The future of green building ratings
Green rating tools are an established way to assess a building’s sustainability. But, asks Philip Hirst, what is their true value, and how can investors use them more effectively?
At a time when pledges to deliver a low-carbon economy are being made by governments and businesses the world over, the real estate sector – being responsible for 40% of total global carbon emissions – has a huge role to play.
One of the most established ways those in the industry choose to demonstrate a building’s sustainability and commitment to more sustainable outcomes, including lower carbon emissions, is via a green-building rating. Since the establishment of the BREEAM series of ratings in the 1990s, hundreds of these green-building rating systems have evolved across the world. The current estimate is that more than 600 different systems exist, with the US Green Building Council’s LEED system having the largest global coverage.
A building does not have to be certified under a green-building rating to be sustainable. So, as a result, the reasons for developers, tenants, and owners to pursue a green rating – and for investors to use them in their decision making – are varied.
Ratings firstly help to give credibility to a building’s sustainability performance by providing third-party verification. Green-building ratings are therefore often required by governments for their own estates as a means to ensure a certain level of quality is achieved, or by tenants when commissioning or deciding to rent a building. They act as a communication and marketing tool to convey a building’s sustainability level to potential purchasers, tenants and to the wider market.
With increasing regulations across the globe focusing on the sustainability of buildings, voluntary and market-led green-building ratings can also provide a tool to not just ensure compliance with minimum legal requirements, but to exceed them.
Green ratings also provide a clear framework to ensure sustainability is considered throughout a project’s lifecycle, and not forgotten about in key decision-making stages or lost in a complex design process. In this way, they can act as an effective project management tool and help to reduce design-related failures and associated costs.
From an investor’s perspective, many studies have tried to establish if a more sustainable building is a more valuable building, and green-building ratings provide a well-understood indicator of a building’s sustainability against which its value can be analysed. Evidence from studies carried out over the past 10 years suggests that green buildings tend to have higher asset values than conventional buildings. This ‘asset value’ equates to higher rental values, lower operating costs, higher occupancy rates and lower yields.
The World Green Building Council undertook the largest review of studies into the link between green-building ratings and value, and found that having a green rating could decrease a building’s sale price by as much as 15% or increase it by up to 30% compared with a conventional building. Similar ranges of -7.5% to 25% for rental values and 0-23% for occupancy rates were also found, although, on average, buildings with green ratings were found to be more valuable and easier to lease. The study also found that, overall, green buildings did not cost more than a ‘non-green’ building to build and that the price differential was largely based on perception rather than data.
Other findings from these studies suggest that higher levels of certification tend to result in higher sales and rental values, although this is less certain and the actual amount of increase varies between countries and studies. Sales-value increases were also found to begin at certain certification levels, meaning that merely having a certified building was not enough – the level of certification had to, in some way, be above the market norm. But at the same time, extremely high levels of certification did not necessarily translate into extreme variations in sales or rental values. Indeed, one of the studies found that for each additional green building in a particular area, the rental and sale premium for a certified building in the same area decreased. This is also related to a key finding from the study that in markets where green is more mainstream, there are indications of emerging ‘brown discounts’, where buildings that are not green might rent or sell for less.
Using green ratings more effectively
For investors, green-building ratings can be useful in deciding whether to buy or sell a building, or to invest in a project, in terms of its physical design and its value. But how can investors ensure they maximise the value they derive from these ratings?
Firstly, they should ensure that the sustainability parameters measured by a rating match those that are important to them. For example, different ratings put different emphasis on carbon reduction in terms of the points that are available and the levels of reduction required. To give some context, at COP21 in Paris, leading organisations in the property sector, including JLL, pledged to play their part in reaching the 2˚C climate goal by moving towards net-zero new buildings by 2020, and net-zero refurbished buildings by 2030. Investors should therefore consider if particular green-building ratings and scores go far enough in their ambitions on key sustainability parameters.
“Many studies have tried to establish if a more sustainable building is a more valuable building, and green building ratings provide a well-understood indicator of a building’s sustainability against which its value can be analysed”
Secondly, investors should consider market demand for ratings. As mentioned, there are over 600 green ratings globally and they are often rooted in their country or region of creation. For example, analysis conducted by JLL on green-building ratings in the Middle East found that there were 603 LEED registered projects in Dubai, but no BREEAM registered buildings. In addition, the Government of Dubai also launched its own Al Sa’fat Green Building Tool in 2016 – yet another rating for buildings in this key real estate market.
Another consideration for investors is the extent to which the ratings are audited. Most ratings tools are not audited and are predictive of performance. A gap is opening up between buildings that have been designed to high levels of performance under green rating systems and their real in-use, operational performance. It is therefore important for investors looking to make a medium or long-term investment to consider how performance will be achieved in reality. This could be through using operational green ratings, such as BREEAM In-Use, but could equally be about assessing a building or developer’s handover procedures, operating practices or post-occupancy testing regime.
Despite their challenges, the intelligent use of green-building ratings has become widespread in the real estate industry and by real estate investors. But what does the future hold for green ratings as their numbers multiply and as the real estate industry, governments and investors become more adept at achieving sustainable outcomes?
