1031 Tax Exchange: Greening Your Portfolio

I was reading a commentary in the Business Journal the other day. Without concrete examples, it stated that the development community is using the 1031 Tax Exchange tool to divest themselves of under performing buildings and replacing them with greener high performance buildings. The authors Michael Minunno and Stephan Wayner with Bayview 1031, acknowledge energy efficiency, resource conservation, and environmental sustainability are increasingly becoming a factor in property valuation. I wish they had more examples of how this tax break is being used, but it led me to do a little more research into what a 1031 tax exchange is.

A 1031 tax deferred exchange basically allows a property owner to reinvest capital gains into a similar property. There seem to be a variety of scenarios of how this can be done. Instead of trying to explain how it works, here is a link to an explanation of its benefits. If this is true, this surely will be a boost for green building.

This of course raises the question, are green buildings valued more? Not surprisingly they are, but according to Kevork Derderian, owner of Continental Offices Ltd., in a Building Operating Management article acknowledges that while buildings may be leased faster, the rents they demand still have to compete with other properties, so it is difficult to raise rates. But if Net Operating Income (NOI) is a component of the equation that many used to value a property for investment, then you would expect a more efficient building to yield higher values for the owner. This must give an owner an advantage when competing with properties that cost more per square foot to operate.

This is underscored by Robert Sauchelli, program manager for Energy Star:

“That NOI and energy are connected makes sense for building owners, says Robert Sauchelli, program manager for Energy Star Buildings. The owner of commercial space that is higher in quality and has lower operating costs has several choices, Sauchelli says. One is to keep the rents the same, increasing margins and profitability; valuation of the property, then, would eventually reflect that. Or, if the lease is such that energy costs are not passed through and the property is in a more competitive market, the owner could pocket the energy savings, reduce rents, improve occupancy and therefore increase profitability. Or the owner could, of course, increase rents and profitability, getting a double boost. “ “Can Green Be Gold?”, Building Operating Management

According to a Rocky Mountain Institute analysis that is referenced all across the web, but I can not find the original study, has determined that building with a capital rate of 10% worth $1,000,000 can see a return of $10 for every dollar saved. The less a building takes to operate the higher the capital rate if the value of the property remains constant. (This link is a good overview of NOI and Cap rates. Measuring Value and Performance of Investment Real Estate). According to the previous link, the cap rate may also be a measure of risk and require higher cap rate when the property is considered riskier.

An Advanced Building report about the benefits of high performance building (Benefits Guide : A Design Professional’s Guide to High Performance Office Building Benefits) has some more detail in valuing high performance buildings and is worth reading if you are interested in knowing more. Obviously this is just one component of valuing a property. Either way, there are examples of green buildings selling for higher prices than non-green buildings. Another article in Building Operating Management, “Green Developers Break New Ground: Speculative office buildings are beginning to go green. The reason: profits", highlights two recent sales of large office buildings (One South Dearborn Street and 111 South Wacker Drive) in Chicago as examples. I am sure there were other factors involved, but I am sure high performance didn’t hurt, particularly a LEED rated building that has been through the commissioning process and includes measurement and verification systems in the building. You know what you are getting and how it is performing. These are all valuable tools in helping to maximize and maintain value.