The prospects for the first completely green Real Estate Investment Trust, or REIT, are closer to becoming reality. A well-known pioneer in the commercial real estate industry has registered an offering with the SEC for a REIT called Green Realty Trust, Inc. As reported first by CoStar Group, Rob Hannah, CEO and co-founder of TSG Real Estate, a Chicago firm, has made what appears to be the first foray into an all-green REIT. There are other REITs that have a significant number of green properties in their portfolio, such as Liberty Property Trust (NYSE:LRY), which has 21 green buildings in its portfolio of about 700 properties. There are also several private real estate funds, such as the Rose Smart Growth Investment Fund and the Revival Fund, that have been launched within the last two years whose mission is to invest in either new or existing buildings that meet green criteria.
Green Realty Trust has devised an investment strategy that aims to meet the need of increasing demand by commercial users and tenants for green standards by increasing the supply of green buildings for lease. According to its prospectus, targeted investments include green properties that (1) are certified under the Leadership in Energy and Environmental Design (LEED®) Green Building Rating System; (2) satisfy criteria for energy and environmental design under other established environmental rating systems; or (3) are properties that it intends to develop, re-develop or renovate for subsequent certification as green properties.
The REIT has set up a Green Advisory Council made up of industry experts that will provide analysis on possible acquisitions. According to the CoStar article, Hannah plans to focus the REIT’s acquisition efforts on existing buildings rather than new construction to try and narrow the list of direct competitors. The Rose Smart Growth Fund is also pursuing a green conversion strategy. The CoStar article does a good job of pointing out the challenges involved with focusing on existing buildings by drawing reference to a study by RREEF:
Investors have shied away from large-scale green retrofits partly because many green cost benefits, particularly regarding energy conservation, are measured over 20 or 30 years, far longer than the typical investor’s holding period. And the conversion process is no walk in the park, especially with tenants in place. According to the RREEF report, ‘Many of the points required for [LEED] certification are more easily attained when the building is empty, especially for older buildings. If a building has tenants in place, the renovation costs can pale in comparison to the value of income lost during renovations and the costs incurred to re-lease the space, even if at a higher rent. Tenant lease restrictions may also limit an owner’s ability to relocate tenants to undertake the renovations.’
Another concern is that ‘the market premium for renovated green buildings is still not clear,’ the report says. ‘The cost and net benefits of renovating existing buildings to green standards is much less clear because the extreme diversity of the standing stock (e.g., age, condition, quality, style of construction) makes blanket statements essentially meaningless.’
Such challenges may actually be a bonus to the Green Realty Trust’s affiliates. According to the prospectus:
We believe that there will be a significant opportunity in our ability to offer services, including design-build through our Green Advisory Council and financing to enable our tenants to achieve tenant-improvement (LEED for Commercial Interiors) certification. For example, we may engage the businesses that members of our Green Advisory Council represent to advise our tenants how to build-out their leased space in environmentally-friendly ways, help finance their green improvements and teach them best practices for incorporating sustainability in their corporate environments. Providing these services to our tenants directly or through our affiliation with Green Advisory Council members will enable us to generate higher rental income from our properties and will provide greater tenant attraction and retention. Green tenant finishes make traditional commercial spaces less of a commodity and more closely identified with the entity that occupies the space.
The prospectus readily admits that such opportunities for its affiliate may cause conflicts of interest. The prospectus also clearly states that its focus on green building investments is one of a number of potential risks that investors need to be aware of because the REIT will be more competitively vulnerable than if its investments were more diversified and that the acquisition and conversion costs of green buildings could be higher than the costs associated with conventional buildings. However, the Trust also states such conversion efforts will bring about operational savings within a short time period, potential appreciation in the property’s value for resale, and increase the distribution to shareholders.
A REIT is an entity created to allow individual investors to own shares in a portfolio of properties. There are benefits of investing in a REIT rather than directly owning a property, which include increased liquidity, reduced risk through a diverse portfolio of properties, and tax advantages. Green Realty Trust will be a non-traded REIT, which means it will not be publicly listed on an exchange. It will also be structured as an “Umbrella Partnership Real Estate Investment Trust,” or UPREIT, which allows a transferring property owner to defer taxable gain on the transfer of his/her property to the partnership in exchange for units in the partnership. Green Realty Trust feels this will give it an “advantage in acquiring desired properties from persons who may not otherwise sell their properties because of unfavorable tax results.” The UPREIT is, in essence, a way to facilitate what are called “like-kind” or “1031” exchanges to defer capital gains taxes on the sale of investment property. The UPREIT structure is something that Mr. Hannah is especially well versed in as he previously helped develop an IRS Revenue Procedure on Tenant-In-Common compliance with 1031 exchanges and created an exchange insurance policy. TSG Real Estate, one of Hannah’s other companies, specializes in investments of this type.
Green Realty Trust, which initiated its subscription offering in 2007 and which needs to sell a minimum of $2,000,000.00 shares by the end of 2008, is being launched in an increasingly constrained credit environment. The issuance of Commercial Mortgage Backed Securities (“CMBS”) has fallen off dramatically since last summer and many are beginning to project that the commercial real estate market nationwide is entering the late stages in the market cycle. If Green Realty Trust’s offering has success attracting subscribers, it may be well-positioned to take advantage of a down cycle environment where cash will be king. If the REIT has to rely more heavily on debt to fund its real estate acquisitions, the Green Realty Trust may be in for a rough initiation period.
I, for one, wish this REIT much success as I hope it serves as a model for other green-related REITs and investment funds.