Peter Verwer is the Property Council of Australia's long-standing CEO. He spoke to Richard Lowe at this year's MIPIM about sustainable properties, tax regimes, Australian superannuation funds, valuations and IFRS
Last year's MIPIM convention in Cannes was different to its predecessors for a number of reasons. Not only did it reach a peak in terms of delegate numbers - 29,000 - but it also saw the issue of sustainability take centre stage. For much of 2007 and 2008, sustainability became a growing source of focus and attention for the real estate industry, and MIPIM in 2008 seemed to reflect this, hosting the British Property Federation's first ever international conference on the topic.
Twelve months later and MIPIM 2009 has a different feel. The tumultuous financial events of September 2008 and a far bleaker economic picture have inevitably diverted attention to more pressing matters of debt management and property market fundamentals. Nevertheless, the BPF returned again with its sustainability seminar, picking up from where it left off last year.
The topic is of central importance to Peter Verwer, who, as chief executive of the Property Council of Australia (PCA), represents the interests of a A$600bn (€324bn) industry that is acutely aware - perhaps more than others - of the implications of global warming on the built environment.
For many Australians, such topics as carbon emissions, energy efficiency and water usage are very much politically and socially relevant. Verwer lists sustainability - in its widest possible sense - as one of a number of critical issues for the PCA, alongside such things as taxes, bureaucracy, infrastructure investment and, naturally, the state of the credit markets. It is not that surprising then that Verwer has taken part in the BPF's sustainability panel at MIPIM, both in 2008 and 2009.
As he speaks in the café bar of the Carlton Hotel in Cannes, it is apparent that Verwer does not particularly relish the fanfare and showboating (literally, in some respects) associated with the week-long French spectacle. What appears to be a preference for directness and succinctness over unnecessary complexity or flamboyant excess looks almost like a personal extension of the PCA's continuing campaign against red tape and overgrown tax structures in Australia's real estate markets.
Australia currently has 125 business taxes, Verwer points out. "I understand Britain has 40. Ninety percent of the revenue is raised by 10 taxes, so why do we need the other 115?" he asks.
Whether such an alignment between CEO and association is real or imaginary, it would make sense: Verwer, a PCA employee all his working life, has been in the top role since 1992. He originally joined the association as a researcher, as he likes to put it, "straight from the maternity ward".
Returning to sustainability, Verwer outlines the big question for the industry: is it a concept that "has come and gone or are we moving into sustainability 2.0?"
Looking back to last year's MIPIM, he reflects that the issue has "moved along incredibly swiftly". He says: "The key focus is environmental capital. Has that issue moved when it comes to the built environment? The answer is yes."
One needs to specify what is meant by sustainability and for Verwer it is a wide-ranging theme with four major parts or forms of capital: economic, social, natural and governance. One main challenge unites them all: how they can be best managed "to provide dividends to society".
How directly relevant this is to pension fund investors is far from easy to conclude. As investors often with responsible investing agendas and social and governance requirements, the sustainability or energy efficiency of buildings held in a portfolio is undoubtedly important. However, emphasis will always be on ensuring the best returns (with optimum levels of risk) for pension scheme members.
Verwer responds by breaking the issue into three parts. The first relates to the impact energy efficiency of buildings has on investment returns. "There is no hard and fast evidence that green buildings are better environmental performers," he says. "I have looked at the arguments, I have looked at the data from the various green groups, and to the extent that it ever was convincing it has been rendered irrelevant by the current economic circumstances."
Verwer takes issue with conclusions drawn by McKinsey & Company to the effect that investing in sustainable or energy efficient buildings - or improving the sustainability of energy efficiency of buildings - will pay for itself, prompting people to view the practice as a ‘win-win situation' or a ‘no-brainer' for investors.
"McKinsey makes a big thing of saying that investing in energy efficient buildings pays for itself, because you get lower energy costs. This is a top-down approach and tends to avoid taking into account factors such as tenants, which I think is a weakness in the approach," he says.
Verwer does believe there will be a payback - a measurably positive effect on investment returns - but only in the long term. "A good-old-fashioned property surveyor will tell you… ultimately there is a payback, but it is not four or five years. It is 15 to 20 years."
This is why PCA is adamant that government incentives are needed to persuade investors and property owners to speed up their energy efficiency improvements. "We need to find incentives that bring that gap back to the four or five years that McKinsey has theoretically identified. And the best way to do that is incentives, tax incentives."
Yet, even without the advent of government-induced incentives, investors need to consider the effects that sustainability standards of buildings will have on their investments. This is Verwer's second point and one he stressed at MIPIM in 2008: that better performing buildings will not necessarily achieve higher rents or capital values, but the poor performing ones will suffer negative effects.
