Financing isn't the first thing that comes to mind when you here the term green building. Instead it's usually solar panels, bamboo flooring, or a piece of plumbing equipment you're not sure you really want to understand. But just like other building materials, green products cost money. What makes them different is that green products typically provide a greater return on investment than conventional products. One example is - yes you guessed it - a plumbing product; the dual-flush toilet. This fairly straightforward innovation recognizes that you need less water to move liquid waste than solid waste, and thus dispenses water allocation accordingly. Less water means a lower water bill so that, over time, the approximate $150 increased investment in the toilet gets returned threefold, with net savings over the 15-year lifespan of $300 and an annual return on investment of about 13%. This makes the dual-flush toilet an excellent long-term, low-risk, high-return investment. Green buildings exhibit these same characteristics. The initial upfront investment of about 3% delivers predictable energy and water savings and reduced maintenance costs year after year. The challenge lies in figuring out how to fold this added value into the project's financing structure. Most of the time there is a chasm between construction and operation budgets. Funds saved through integrated design can't be stored away to pay future bills. While property managers certainly appreciate lower operating costs, providing construction funding that will be paid by the difference between the hypothetical bills and the lower actual bills is often seen as an esoteric, and impractical, accounting exercise. The aversion to using creative accounting to bridge the gap between construction and operation budgets is only growing stronger with the current fluctuations in the market. Increased scrutiny is already being applied to the underwriting process for many deals. This reaction may be good at the level of individual project, but will be severely counterproductive if applied to the affordable housing industry at large. To date, the path to crediting borrowers with the benefits of green building has been rocky and not well followed. Much effort was put into establishing the energy-efficient mortgage and later, a location-efficient mortgage. Both products credited single-family purchasers with additional income, based on assumptions regarding lower utilities in Energy Star homes or lower transportation costs when homes are close to transit. With more income the borrower could afford a slightly more expensive home, which was one way to cover the increased costs associated with the green features. These are good ideas, but by focusing on the income side of the equation in a period when mortgage lenders were rolling out much more aggressive income-enhancing products, both the EEM and LEM were largely unused by mortgage underwriters. To be truly attractive, the green loans needed to address the loan-cost side of the equation, or the interest rate. This is how people shop for loans and is the context in which interest in the green-based products would be attractive. It also makes sense because if green buildings are more stable in terms of utilities and maintenance there should a reduction in risk and in turn an ability calculate a more accurate risk-adjusted return (or lower interest rate) While no major commercial mortgage lender had put a reduced-rate green product on the market before the housing lending market started to unravel, some interesting ideas were being put forward. Perhaps the best developed proposal to date came from the State of New Mexico Mortgage Finance Authority. Their proposal was to offer a home loan at 50 basis points below current interest rate to buyers of certified green homes. They're reasoning behind the reduction was this "In recent year, the affordable housing community has come to recognize that energy-efficient environmentally-friendly design and building methodologies can make significant contributions to both environmental protection and community sustainability and can create housing that is both healthy and less costly for residents to own and operate. " Unfortunately the program was launched just months before "creative" mortgage lending ceased to be seen as a good thing. At this point the program still exists on paper but it is unclear if the product will weather the current financial lending storm. The lending world would do well to take this market turmoil as an opportunity to reexamine underwriting criteria to determine if the information requested is actually productive at reducing risk, or if other information would be more useful. And if important data is being overlooked or ignored, now is the chance to introduce it into the process. The design and construction of green buildings has seen incredible growth and sustained innovation over the past decade. It is time for the financial community to catch up. Instead of focusing on how to leverage short-term profits, efforts should be redirected to determine how to best value the long-term benefits of going green. What do you think? Leave us a comment. ———- Walker Wells, AICP LEED AP, is Director of the Green Urbanism Program at Global Green USA and the editor and co-author of Blueprint for Greening Affordable Housing. m