before tax cash flow) $ 375,000
Under the proposed Jones Lang LaSalle plan described in this memo, the following
analysis reflects the distinctions:
If Office Building retrofitted (under proposed JLL plan)
Rent Income $ 4,200,000 assuming rents increase 5%
OPEX $ ( 1,137,500) assuming OPEX fall 35%
OPEX differential to JLL $ (306,250)
NOI $ 2,756,250
ADS $ (1,875,000)
BTCF $ 881,250
In this case, the risks and difficulties to the building owner are mitigated:
� In essence, the major risks and challenges have been removed.
� JLL guarantees a baseline OPEX savings for the owner and shares potential
upside of additional savings above an agreed upon baseline figure3.
� JLL provides all upfront capital (through a fund of green retrofit securities);
financing is no longer an issue.
� Given the technical expertise of JLL and its partners, the performance risks
and uncertainties can be significantly reduced.
� The cash-on-cash return (BTCF) rate is slightly lower than a typical retrofit;
however, the risk-adjusted cash return to the building owner is significantly
improved. This is the key metric that property and investment decision-
makers use.
A BR IEF DESCR IP T ION OF T HE FINA NCIA LS
Given the example building retrofit above, it is possible to demonstrate further how
the financial side of this proposition might work. In the example of the building
retrofitted under the JLL plan, an annual cash flow of $306,250 would pass into a
pool (from the OPEX savings differential before and after the retrofit). Moreover, if
this building retrofit was replicated with nearly one hundred other office buildings,
you would have a commensurate number of cash flows (on the savings differentials
from these buildings) streaming into the pool.
In essence, this annual cash flow is a yield on the upfront capital investment cost for
the retrofits. Some of this yield (approximately 1/10th of the 10% yield OR 1%) would
be received by JLL PDS in place of a traditional professional service fee. For all
3 This method is an extension of a currently used retrofit financing technique called energy
performance contracting (in which an energy service provider pays the initial retrofit costs
and recovers this capital through sharing in the energy cost savings). Thus far, the U.S. federal
government buildings have been a major player engaged in this financing technique;
however, EPC has not been widely used for commercial office buildings.
practical purposes, this investment pro-rata contribution would be paid out just like
that professional service fee. Or put another way, JLL PDS would receive its
professional service fee at the same time as the upfront capital is deployed from the
fund. The fund would recover this fee by allocating 1% on the retrofit savings
differential back into the fund (see Appendix, Exhibit 2).
Whenever you have a relatively uniform class of cash flow-producing assets, it is
possible to pool the cash flows and securitize these cash flows, so that they become
liquidized for investors to more easily access (Rose & Hudgins, 2010). Here, the pool
of income created by the cash flow from several of these retrofit projects would
allow for the creation of asset-backed securities, or “green retrofit” bonds. JLL
Capital Markets or an outside investment bank would receive a servicing fee for
bundling the securities, managing the receipt of cash flows, and other oversight of
the fund. The pool of cash flows from which these green retrofit bonds are created
could then be divided into tranches that offer varying risk and return profiles when
securitized, or a form of credit enhancement could be given to the green bonds to
guarantee certain return profiles.
Initially, I propose three basic types of funds that will have varying risk, return
profiles, and bond maturities: (1) retro-commissioning, (2) comprehensive green
retrofits (JLL integrated energy retrofit method), and (3) LEED certification. The scale
and complexity of each of these energy-saving projects will allow JLL to engage all
segments of the commercial building energy savings market. Furthermore, the
existing capacity of JLL to estimate the NPV and IRR for a retrofit project versus
energy efficiency attainments will allow higher yielding projects to be securitized
separately from lower yielding ones (see Appendix, Exhibit 1).
The Green Retrofit Securitization Process
10% 9% 8.5%
Pass-thru
Yield on
OPEX saving
differential
after
retrofit
~10%
JLL PDS
retrofit
service
contribution
1%
JLL Capital
Markets with
LaSalle
Investments
(Or outside
investment bank)
Servicing fee
0.5%
Internal or
external credit
enhancement
0.5%
(Optional)
Investors
8.0%
ST EP S T O IMP LEMENT
To implement such a bold plan would require three things: (1) a large pool of assets,
or in this case buildings with the potential to be retrofitted, (2) an initial funding
source for the building retrofits and the securities, and a (3) method to ensure
relative uniformity among the underlying retrofit projects. All of these requirements
are achievable.