"There is going to be greater competition in the leasing market, because demand is shrinking. So there is going to be great pressure on vacancies and therefore rental growth. And so the better buildings will survive," he says.
"A more eco-efficient building - less in, more out - is going to be more competitive. A good analogy is with airbags in cars. To the extent that users ever paid a premium for airbags, that fast disappeared. But if a car doesn't have airbags, it isn't worth as much as the next one."
The third issue, which needs to be separated from the other two, is that of ethical or socially responsible investing. Verwer says: "Eco-efficient buildings or buildings for which owners have made a commitment to upgrade are likely to fit the profile of a responsible investor."
Does it make sense for institutional investors to target dedicated green property funds, for instance, through which investors could gain access instantly to investments labelled ‘green'? Or should they be looking to integrate sustainable principles into all their investments and push fund managers to improve assets? Verwer is inclined to favour the latter.
"I don't think this is a boutique area of investment," he says. "To the extent that specialist funds will be created, the market will judge whether they provide the returns. This issue is more important in terms of mainstreaming. It should be second-nature for the buildings to be eco-efficient. The more important trend is for eco-efficient building design and management practices to become the mainstream."
Looking at the wider real estate issues for Australian pension funds, Verwer explains that the big debate has moved from which is the best form of superannuation fund - that is, employer-sponsored industry funds that have tended to invest more in alternative assets like real estate versus retail funds for individual investors, which often charge higher fees.
"There has been a very interesting debate over the last few years as to which style is the best and which style produces the greatest returns and retirement wealth. And that debate has moved on to which format tends to have the biggest exposure to real estate," he says.
"The industry funds have tended to put a lot more into property - well over 10% - and this has served them very well. They have had very strong returns by not just investing in existing assets but development as well. The two big questions are: (a) are they overweight in property and (b) how is property going to perform as part of their portfolio mix? Have they got too much of it and for what they have got how is it going to perform relative to other asset classes? We will see over the next years."
There is a general consensus among the industry funds that they will not adjust their real estate weightings. "But that is really going to depend on how the property sector performs in Australia," Verwer says.
Latest International Property Databank (IPD) numbers show the largest individual quarterly decline in the capital values in the Australian market since 1993 during the fourth quarter of 2008. During the same three-month period, average office and retail capitalisation rates increased by 50 basis points.
"On average, from peak, property values are down 20%," Verwer says. "The issue is have they been discounted enough? Do the valuers accurately represent current supply and demand fundamentals? There are those who say they have and those who say they haven't. We will soon find out."
In the meantime, this ongoing debate centres around a fundamental question for long-term real estate investors: what is the role of property valuations?
Verwer says: "There are those who say: I still have rental growth at 6%; I still have my tenants locked in for five or 10 years; this real estate is performing like a bond with a potential long-term kick-out, so why should it be marked down severely when it is being held for the long term?
"It is the classic argument to which the response might be: it is what mark-to-market means. But for a pension fund, in particular, they are definitely holding over the long term. They will hold over two or three cycles. So in the total return equation the income growth component is more important."
Verwer believes that 2009 will prove to be the year of valuation debate, but not only in relation to "determining the return to investors", for both long-term holders and shorter-term opportunistic players. An important related question, Verwer suggests, is what role do these valuations play in the statutory accounting process and within the regime of the International Financial Reporting Standards (IFRS)?
"Nobody likes to talk about it in polite company, but it needs to be discussed in 2009," he says. "Every reporting system is the same: here are my accounts; here is the statutory result that conforms with IFRS; here is my loss; now let me tell you how it really went."
In other words, companies are running two sets of books, Verwer says, and this situation is something that regulators and the real estate industry have to start addressing this year.
"The role of valuation and the entire international harmonisation project need to be carefully scrutinised. And regulators and standard setters shouldn't run away from that debate, because the global financial crisis is a time to re-examine all of the market principles, whether they be market principles or public policy principles that have enjoyed free rein over the last 15 years," he says.
"This is a key one: the role of valuation per se and the role of valuation in the statutory accounting process and what IFRS is really trying to achieve. It certainly hasn't created international harmonisation. It certainly hasn't created more transparent markets, which I understood were its twin goals."
Verwer is clear that he is not holding IFRS responsible for the current market situation, but he does think there needs to be more debate.
"IFRS is meant to be a common language for its comparability of accounts in different countries, which creates a more transparent market place, which ensures there are no artificial blockages to the driving forces of the markets, such as liquidity," he says.
"Is it fulfilling that role? If every reporting season what is being reported is two sets of books, the answer can at least be questioned."