Investment in sustainable real estate has become a fiduciary responsibility - indeed, investors can make a major contribution to reducing emissions. But changes need to be made to move us forward, say Hoong Wey Woon and Darren Sriharan
Sustainability in real estate has become a topic of great importance over the past few years, and continues to be a widely debated subject. The United Nations Environment Programme Finance Initiative, Sustainable Construction and Buildings Initiative (UNEP SBCI, 2006) has suggested that the ‘built environment', through its construction and use, accounts for 40% of both global energy use and carbon dioxide emissions, 30% of raw materials usage and 20% of water usage.
Meanwhile, the Intergovernmental Panel on Climate Change (IPCC, 2007) has identified buildings as having the greatest potential for carbon mitigation at lowest cost, at any given cost per ton of carbon dioxide and every level of economic and national development.
As a result, concern over climate change is encouraging ever more demanding legislation and regulation for landlords and occupiers of buildings. In addition, rising energy prices are increasing occupation costs and the physical impacts of climate change pose substantial longer-term risks to future property values. This has led to the introduction of new schemes focused on sustainability such as the Building Research Establishment Environmental Assessment Method (BREEAM), which rates and grades new developments.
More recently, IPD has launched the IPD Sustainable Property Index (ISPI) which identifies ‘sustainable buildings' and assesses the performance of ‘greener' properties. The UK has introduced Energy Performance Certificates (EPCs) that are mandatory for any real estate asset. In addition, larger public buildings must openly disclose to the public Display Energy Certificates (DECs), which will indicate the energy efficiency of public buildings whilst in operation. The compulsory EPCs and DECs have helped to push investors to place added emphasis on the energy efficiency of their real estate assets.
Delivering sustainable returns
There is a growing belief that over time more environmentally conscious buildings will experience higher net income growth and be viewed as lower risk and thereby deliver higher returns. Sustainable Investment (SI) can be defined as investment decisions and ownership practices that incorporate environmental and social issues. An increasing amount of evidence and research is showing that SI in real estate can help:
• Create brand value and reputation benefits;
• Enhance capital growth and rental income;
• Lower operating costs;
• Improve tenant retention;
• Reduce depreciation costs compared with non-sustainable buildings.
SI has shown superior returns in the equity market; the average SI equity fund outperformed the MSCI World Index by 36% over the past five years. The SI real estate market is much more limited but demand for SI real estate products is increasing and this will continue over the long run as investors seek to hold a ‘future-proofed' real estate portfolio. The need for SI in real estate is strengthened by the political and social determination to tackle climate change as well as the potential energy crisis.
If environmental issues are set to affect the current and future value and performance of property assets, then the environmental performance of property assets must be seen as a fiduciary as well as a social responsibility for pension funds. It is the fiduciary responsibility of trustees and investors to understand the implications of these issues and to seek economic ways to improve the sustainable assets. Diverting capital towards investment in sustainable real estate can be seen as protecting the long-term financial future of fund members and investors.
Proactive in fiduciary duty
Property is a key part of both the problem of, and the solution to carbon emissions growth. The Institutional Investors Group on Climate Change (IIGCC) believe that pension funds, their managers and its trustees can make a serious contribution to reducing carbon emissions. A major factor in driving this forward is through demanding relevant information on the environmental impacts of their property portfolios. The information should be in the form of simple, meaningful metrics that are cheap and practical to gather across all properties.
The IIGCC has identified a range of metrics, in particular recommending those recently suggested by the UK Green Property Alliance.
These metrics concern the following areas:
• Energy usage and energy efficiency: The level of carbon dioxide emissions is a key metric relating to the environmental performance of a building;
• Water usage and efficiency: If a property can provide some of its own water needs, it can keep costs lower and be a lower risk;
• Waste production and recycling: If the costs of waste are high then a property with a good waste recycling and management system should experience fewer deductions from net income flow;
• Accessibility: If the cost of travel by petrol and diesel powered vehicles is set to rise, out-of-town occupiers might need to offer higher wages to compensate. Proximity to or availability of public transport or site-related travel plans, and/or the existence of facilities for bicycle users, should help alleviate these issues and improve asset value.
• Situational risks: If a property is at risk from flood or coastal erosion, it could grossly affect the value of an asset, particularly if the risk becomes so great that insurance cover is withdrawn;
• Land consumption: It is important to understand what the balance in the fund has been between new development and asset refurbishments. When development or refurbishment is required, it is clear that it would have less of an environmental impact if the materials were sourced locally;
• Tenant and supplier engagement: The property fund manager has both the ability and the responsibility to engage with other key stakeholders in the fund and its properties, with respect to their environmental performance and credentials.
The IIGCC believes that pension funds should encourage the multiple providers of environmental metrics to work more closely together and better ensure mutual compatibility. If standardised metrics and reporting can be achieved, environmental performance measurement practices could evolve to sit alongside existing investment performance analysis. At this point, as with investment performance metrics, they could be used to compare the environmental performance of different fund managers.
A step change
As discussed above, fundamental changes need to take place within the real estate industry before sustainability improvements will become more widespread and commonplace.
The next steps must include:
• KPIs that accurately capture sustainability performance and improvements due to company/fund manager initiatives;
• A consistent sustainability performance reporting and measurement system across the industry. This will enable data to be more easily interpreted and compared across different funds and companies;
• An increase in the number of research papers addressing the subject to provide investors with a better understanding of the value of sustainable investment;
• Landlords incorporating sustainability into their valuation-of-worth methods and provide tenants with information on their expected savings from reduced occupational costs in order to justifiably command higher rents;
• The ISPI concentrating on isolating individual parts of sustainability to provide information on the financial benefits of SI.
It is also important to build on the schemes already in place, and property fund managers should be encouraged to establish BREEAM in use ratings on properties across their portfolios. BREEAM would be a natural ‘proxy' measure that pension funds and the wider property industry could obtain consolidated information on in a reasonably easy way. In addition, there is potential for the number of properties covered by the ISPI to grow as fund managers supply more data.
Hoong Wey Woon (left) is fund manager and Darren Sriharan is global real estate-analyst at Aviva Investors