Firstly, JLL’s Property Management and Brokerage units already have direct
relationship with hundreds of buildings. This includes specific data on their
operational expenses and energy costs. Additionally, the portfolio of property under
JLL’s management offers a direct opportunity to approach existing clients with a new
proposal to retrofit their buildings, reduce their operational and potentially increase
rents all at no additional cost to the building owners. These existing relationships
would allow JLL to rapidly deploy capital from an initial fund to create a large enough
pool of cash-flow producing assets. For most companies and potential competitors, it
would be difficult to attain the scale necessary for an adequate securities market. JLL
has a unique advantage due to its size and (the previously mentioned) existing
relationships with building owners.
Secondly, a critical element in implementing this proposal would be the need for a
large, off-balance sheet initial capital pool from which to sell the first “green retrofit”
bonds and front the costs for the tens or hundreds of initial building retrofits. In
securitization, and initial loan fund is replenished on the financial investment side by
selling bonds (or securities) with a claim to some of the cash-flow from the capital
investment. Once begun, the pool would be self-sustaining, replenishing the fund
through the cash flows from the savings differential on the retrofit assets. The
startup of the fund, however, would require anywhere from tens of millions to well
over $100M dollars. This could be raised three different ways: (1) partner with a
major investment bank that would provide the initial capital for the fund, OR (2)
raising a large fund through LaSalle Investment Management OR (3) –since JLL is a
publicly traded company—initiate a follow-on public offering of company stock. A
follow-on offering would likely give access to cheaper capital than any other method.
Furthermore, the risks created by holding additional debt if the funding were
provided by an investment bank would weigh negatively on JLL’s balance sheet. The
only downside worth mentioning here is that a follow-on offering would be dilutive.
That is, with the issuance of new shares, the earnings per share would decrease
initially (as the earnings are spread over additional shares). However, a market aware
of JLL’s intentions for the FPO would price-in future earnings growth from the green
retrofit proposal, leading to lessened impact on the company stock price.
Thirdly, JLL because of its scale and vertically integrated business model has a unique
capacity to provide uniformity to the building retrofit projects. Since asset-backed
securities usually consist of high-quality, relatively uniform underlying assets, the
challenge for this type of proposal would typically be the myriad of different
procedures, methods, and goals involved on retrofit projects from building-to-
building. Due to JLL’s size, it has the capacity to offer a standardized set of
methodologies or guidelines for retrofit projects to ensure that the asset/cash-flow
pools are within a similar class. This approach would be very difficult for a smaller
company to replicate. In theory, JLL could pool retrofitted building assets based on
geography, specific retrofit type, the age of buildings retrofitted, the aggressiveness
of energy reduction targets or some combination thereof. There are fewer than two
or three potential competitors that could hope to bring uniformity to such a large
pool of assets as JLL.
HOW J LL WOU LD BENEFIT
Project Development Services
The JLL PDS unit would be instrumental to the fulfillment of this project because it
would provide expertise regarding overseeing and pricing building retrofit projects.
Exemplary projects like the retrofit of the Empire State Building have demonstrated
the capacity of JLL PDS to bring together the appropriate parties to execute a
complex retrofit project on a short timeframe.
In terms of business model, PDS would retain its same fee for service model. It would
simply be funded from the securities and investment pool of funds.
Property Management
The JLL Property Management unit is the vehicle through which the savings
differential will be realized and captured. By managing and operating the building to
the proper design/commissioning specifications as well as serving to provide critical
data on the building systems performance (after the retrofit), the Property
Management unit will ensure that each retrofit building asset meets anticipated
energy reduction targets.
In terms of revenue generation, Property Management would receive its typical
building management fee. This fee is likely to increase proportionally with NOI
increases after a retrofit project. Additionally, this product will be helpful in
attracting new building clients.
