There is a difference between how real estate valuers and fund managers factor sustainability into valuations. Last year, the surveying industry started to bridge that gap from their side, and now the fund management community is doing the same from its side


Sam Carson is deputy chair of the ESG committee of Association of Real Estate Funds (AREF) and head of sustainability at CBRE

Richards, Paul

Paul Richards is managing director at AREF

The Royal Institutional of Chartered Surveyors (RICS) recently published a global framework for including sustainability factors in commercial building valuations.

You may well have read it, so we won’t summarise it here. Suffice to say, it clarifies what valuers should be looking for across the full range of environmental, social and governance (ESG) issues. It’s an excellent piece of work, but it’s written for valuers. And, given they assess market value at the time of the valuation, this may not include detailed, UK-specific factors affecting long-term strategic investment decision-making.

With different aims, valuers and fund managers require a common basis for articulating performance. For example, what should asset owners request of valuers? What data are valuers likely to request from funds – and how can funds standardise that data? How can fund managers interpret information provided by valuers on ESG when assessing fund performance?

We convened a group of property fund industry experts from across our membership to find some answers. At the same time, we’ve tried to aggregate standard industry practice in this important area, so that everyone knows what the baseline is.

Different ways of determining sustainability

It is probably worth restating the obvious: sustainability and ESG are slightly different things. ESG relates to the assessment and recognition of environmental, social and governance risks within an investment. These are ‘input’ considerations into an investment. 

Sustainability typically refers to practices which promote long-term value – ‘output’ impacts. In other words, assessing an ESG risk should result in a sustainability activity to manage the outcome.

From a practical perspective – and this is all about being pragmatic – if we can identify a common set of risks to value, and a way of quantifying those risks in accordance with investor pricing, then we have a better understanding of influences on asset value.

Energy performance certificates

Considering all the above – and accounting for the relative importance attached by each fund manager to climate, biodiversity, social value and impact – we have three recommendations.

The first is the way valuers assess energy-performance certificates (EPCs). They model an asset’s performance, but also indicate regulatory risk exposure, and can be used as a proxy for asset quality and/or relative operating costs. Where EPCs highlight the need for significant expenditure, a pay-back test can result in exemption. However, this may reflect poorly on the market positioning of the asset.

While some argue the relative imperfections of EPCs, we cannot deny they are pervasive – indeed, the absence of an EPC may be noteworthy as a risk. The Association of Real Estate Funds (AREF) recommends EPC data is provided at an individual EPC level to real estate fund managers or their managing agents.

Green building certificates and ratings

Green certificates are dominated by BREEAM in the UK – but there are others like Well Standard which focus on wellbeing. Green certification is a way of buildings packaging a complex number of sustainability features in a way the market can easily recognise. For this reason, green certifications have generally been associated with outperforming the market – the so-called ‘green premium’.

There are several certifications, but to affect value there must be a notable demand in the market for the certification with a related scarcity of supply of it. A relatively unknown certification, even demonstrating high-quality sustainable features, might not impact value any more than the features it represents if the market does not know how to interpret it.

Our recommendation is that fund or asset managers should provide details of any certifications, stating the date and version of the green certificate. If the certification has not yet been achieved, the status and/or target should be provided instead.

Localised physical risks

Some physical risks are common across the UK. Others are not – and the prime candidate in this category is flood.

Flood risk imperils an asset’s operating costs, causes damage, leads to loss of access and reduces its appeal to investors and occupiers. It can affect the asset exit strategy, liquidity or carry other long-term investment risks, as shown by recent research.

Climate risk reporting under the TCFD recommendations include modelling macro physical risks, such as heat or water stress. However, long-term physical risks might not be present in RICS-governed market value today.

The role of the valuer in this case is to reflect the impact on value of the specific risk to the asset in alignment with the market. Flood risk is a physical risk that can vary within a small area, depending on the topography, and this can be identified in standard flood-risk maps the industry has already adopted in practice. This makes it more relevant to valuers than other physical risks that have less localised impacts and for which the adoption of risk analysis is not fully established.

Valuers should advise on known current or future flood risk, the presence of any flood-risk defence measures, and whether insurance is obtainable on standard terms.

Greater market alignment

We see the need for more market alignment on how sustainability is commercially considered in real estate. This will provide clarity and certainty in how fund managers and asset managers invest in real estate assets. And it can build on the valuable work done by RICS.

Our recommendations above – covering EPC, green building certificates and physical risks – are likely to become outmoded at some stage. The pace of change in response to climate risks is fast and quickening. We may find that new metrics and considerations are required to better articulate the commercial view of the value of sustainability features in real estate.

But we need common ground from which to start. Our recommendations establish where that common ground is. You can read our full report here.