Green design, Office, Leasing, Pricing,

This study explores the dynamic nature of premia for energy-efficient design in the market for office space. Stationary premia for Energy Star-and Leadership in Energy and Environmental Design (LEED)-certified property transactions are estimated at 16.4 and 10.6% respectively, on a price per square foot basis. We provide evidence to suggest that these premia should not be uniformly applied to all properties, but that adjustments should be made to account for individual property characteristics and changing market conditions. In particular, variance in the premia for Energy Star-labelled assets is consistent with expectations for the actual impact on operating expenses. Premia for LEED-certified properties are more responsive to the expected marketing benefits accrued by tenants. LEED premia are increasing with market acceptance during the sample period, rather than decreasing as the novelty effect expires. Investment in both categories of property with energy-efficient design is increasingly advantageous during periods when office market conditions have softened.

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This study introduces the cap rate spread as a novel metric for underwriting commercial mortgages. Cap rate spread is the difference between the cap rate and the fixed coupon rate. The spread predicts performance risk in a sample of 24,951 commercial mortgage-backed securities loans during 1993-2011. We demonstrate that the cap rate spread includes crucial information about performance risk. The results arise from the role of the cap rate spread in generating positive or negative leveraged returns to equity in situations where additional equity is required. Incorporating simplistic cap rate spread requirements in commercial underwriting is expected to reduce loan performance risk.Standard underwriting models for approving and pricing debt on commercial loans rely upon classic measures such as the size of the loan relative to the value of the property (loan-to-value ratio [LTV]) and the ratio of net income from the property to the annual debt payment obligation (debt service coverage ratio [DSCR]). Yet, the 30-day delinquency rate on commercial mortgages has recently skyrocketed, including on commercial mortgage-backed securities (CMBS) loans that rose from less than 0.5% in June 2008 to consistently greater than 8% since June 2010. 1 Although a portion of these CMBS delinquencies were originated with excessive leverage and thin debt coverage, many distressed commercial loans would have otherwise passed traditionally conservative underwriting standards. This suggests that conventional underwriting methods should be given a critical evaluation. In this study, we propose the cap rate spread as a new metric for underwriting that introduces information that is available at the time of origination, but not fully reflected in stand-alone LTV or DSCR measures.LTV is widely used to determine loan risk and one of the most commonly cited indicators that are used to characterize individual loans and the broader lending environment. As the loan amount approaches or exceeds the value of the underlying asset, equity vanishes and default risk increases. DSCR is another important measure that provides a basic assessment of the borrower's ability to remain current on debt payments in the event that operating cash flows from the underlying property are impaired. With a higher DSCR at origination, the debt service has a greater cushion against the impact from reduced rental income or increased expenses. The key limitation to LTV and DSCR criteria, when considered in isolation, is their failure to relate cash flows to asset values. This is true, even though incentives for equity investors are driven by yields that are defined by cash flows relative to asset values.LTV is a ratio of asset values only, and includes the loan amount (i.e., the lender's asset) in the numerator and the property value in the denominator. DSCR is a ratio of cash flows only, and includes net operating cash flows from the property in the numerator and debt cash flows in the denominator. Recognizable measures already exist that relate cash flows to asset values...

No abstract