New legislation in the UK will allow tax -incremental financing allied to other innovative financing models to provide a vital new source of funding for sustainable real estate projects, says Pete Halsall
We remain in a brave new world full of opportunity. Debt-based models to support new development will not work for the foreseeable future. It is not just about sourcing higher levels of capital to get new developments funded, it is also being confident that capital can be sourced by buyers, both commercial and residential.
For the majority of developments, which require recycling of capital, there is no point raising the money if buyers can't do likewise. Regulation of the banking industry and what's really going on in banks will continue to constrain new capital at both ends.
There is light in the growth of institution-friendly and development-driven private rental sector projects. But in terms of meeting the broad sweep of capital for the residential market in particular a significant gap remains. Additionally, the new government in the UK has signalled an end to large-scale capital investment support for regeneration projects, rendering many of the badly needed urban development projects in financial deficit. Until it resolves itself the supply of new property will remain shrunken, in spite of the strong demand for new homes.
Enter sustainability and assistance from new government financing and renewable energy programmes.
Evidence over 20 years demonstrates the considerable benefits of sustainable community development:
• More attractive and marketable properties with higher amenity levels;
• Higher property values with reduced long-term operating costs;
• In the workplace context, the benefits widen to include enhanced workplace productivity, increased staff retention, reduced worker absence due to illness and better corporate appeal to higher-calibre staff.
Indeed, the growing numbers of new sustainable buildings appear to be outperforming their less green rivals. Many properties constructed to building regulations minima are underperforming during operation, in some cases requiring 80-120% more energy in use than was designed for. The government is waking up to this in funding a gamut of post-occupancy monitoring projects. It seems likely that a requirement to test the actual performance of a completed building - rather than just sticking a certificate on the wall - is now only a matter of time. But why should sustainable buildings fare any better?
Well, you have to conceive, design and build them differently. Attention to detail becomes much more critical. Technology selection and installation are much more rigorous. Construction inspections likewise. So not only are they designed to perform better, but a recent study shows that they are much closer to expected design performance than their rivals.
Surely then capital will flow to developments where investors can be more confident that the buildings will deliver to their higher design requirements: more purchaser friendly and authentic, as well as being a better long-term investment.
Sustainable projects are typically more capital hungry than their less eco-friendly rivals, however. Centralised renewable energy systems that deliver sustainability not only add to initial costs, but also require a critical mass of initial development to be viable. The close synergies between sustainable community development projects and cleantech - the emerging industry that is providing sustainable technologies and renewable energy systems - could attract capital to sustainable property otherwise destined for more risky venture capital investments in the high growth cleantech businesses.
For now, the gap remains however, in terms of funding the sustainable infrastructure element of projects or in providing additional income to make developments viable. Enter ‘Tax Incremental Financing' or TIF, which enables the project sponsor, usually a local authority, to borrow against the future tax income derived from new development.
The UK coalition government has announced that it will proceed with TIF and that primary legislation will be implemented to enable it to happen. Indeed, the Scottish Government has already stolen a march and approved the first such project last year at Leith Docks in Edinburgh involving £84m (€99m) of TIF finance.
The deficit is not going to disappear any time soon and investment in new development and infrastructure will remain critical to the UK's competitive advantage, with TIF already kick-starting the foregoing major regeneration project in the absence of government cash. At this point I make a prediction: TIF will become as pervasive as PFI (private finance initiative).
TIF could open a plethora of new investment opportunities and products for institutions, with the attraction to investors of long term income streams collected by rates officers.
Further supporting initiatives for new capital investment include the Feed in Tariff (effective from March 2010) for renewable energy schemes, and the Renewable Heat Incentive (scheduled for June 2011). Both of these schemes provide long term - ie, 10-25-year - guaranteed income tariffs (with annual adjustments against the retail price index) to support investments in renewable energy.
The Feed in Tariff provides a payment for the amount of energy generated per annum and in addition for the amount of energy that is surplus and sold to the grid. In assessing the financial return, a hidden benefit is the amount of avoided cost in reducing or eliminating the electricity bought from the grid. These schemes, which can be implemented on the same development, utterly transform the economics for investment in renewable energy infrastructure.
These new tariff arrangements will mean that new capital will undoubtedly be attracted to new sustainable community developments with attractive and long-term returns for investors.
So, it seems that the nexus of sustainability and property provides rich ground for investment with the potential for much needed capital to be attracted back to this most auspicious of asset classes. As for the issue of capital at the other end of the process? The sustainable or green mortgage beckons, but that is another story.
Pete Halsall is managing director, BioRegional Quintain