Do Sydney tenants pay energy efficient office premiums? Jeremy Gabe & Michael RehmJuly 2013

INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS A dominant narrative is that energy efficient buildings increase rents relative to uncertified property ModelMkt. ValueRentsOccupancyNOICap Rate Pivo & Fisher (2010) +8.5 % (appraised value) +5.2 %+1.3 %+2.7 %-52 basis pts Eicholtz et al. (2008/2010) %+3.3 % Fuerst and McAllister (2011) +26 %+4 % Premiums observed in US Energy Star properties (controlling for key hedonic characteristics, e.g. location, size, age, market trends) All of these studies worked at the building (asset) scale Rent discounts for poor NABERS-rated properties observed in Australian properties (relative to uncertified properties; Newell et al. 2011)

1.Asking Rent 2.Average Rent Rent premiums at the asset scale could arise because of higher income, occupancy, or market timing INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

The lease transaction scale can isolate whether higher income is a cause – do green office tenants pay more? Chegut, Eichholtz, and Kok (2012) – 24-30% annual face rent premium for BREEAM buildings – Premium includes unmeasured quality characteristics (omitted variable bias) Kok and Jennen (2012) – % face rent discounts for low energy rating – C-grade (not A- or B-grade) had highest rents – Possibility of multicollinearity of target variable with building age INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Using Sydney as a case study overcomes some limitations of the first green lease studies All major office buildings are rated Rating based on audited performance Rating reviewed annually Market consensus on building quality grading Face vs. Effective rent Single market, with well- defined submarkets INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Australia has a comprehensive system of environmental performance reporting for commercial office buildings NABERS Energy 12-month site energy consumption audit Converted to source GHG emissions GHG emissions compared with city median to determine star rating INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS 0-stars Very Poor 6  Market Leader

Evidence of Private Investment in Environmental Performance INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Why do Sydney owners invest in energy efficiency? Government Interventions – Supply AusIndustry Green Building Fund grants ( ) Energy Upgrade Agreements (cheap loans to owners repaid by future tenants via property taxes) – Demand Mandatory rating advertisement before sale/lease State/Federal government accommodation rating floors (4/4.5 star NABERS Energy) Corporate Social Responsibility Arms Race – Australian property funds ranked top in the world Operating Expense Savings – Gross lease (full service) contracts only Rent Income Premiums? INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Tenants face weak financial/legal incentives to rent green office space at a premium; owners face stronger incentives to invest Energy Carbon Tax Space (Net Rent) Labour $4,700 per m 2 $542 per m 2 $17 per m 2 $2 per m 2 TENANTS (Net Lease) CSR and other intangible benefits remain as possible drivers INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS OWNER (Full-Service Lease) Energy Carbon Tax Management Property Taxes $50 per m 2 $70 per m 2 $17 per m 2 $2 per m 2

Hedonic Price Analysis – Unit of Analysis: Lease – Net rents converted to Gross – Dependent Variables: Natural log of initial gross face rent per m 2 Natural log of effective gross rent per m 2 Research Scope & Methodology INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS ln()=(,,, ) = Vector of market characteristics = Vector of lease characteristics = NABERS Energy characteristics u = Stochastic term

Data Lease Transactions – 708 unique lease agreements with face rent – 339 unique lease agreements disclose full signing incentives – January 2007 to September 2011 INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS DESCRIPTIVE STATISTICS Mean(Std. Dev.)

Results – Effective Gross Rent *Significant at 95% Level **Significant at 99% Level Independent Variable 1234 NABERS Energy Rating at Commencement 0, 1, or x or or Reference 4.5 and up 7.58x10 -3 Poor Rating (2 and below) Average Rating (2.5 to 3.5) Reference High Rating (4 and above) 2.80x10 -3 Natural Log of Energy Intensity Lowest Floor Leased Level 9 or lower Reference Level 10 to ** 0.064**0.060** Level 20 to ** 0.106**0.115** Level 30 to **0.205**0.211**0.202** Level 40 and above 0.291**0.294** 0.293** Operating Expenses Liability Net Lease 0.141**0.140** 0.144** Gross Lease Reference Independent Variable1234 Lease Term Short (4 years or less) **-0.084**-0.079**-0.084** Average (5 years) Reference Long (6 years or more) Building Quality Rating (PCA) Premium 0.216**0.213**0.207**0.208** A-Grade Reference “Secondary” (B-Grade and C-Grade) **-0.114**-0.117**-0.114** Type of Negotiation New Lease 0.077**0.075**0.067**0.078** Renewal/Expansion (Tenant already in building) Reference Leased Area (m 2 ) -2.96x x x x10 -5 * Leased Area Squared 2.65x x x x10 -9 Size of Entire Building (natural log) 0.081**0.083**0.087**0.084** Walking Distance to Train (natural log) -1.70x x x x10 -4 Building Age at Commencement (years) -4.75x10 -3 *-5.11x10 -3 *-4.85x10 -3 *-4.96x10 -3 * Building Age Squared 7.49x10 -5 **7.87x10 -5 **7.18x10 -5 **7.67x10 -5 ** Constant 5.482**5.468**5.425**5.278** Locational Variable (4 Submarkets) Included Time Dummy Variables (Semi-annual periods) Included Adjusted R-Squared INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Conclusions No evidence of a premium/discount based on energy attributes – Tenants respond as expected to financial and legal incentives – CSR initiative not strong enough to pay space premiums – Cannot reject an alternative hypothesis that rent premiums in building- scale studies caused by method used to calculate a single rental price INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS

Conclusions Split incentive between owner/tenant not a clear barrier – Tenants have an incentive to negotiate a full-service lease: Net Rent + Outgoings > Gross (Full-Service) Rent – Energy Upgrade Agreements: Are tenants funding capital appreciation? INTRODUCTION – RESEARCH QUESTION – CASE STUDY CONTEXT – DATA & METHOD - RESULTS