Illustration by Fabrizio Lenci
In August, work is expected to start on upgrading Curtain House in Hoxton, London, from a Grade II listed ‘substandard asset’ into a sustainable landmark. The five-storey Victorian warehouse is the first acquisition from the newly created Aviva Investors Climate Transition Real Assets Fund.
According to brokers close to the deal, the fund not only priced in the cost of decarbonising the building but made “aggressive assumptions” on the impact this would have on its rental and occupancy rates and was able to outbid its competition.
In February, there was a similar story when US-based investment company, Kennedy Wilson, bought the 203,400 sq ft Waverleygate building in Edinburgh, Scotland for £78m. By anticipating a higher uplift in value based on the building’s current and potential green credentials, it also outbid an array of institutional investors.
These deals are anecdotal evidence that, in some sectors of the commercial real estate market, the greener the property, the higher the potential premiums in rental, occupancy and sales price. The debate around a ‘green premium’, whether it really exists and if sustainable-certified buildings can achieve a return on investment has long raged in the industry. The issue has been data. The commercial property world turns on data but historically factors such as a building’s sustainability haven’t been consistently collected or factored into a valuation, making the wider picture very opaque.
“It hasn’t filtered down through the entire market yet, which makes it really difficult from a market value perspective,” says Emily Chadwick MRICS, head of ESG & Risk at global real estate agent JLL.
But change is on the way, most notably in the offices market where a push from investors, occupiers and from legislation are creating momentum to ensure the green premium becomes universally recognised.
Despite the lack of widely held market data, there is a growing body of evidence indicating the impact sustainability can have on property value. In the US, data from the representative body for REITs (real estate investment trusts), Nareit, shows that green certified buildings can translate into a 31% increase in sales values, 23% higher occupancy rates and an 8% increase in rental incomes. REITs in the US collectively own about $3.5tr in assets, so the data is highly representative.
Global property agent, Knight Frank, has gone as far as creating its own price model to calculate the contribution of green ratings to sales values for prime offices in London, Sydney and Melbourne. It found an 8% to 18% price premium for green-rated offices compared to those without any sustainability certification. In central London it showed a 13% premium on rents and 10.5% on sales prices on BREEAM outstanding- and excellent-rated buildings.
In the UK and European office market, Chadwick says that there are four main factors driving the “value of green”. First, she points to corporate occupiers, many of which have set sustainability targets that require a green-certified environment. Second, among investors there is growing competition to acquire assets and gain “first mover” advantage. In addition, the fear that borrowing against climate-negative portfolios might become difficult, Chadwick adds, is pushing investors to consider “the assets they have and what they are doing with them”.
And finally, there is legislation – probably the biggest driver of all. The multiple layers of disclosure regulations in the EU and the UK are starting to push investors, landlords, occupiers and developers to climate-proof their portfolios either through acquisition or retrofitting. These layers range from minimum energy-efficiency standards to the EU’s taxonomy to prevent greenwashing, right down to new rules introduced in the UK this April that mandates large companies and financial institutions to disclose their climate-related risks. This move is to encourage companies to set out their emissions reductions plans publicly, and the UK is the first among the G20 countries to align with the Taskforce on Climate-Related Financial Disclosures (TCFD), a global industry-led group.
On a more granular level, RICS has updated its Red Book standards, which took effect in January this year. Chadwick, a member of the RICS expert working group says the changes “add clarity and strengthen what was already there”. She points to the two main changes: a requirement to have sufficient ESG data on buildings that are being valued and to comment on the impact a building’s sustainability credentials have on a valuation’s reasoning. She adds that JLL has already upskilled and rolled out a new data checklist. “I think it’s important that RICS is requiring that, it sends out a strong message,” she adds. Knight Frank’s Bowman concurs that a building’s green credentials are of increasing importance to stakeholders and its valuations are ‘in line’ with the market.
“Different market sectors and geographies are embracing ESG at different rates” Gillian Bowman MRICS, Knight Frank
In Canada, Bowman’s earlier comment on the different ESG journeys across the world rings true. Alexandra Faciu MRICS, a consultant in portfolio and asset management and a member of the RICS Americas regional board, says the lack of data and evidence means “there’s some way to go” in Canada before the value of green is recognised. While there’s investment in green assets, and currently an effervescent market, there is no way to capture what is creating value.
“[Investors] can’t see the financial benefits because there’s no data and that’s where we are,” she says. “Everyone I speak to, I stress how important this is and how in Europe companies have been looking at ESG and sustainability for the longest time.”
She expects this to start changing in the next year to 18 months, as transactions increase after the pandemic. But she adds that global disclosure requirements on capital markets, expected at the end of this year from the International Sustainability Standards Board, will have a huge impact. Disclosure standards are currently fragmented, and these are expected to provide a single global baseline and give investors much clearer information.
Canada is also grappling with ageing property assets and very little retrofitting. “The only way to have a green portfolio at this time, is to build it, as opposed to retrofitting it,” Faciu says.
However, the Canadian government is stepping up its green energy efforts with a CA$200m Deep Retrofit Accelerator Initiative. One of the first projects will be retrofitting 10-12 commercial and residential buildings in Toronto to build market confidence in retrofitting and de-risk investment. Each project will have to result in a 50% reduction in emissions.
It's a hugely transitional time for commercial property across the globe as developers, landlords and investors grapple with the demands of a net-zero future. And valuers must wait for the market to catch up. “As valuers, we are reflecting the market, not making it. Our hands are tied until we see the market fully demonstrating sustainability,” says Chadwick.
“Investors can’t see the financial benefits because there’s no data” Alexandra Faciu MRICS, portfolio and asset management consultant