A key trend on the minds of investors is the rise of health and wellbeing in buildings. The WELL certification has quickly become a well-understood standard in this area. Indeed, it is a rigorous standard that is accompanied by regular checks to maintain accreditation and it therefore addresses some of the limitations of traditional green rating certifications that are based on design assessments only. However, as with green certifications, a building does not have to have a rating to be healthy. Therefore, how the WELL standard or other health and wellbeing focused ratings are used and adopted by the real estate sector and investors moving forward remains to be seen.
A final consideration is community ratings. Green-building ratings are widely used and hundreds of thousands of buildings around the world have been certified using them. By contrast, use of community ratings is a new phenomenon that is emerging as an option for the largest and highest-profile new developments, which incorporates not just buildings but public spaces such as squares, parks and streets. For example, the Beijing Olympic Village (LEED for Neighbourhood Development) and Stratford Olympic City, London (BREEAM Communities) both obtained community ratings. Although a building or project might not always warrant a community rating, greater consideration of sustainability issues beyond the red line of a building – and particularly social and economic issues – is something that green-building ratings and their users will have to adapt to.
So for green ratings to replicate the growth they have seen since the 1990s and to remain of value, they will need to adapt to new sustainability challenges including net-zero buildings, health and wellbeing and socio-economic issues. However, ultimately green ratings do solve some of the fundamental problems for all stakeholders in a building. They provide a system to manage the complexity of sustainability; they help a building to comply with legislation; they measure value; and they provide objective evidence of performance.
The type, number and focus of ratings will evolve over time, but by addressing those fundamental issues green-building ratings are likely to remain a key tool for the real estate industry and its investors in the future.
Philip Hirst is director of upstream sustainability services at JLL
Australia’s world leader
Local Government Super continues to top the list of ESG investors, despite its modest size.
Australia’s Local Government Super (LGS) fund has repeatedly outranked the world’s asset owners when it comes to setting and implementing strategies to deal with investment risk from climate change. In the five years since London-based Asset Owners Disclosure Project (AODP), a not-for-profit organisation, launched its first Global Climate 500 index, the fund has ranked number one in three years and was second in the other two years.
In the most recent AODP survey, published in May 2017, LGS, which handles the savings of 90,000 mainly local government employees in New South Wales, ranked first again, ahead of the UK’s Environmental Agency Pension Fund, New York State Common Retirement Fund, fellow Australian fund First State Super, and the Netherlands’ Stichting Pensioenfonds ABP.
For LGS, an AUD11bn (€6.9bn) minnow, to be able to repeatedly swim ahead of global capital whales to land the top prize is testimony to the rigours of its investment strategy and conviction.
Bill Hartnett, head of sustainability at LGS, says: “We have long accepted the body of evidence available from climate science and the urgent need to address the impact of climate change, not just on the environment but also for people, societies and consequently on businesses and our investments,” he says. “As a long-term capital allocator, as well as an investor, we are making decisions now that will affect our investment for 30 or 40 years.”
Hartnett says the real credit goes to the fund’s trustees who in 2001 began addressing environment, social and governance (ESG) concerns by divesting tobacco companies.
“The trustees saw it as a fundamental responsibility in fulfilling their fiduciary duty to incorporate ESG and climate change considerations into our core investment decision-making process,” he says. “This is what has differentiated LGS. We have not treated climate change as a voluntary member fund option, but rather integrated it deeply within our default investment strategies.”
More investors have been realising the need to mitigate climate change risk. Hartnett points to the likes of the Norwegian Government Pension Fund and the Netherland’s APG and PGGM, for which investing responsibly is front and centre of decision making.
Increasingly, too, he says, global asset managers are taking the climate change issue more seriously, and developing good investment products. “It is extremely important to keep to the two degrees temperature target [set in Paris in 2016],” Hartnett says. “If the threat of extreme weather events is not controlled, it will eventually force very strong regulatory responses, leading to a variety of difficult geopolitical and societal issues.
“There is a conundrum about how to integrate short-term investment needs versus long-term real-world issues such as climate change, which are already and increasingly will impact investment returns. However, we are getting the experience and confidence that both short-term and long-term goals can be achieved.”
LGS tightly controls its investments through an AUD950m impact-investment programme. “We started with green bonds in 2012 and they have been a great success story for us,” Hartnett says. “We invest in clean technology through private equity and renewable energy infrastructure in Australia and emerging markets.”
LGS has AUD2.2bn invested in private market assets. These include infrastructure, private equity, private debt and direct property, which it manages internally. It has 12 properties in New South Wales. “They are not modern skyscrapers,” says Hartnett. “More like 25-year-old, B-grade office industrial buildings and shopping centres.” LGS began retrofitting its buildings in 2010, and the portfolio became the first in Australia to achieve a five-star Green Star performance ratio.
“I emphasise performance, because you see a lot of buildings built to five or six-star design standard,” says Hartnett.
LGS has embarked on its second retrofitting programme. “We have, so far, achieved close to 45% savings in energy costs,” he says. “At the same time, over the last couple of years, the investment return of that portfolio has been around the 20% per annum mark – one of the best in the industry. This continues to demonstrate to us that you can focus on sustainability and get great environmental outcomes as well as investment returns.”
Within the infrastructure sector, LGS predictably focuses on renewables, both in Australia and emerging markets. “Overall, we are not aspiring to be the top short-term performer. We are a second-quartile performance fund over the short and long term. We are satisfied with that.”