Sustainable investment in real estate
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19 March 2019
Sustainable investment is about the responsibility and potential the real estate industry holds to reach climate and environmental sustainability targets. In a rapidly urbanising world, the real estate industry lies at the center of an unprecedented level of growth and activity.
Investors, occupiers, cities as well as governments can and have to play a key role to achieve a reduction of greenhouse gases in the context of the construction and operation of real estate
We asked the opinion of two thought leaders in real estate: Dr. Richard Peiser, the Michael D. Spear Professor of Real Estate Development and Director of the Master in Urban Planning Program at the Harvard Graduate School of Design and Dr. Thomas Wiegelmann FRICS, managing director of BLUE Asset Management, Honorary Adjunct Professor at Bond University and member of the Harvard Alumni Real Estate Board
The World Economic Forum states in their report "Environmental Sustainability Principles for the Real Estate Industry", that the real estate sector consumes annually over 40% of global energy p.a., that buildings originate 20% of global greenhouse gas emission, and use c. 40% of raw materials respectively.
A major concern of environmental sustainability is related to climate change. At COP21, the Paris climate conference that took place in December 2015, 195 countries adopted the first ever agreement, which sets a target for reducing negative effects from climate change by limiting global warming to well below 2°C. The World Bank estimates, the real estate sector has to reduce CO2 emissions by 36% by 2030 to support staying within the 2°C threshold. If the world's nations do not reduce global warming quickly, temperatures may increase dramatically in the coming decades.
Disastrous results will likely include scarcity of food and fresh water, the spread of diseases and rising sea levels, which will flood coastal cities and submerge many island nations. The United Nations Intergovernmental Panel on Climate Change (IPCC) estimates that a 1.5°C average rise may put 20-30% of species at risk of extinction. In addition, increasing extreme-weather events like storms and floods are likely to affect the property industry and infrastructure having a major impact on economies and investment performances.
Governments and cities shall further proceed in establishing and adopting sustainable and comprehensive long-term policies incentivizing real estate investors to collaborate and support such initiatives. This implies that the real estate sector will remain a prime target for policy action. This presents new challenges and opportunities for the real estate industry with profound implications for both owners and occupiers.
Why we should consider sustainability when making investment decisions?
For industry practitioners at all points of business, weaving climate and sustainability considerations into key decisions is a responsibility. But what many do not yet realise is: guiding market decisions toward sustainable, climate-friendly outcomes will actually generate financial and economic payoffs for the real estate industry and for investors, especially on the medium and long terms.
Sustainable property investments have developed from a niche concern to a mainstream product for new real estate developments and investment products over the past decade. Green buildings represent a significant share of global development projects, which is expected to further grow.
When investors invest into new development projects, those shall have or qualify for a sustainability rating.
In order to achieve the reduction in CO2 emissions necessary to preserve the environment for future generations, we must undertake sustainability-minded retrofits and renovation of existing buildings. This process is bound to be burdensome in the short term—certain sustainability-driven features pay for themselves, while others do not at this time—but is nevertheless a reasonable cost-efficient way to achieve the reduction in CO2 emissions that has been deemed necessary. When underwriting existing property energy efficiency is an important component of commercial DD as well as CapEx requirements for green retrofit and renovation of existing stock.
We are convinced, that many existing properties will be rated as not "future-proof" and will successively fall behind when competing for customers and occupancy rates and investors in the mid to longer term future. As a result, we expect that for those properties a significant discount for a lack of sustainability ("grey discount") will have to be considered in the future. Mindful investors anticipate and understand the impact of such developments and trends to reduce exposure to long term risks.
What are the challenges of investing in more sustainable buildings?
The causal chain between the effects of cost-spending on sustainability investments and the resultant effects and benefits tends to be diffuse, but several data points and case studies illustrate key and pivotal trends and suggest the factors that will play increasingly weighted roles in long-term costs and values.
In the absence of one fully uniform certification system, it is still difficult to measure, standardize and compare monetary valuation of sustainability aspects. Standards include inter alia LEED (North America, Asia), BREEAM (worldwide, especially UK), HQE (especially France), DGNB (especially Germany) and CASBEE (especially Japan).
Potentially higher initial costs for buildings are particularly obstructive when short amortization periods and high yield expectations are at the center of attention.
Investments into sustainability characteristics are expected to "pay off" in the medium and long run.
From the perspective of owners and investors, sustainability costs are not symmetric with resulting energy savings. In other words, energy-saving measures require significant one-off capital expenditures to be borne by owners and investors, but the resulting reduction of operating costs usually occurs over time and benefits mostly tenants.
Employer demand for greener spaces is increasing, and what are the motivations behind this?
Green buildings refer to both, structure and the using of processes that are environmentally responsible and resource-efficient throughout the life-cycle.
From the perspective of users, a high degree of transparency with regard to the measures that lead to certification of a building is important.
Key areas of focus are the reduction of energy consumption, the protection of natural resources as well as the provision of a healthy and well-being working environment.
Amongst many studies, the "World Green Building Trends 2016" report by Dodge Data & Analytics provides insight from respondents expecting a 14% savings regarding operational costs over a holding period of five years for newly developed green buildings. The savings potential for green retrofit and renovation projects is expected to be around 13%.
Many major corporations require new leases to meet sustainability objectives (so called "green leases"). Those include specific provisions to define specific responsibilities and obligations with regards to the sustainable operation of a property.
Businesses and in general organisations are increasingly looking as to how they fulfil their obligations to reduce their ecological footprint – such might be intrinsically motivated or in the anticipation that there will be increased legislation, globally, which will inevitably push them along that path. To our experience, governments, listed companies and IT companies are comparably motivated to use green buildings.
For the investor this all means that green buildings can support the creation and investment into better performing assets and thus create a competitive advantage on a mid- to long-term basis.
“"Key areas of focus are the reduction of energy consumption, the protection of natural resources as well as the provision of a healthy and well-being working environment."”
Is it possible to quantify the effect of sustainable building practices?
The core challenge for many investors still lies in the frequently diffuse causal chain between the effects of costs and the resultant effects of benefits of investments into sustainability measures.
Research has illustrated that property pricing is increasingly distinguishing between properties and portfolios that exhibit different sustainability-related features and resulting performance. Also, evidence shows that more sustainable properties correlate positively with higher rental premiums. Secondly, green buildings tend to have lower vacancy rates as well as lower operational costs.
At the same time, there is still a need for enhanced empirical evidence of causality between sustainability and performance/ value. The importance to further develop “business cases” for sustainability in a transparent way is therefore crucial. Life-cycle assessments and resulting life-cycle cost considerations are becoming increasingly important and turn the focus on the long-term benefits of sustainable real estate.
In all this context, technology is undoubtedly playing an important role in providing cutting edge solutions to monitor, in close to real time, the performance of buildings.