The Effect of Green Retrofitting on US Office Properties: An Investment Perspective

Abstract

Buildings are responsible for over one-third of all resource consumption, greenhouse gas emissions, and energy consumption. Commercial buildings represent approximately half of that total. In mature economies such as the United States, new construction annually represents only a small fraction of the existing stock of buildings. Hence, retrofitting of commercial buildings, through major renovation projects, is extremely important for sustainability within the built environment. Most studies of green building economics have focused on new construction. This paper is one of the first to focus specifically on retrofit green. Based on a larger sample than most previous studies of new construction, we quantify the magnitude of value enhancement created by green retrofit of US office buildings. This paper is also the first to consider the subsequent investment price dynamics effects of such sustainability. Methodologically, we introduce an innovative way to control for other effects to isolate the value impact and the investment risk and return impact of green retrofitting. We do this by applying a repeat-sales model of only (and all) buildings which will ultimately be retrofitted (in our sample). By using new real estate price indexing methodology, namely a structural time series model employing a hierarchical repeat-sales (HRS) specification, we can build statistically rigorous comparative price indexes of retrofit green, versus non-green, office buildings in the US, quarterly for the 2005-2014 period, even with relatively scarce transaction price data (441 pairs). We find substantial value enhancement in green retrofit projects (between 10% and 20%), and we find evidence that retrofitted green buildings provide investors with lower asset price volatility. But during and just after the Financial Crisis the premium dropped temporarily to near zero, suggesting that the demand for green property investment is income-elastic.

Keywords: commercial real estate, sustainability, retrofit construction, repeat-sales model, structural time series, green buildings

JEL Classification: R3, C32, Q5