JLL support financial and asset management though a bespoke ESG valuation model

RICS COP28 Case Study

Introduction

Our team comprises a group of chartered surveyors and RICS registered valuers; we specialise in providing consultancy on the impact of ESG on real estate values.

One of our goals is to help break the valuation deadlock, which is an emergent phenomenon where valuers are unable to reflect the full range and impact of ESG risks in regulated valuations. We aim to enable the built environment to decarbonise while promoting and protecting asset values.

We were instructed by a multinational investor who wanted to implement a decarbonisation strategy while understanding the risks and opportunities the strategy represented to asset values in their portfolio. The insight we provided helped them develop an asset management strategy that aligned with their decarbonisation goals while delivering strong financial returns. The portfolio was spread across five European countries and primarily consisted of three different asset types: office, industrial and residential.

Our input provided the business case for implementing their decarbonisation plan for various assets under management.

Challenges

There were three main challenges when approaching this project:

1. Due to the range of asset types and countries in the portfolio, we needed to develop a future-looking impact on value proposition in a market with limited historic evidence. We also needed to ensure understanding and buy-in from multiple key stakeholders in the investor landscape (fund management, c-suite, asset management and sustainability team) in order to change mindsets on potential financial impacts related to ESG.
2. In order to show the risks and opportunities of different approaches, we needed to understand the risks for both a ‘business as usual’ approach, where limited decarbonisation efforts were made, and a ‘decarbonisation’ approach, where the assets were improved as much as possible at the first available opportunity.
3. We needed to incorporate the identified ESG risks and opportunities explicitly into a discounted cash flow (DCF) model. Due to the large number of assets in the portfolio, the DCF model would also need to automatically apply the correct ESG value impact adjustment from our value thesis across all assets in the portfolio, based on a range of variables such as asset location and CRREM stranding year.

Solutions

We created a range of novel solutions to the three main challenges we faced:

1. We developed a two-stage process to solve the first challenge of creating a robust value thesis that was applicable to all asset types and locations in the portfolio. In the first stage, we produced in-depth value impact research reports for each sector in the portfolio (office, industrial and residential). The reports collected and summarised a range of considerations, including academic and industry research, data-driven insights (e.g. National EPC databases and SBTi signatory data), legislative reviews, live deals and occupier and investor trends/requirements informed by our market-facing capital market and agency teams. From this, we created a provisional value thesis for the appropriate premiums and discounts across all sectors and countries in the portfolio. In the second stage, we shared our research reports and value theses with our client, and hosted workshops to discuss the evidence for the proposed adjustments and co-produce a final value adjustment thesis.
2. Our assumptions for ‘business as usual’ and ‘decarbonisation’ approaches were informed by net zero carbon audits carried out by our specialist sustainability consulting team. They included the appropriate capital expenditure for decarbonisation intervention measures and the impact they would have on each asset’s performance.
3. We created a bespoke DCF valuation model, which automatically incorporated adjustments from our value thesis alongside the cost and performance implications of both ‘business as usual’ and ‘decarbonisation’ approaches. A decision matrix automatically applied the appropriate cash flow adjustment based on factors such as intervention year, energy use intensity (pre- and post-intervention), country and asset type.

Outcomes

Understanding the financial cost of decarbonisation is a requirement when formulating a decarbonisation strategy. However, it is also vital to understand the consequences of decarbonisation on asset value, in order for a cost/benefit analysis to be undertaken between a ‘business as usual’ and ‘decarbonisation’ approach. A significant achievement of the project was being able to answer these two questions by using a range of ESG specialists throughout JLL.

Our upstream sustainability consulting team were able to create net zero carbon intervention plans for all assets in the portfolio, which included the necessary capital expenditure required for different levels of decarbonisation and the impact it would have on asset performance. Building on this, our ESG value and risk team were able to align these different intervention measures and costs into a value thesis, and demonstrate the impact of different levels of decarbonisation on cash flow and asset value.

As a result of providing this full scope of ESG advice, we enabled our client to incorporate ESG considerations explicitly and confidently into their asset management strategy. The insight we were able to provide helped the client prioritise interventions that would align their business actions with their net zero carbon strategy by prioritising asset interventions with greatest impact on ESG performance, while also growing or protecting value.

Lessons learned

One significant lesson was that the cost of ‘business as usual’ can be higher than you might first expect. There were a number of assets where the value at risk from not focusing on decarbonisation would be greater than the additional cost required to improve ESG credentials, particularly when factoring in the potential green premiums associated with these improvements.

We also discovered that green premiums and brown discounts can vary significantly from sector to sector and country to country. Our analysis showed that it is wise to focus decarbonisation efforts on markets where there are the greatest and most imminent risks to and opportunities for value, as well as where there is the greatest scope to improve asset ESG performance.

For context, the countries included in the project had clear and strong ESG legislation, and are broadly considered to be more sophisticated and forward-looking in terms of incorporating ESG risks into pricing and decision making. Even with these similarities, there were clear differences between them in terms of achievable premiums and risks of discounts. We also know there can be vastly different impacts in countries and sectors that do not have the same level of legislation or market pressure.

Conclusion

It is vitally important when implementing decarbonisation initiatives to not just understand the cost and impact of intervention measures, but also the impact the measures will have on future asset value. This project showed that despite the increased cost of more comprehensive decarbonisation initiatives, they can still generate an overall better return on investment through elements such as improved rental growth, shorter void periods and greater liquidity/lower yields.

In fact, even when not focusing explicitly on decarbonisation initiatives, it is vital to understand the potential future risks to asset value from a ‘business as usual’ approach. If ESG is ignored, the future risks to asset value could be great, and need to be managed appropriately.