Capital Markets
The JLL Capital Markets unit would utilize its existing expertise in connecting capital
sources to investments like this one. Its Real Estate Investment Banking division
would play a critical role in this capital sourcing from private markets (selling the
retrofit securities to institutional investment clients). The Loan Servicing division
would serve to oversee the actual receipt of income (in coordination with the
Property Management unit) from the individual retrofit investment projects.
In terms of business model, Capital Markets would receive a servicing fee for their
involvement in the securitization process.
LaSalle Investment Management
LaSalle Investment Management already functions as one of the foremost real estate
investment management companies in the world. Their experience packaging
securities as well as raising capital and managing commingled funds would be a
perfect complement to the execution of this green securitization program.
In terms of business model, LaSalle Investment would receive a service fee for raising
capital from institutional investors and helping to manage the green securities and
the risk profiles of the investment pool.
ADVISORS
Alejandro Gonzalez. Jones Lang LaSalle. Vice President.
George Ladyman. Jones Lang LaSalle. Managing Director.
Jean Savitsky. Jones Lang LaSalle. Managing Director.
BIBLIOGRAPHY
Gillis, J. (2011, September 19). Tax Plan to Turn Old Buildings 'Green' Finds Favor.
New York Times, p. 4.
Herring, R., & Levinson, A. (2009, August 5). Unfreezing Securitization: Restoring the
Market's Confidence in Itself. (K. Interviewer, Interviewer) Philadelphia,
Pennsylvania: Wharton School of the University of Pennsylvania.
Jones Lang LaSalle, Inc. (2010). One Building Can Change the World--Empire State
Building's Groundbreaking Leadership. New York: Jones Lang LaSalle
Americas.
Lindsay, D. (2007, April 30). Green Building Mortgage-Backed Securities: The Growth
of Green Design and Renewable Resource Industries. None (Thesis-
Environmental Studies Senior at Lewis & Clark College, Portland Oregon).
Portland, Oregon, USA.
McCabe, J. (2011, February 10). Green Bonds Vital to Building Europe's Low Carbon
Infastructure. Retrieved September 2011, from Oilprice.com:
http://oilprice.com/Alternative-Energy/Renewable-Energy/Green-Bonds-
Vital-to-Building-Europes-Low-Carbon-Infrastructure.html
Nock, L., & Wheelock, C. (2010). Energy Efficiency Retrofits for Commercial and Public
Buildings. Boulder, Colorado: Pike Research, LLC.
Rose, P., & Hudgins, S. (2010). Risk Management: Asset-Backed Securities, Loan
Sales, Credit Standbys, and Credit Derivatives. In P. Rose, & S. Hudgins, Bank
Management & Financial Services (p. 10). McGraw-Hill Higher Education.
State of California. (2010, December 22). Commissioning and Retro-commissioning of
Buildings. Retrieved January 2012, from Green California-California
Department of General Services:
http://www.green.ca.gov/CommissioningGuidelines/default.htm
Stone, C. A., & Zissu, A. (2005). The Securization Markets Handbook: Structures and
Dynamics of Mortgage and Asset-Backed Securities. Princeton, New Jersey:
Bloomberg Press.
APPENDIX
EXHIBIT 1. Return Metrics vs. CO2 Reduction Curve. From Jones Lang LaSalle
presentation document on Integrated Energy Retrofits.
<https://connect.joneslanglasalle.com/ESS/AM/Marketing%20Documents/Forms/Sal
es%20Toolkit.aspx>
The capacity of JLL to adjust building retrofit packages to meet certain return metrics
will allow us to align the yield on our green retrofit securities with the yield on the
underlying retrofit projects. Building owners with varying project return preferences
can be pooled accordingly. [Dana Schneider—Jones Lang LaSalle]
EXHIBIT 2. Sample Discounted Cash-flow Model. Example used to analyze the potential returns from an individual retrofit project to the investor pool and the building owner.
*This discounted cash flow model presents the marginal NPV to building owner (over the value the owner would derive if no change were made to the building). Another portion of the return value chain not considered for the owner pertains to the potential for the owner to
gain significant additional value through an eventual sale of the building asset. If in the future, the owner decides to sell the building after the period of cash-flow sharing with JLL, the owner will realize gains from the capital value added due to the retrofit.
