Originally published in New York Law Journal on June 20, 2012.

What is green due diligence and why would a prospective buyer, tenant, or lender bother with it? As in other areas of the green revolution, the answer ranges from advocacy to dollars.

Many organizations, such as federal agencies, national tenants, lenders, and investors, now have green requirements for new leases, loans, and purchases. They have made the policy judgment that they want the buildings that they lease, acquire, or finance to be green. They are advocates of green. Hence, before leasing, buying, or lending, they conduct due diligence to verify the "greenness" of a property.

Many other investors, tenants, and lenders do not care whether a building is green—they are concerned with property value. What is the return on investment? How good is the cash flow? Does the property have physical defects or problems with its legal status (zoning, etc.)? Are the lease terms competitive? These parties do not care about "green." They must, however, because like it or not, green issues are having an increasing impact on property transactions, even for those who think green is humbug. The reason is money.

The "money" reason is not that green adds value to a property. That subject is a topic of ongoing discussion. (For example, how much if any real value does a LEED rating add?)1 The "money" reason is that there are now many actual green legal and contractual requirements, and also green financial benefits, associated with a particular property or development project. Failure to comply with these green requirements or the conditions for financial benefits can result in real money loss.

Function of Due Diligence

The main purpose of due diligence is to answer the question, "What can I lose?" A party often decides to buy, lease, or lend based on assumptions about the property. Those assumptions derive from the party's initial research about the property or from offering materials or other representations made by the seller, landlord, or borrower. Due diligence is the exercise of vetting the property to confirm those assumptions. If the assumptions are incorrect, the business deal will likely be renegotiated.

How can failure of green assumptions result in financial loss? The answer has two parts:

(1) Green tax and other incentives, as well as green capital grants, can add direct "bottom line" value; and

(2) Failure to comply with green rules in contracts and legislation can result in loss of income, fines, and restrictions on use.

In other words, loss of financial incentives and non-compliance with green requirements can mean direct loss of value.

How Green Value Is Lost

How can green value be lost? There are several ways.

Green financial incentive such as a property tax abatement can mean a built-in cash flow subsidy. For example, a $1 million annual property tax abatement is worth $10 million over 10 years and will be reflected in the property's capitalization rate.

As another example, a green zoning bonus of 30,000 extra square feet for a residential condo would be the equivalent of $6 million in land cost if valued at $200 per square foot and could mean a sale value of $36 million if the sale price is $600 per foot.

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