Green Buildings: Sustainable and Profitable?
Jonathan Cohen, Head of Energy at Howard Kennedy, takes stock of the sustainability-focused legislation, guidance and opportunities surrounding the real estate sector.
There is currently a huge amount of activity involving investments and developments that incorporate green buildings and sustainability. This presents a number of opportunities for investors and asset managers alike. This article looks at some of the key trends, opportunities and challenges of developing such assets in the current market.
Building back greener
There has been a post-pandemic trend of building back better and greener, with corporates, developers and the financial community increasingly considering the environmental, social and economic impact of their business decisions and focusing more on long-term sustainable value creation.
The ‘social’ and ‘governance’ limbs have driven demand for real estate assets which are able to demonstrate ESG-related compliance. In addition, we see that our clients that comply with ESG standards generate lower long-term operational costs, deliver an increase in capital values, higher rents and occupancy rates.
In contrast, buildings with lower or no green ratings often result in a so-called “brown discount” since they tend to suffer from higher occupancy voids and operational costs. They also run the risk of depreciating their capital and obsolescence in the face of tightening ESG-focused legislative requirements.
ESG and the property lifecycle
With ESG now playing a much more prominent role in how companies operate, investors are embedding ESG considerations into every stage of the property lifecycle, from due diligence to acquisitions, and from leasing to asset management.
With operational emissions (energy used to heat, cool and light buildings) accounting for around 28% of all global carbon emissions and embodied emissions (materials and construction processes during the entire building lifecycle) generating a further 11%, pressure is growing on building owners, operators and occupants to reduce their carbon footprint.
The legal framework
One of the challenges an investor should be aware of is the constantly evolving regulatory and legal landscape impacting such investments.
There has been a plethora of ESG-focused legislation and policies introduced over recent years that aim to steer the real estate sector towards ever-greener investments and push the boundaries for ESG integration.
Key legislative and policy developments impacting on those operating in the real estate sector include, but are not limited to, the Minimum Energy Efficiency Standards, GRESB (formerly the Global Real Estate Sustainability Benchmark), climate disclosures, taxonomy regulation and a number of sector and subject specific ESG benchmarks and sustainable building labelling systems.
While keeping abreast of the evolving and dynamic regulatory and legal landscape can be a challenge, it should be viewed as a positive change that will assist investors in identifying and mitigating sustainability-related risks in their existing real estate portfolio. It will also help them to identify potential new assets.
It is also hoped that such increased rules and regulations will improve transparency and accountability and encourage companies to adopt more sustainable practices and help to protect investors from greenwashing (where a company makes misleading claims about its ESG performance).
Green ratings
In addition to key legislative and policy developments, there is also the more basic question of whether or not a building makes the grade when assessed under the numerous green rating systems being adopted in the real estate sector.
There are approximately 600 green certification systems worldwide. However, Building Research Establishment Environmental Assessment Methodology (BREEAM), Leadership in Energy and Environmental Design (LEED) and WELL Building Standard (also known as the WELL certification), are the rating systems which are currently the most commonly used in the UK, although they are also applied internationally.
Although such property certifications will remain important measurements of a building’s environmental performance, we have started to see investors’ focus shifting to initiatives such as the World Green Building Council’s (WGBC) Net Zero Carbon Buildings Commitment, which calls for all buildings to have net zero carbon emissions by 2050.
Green leases
One of the contractual models that can be seen in the market is the emergence of “green leases”.
These are entered into between landlords and tenants to meet certain environmental objectives and can be a tool for investors to monitor and drive the environmental performance of their real estate assets.
Metrics in such leases may include electricity per occupant (kilowatt hours per employee), water used by area, and the volume of waste disposed to landfill as a percentage of total waste produced.
How are lenders and investors assessing risk?
In the real estate sector, lenders are increasingly offering green loan tranches in facilities to finance the development of buildings that meet sustainability standards. Lenders may also offer margin reductions to make their green loans attractive to borrowers.
What lenders are finding in practice is that borrowers who are already providing housing stock that meets increased sustainability standards are now obtaining the more competitive quotes, rather than incentivising those borrowers who do not.
Lenders may also conduct increased due diligence at the “know your client” stage. Banks are increasingly creating borrower-specific climate risk scores and infusing these into the underwriting process for financing. The lender may also scrutinise items such as the borrower’s future production plans or the availability of renewable energy technologies to power the client’s operations.
To conduct this level of due diligence, they will likely make use of technology or data application, as well as hire experts with the technical knowledge of environmental trends to embed into their teams.
In terms of risk assessment, investors and asset owners typically assess a property’s potential for improvements, identify any legacy issues and analyse the impact of sustainability factors, such as physical climate risks or energy efficiency standards.
It’s crucial that asset owners and managers review their current portfolios as well as their future pipelines to ensure that they comply with the above requirements.
This is of key importance to ensure that they are not exposed to the risk of capital depreciation and obsolescence and can therefore focus on long-term sustainable value creation.
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