The allocative inefficiency of green buildings - why the number of green buildings is low and the premium for green buildings is high

The literature on green buildings has blossomed since the study by Eicholtz et al (2009). Researchers have attempted to search for green premiums using property data in different countries. While the studies focus on testing the significance of the green premiums (or discount in some cases), few studies have examined the low supply of green buildings despite the high rent premiums attached to the green buildings. Fuerst et al (2011) suggest that users of ìgreenî offices enjoy an innovative advantage, which decreases over time when the supply of green offices increases. While the innovative advantage applies to most consumable goods, it is, however, more difficult to justify why firms in green offices command competitive advantage over those in non-green offices, if production processes of the firms are the same. For instance, would a legal firm in a green office commands a higher premium than another comparable firms in non-green office? Eicholtz et al (2010) found that the rental premium for green offices is equal to the savings accrued to the tenants over the years. This implies that the tenants surrender all the savings to landlords. This contradicts with the property tax literature (Wheaton, 1984), which argues that building owners absorb, instead of passing on property taxes to tenants. Using the production theory, we develop a conceptual model to examine the high rent and low supply condition in the green office markets. In our model, there are two agents in the economy: a tenant and a landlord. Suppose firms require environmental goods, in addition to labor and office space (capital) inputs to produce their consumable goods. The landlord has an endowment of environmental goods, labor and office space. In the absence of a market for environmental goods, the production model suggests that the environmental goods will be over-used. With the Green rating scheme, it creates a market for the environmental goods. Firms that use environmental goods more intensely in the production will pay a high premium for the goods, while firms that do not require will not pay at all. However, firms that use environment goods intensely could mimic firms that do not use the environmental goods by paying nothing for the environmental goods. There are three possible factors that may lead to under-supply of green offices. On the supply side, higher costs are incurred by landlords in developing green features due to the lack of economies of scale. On the demand side, th