Take the high road

With greater globalisation no sector is likely to be more affected by the drive to sustainability than logistics. Ljiljana Grubovic and Ali Nassiri report

The last two years witnessed a massive change in corporate positioning on sustainability. Climate change, and how to tackle it, emerged as the hot topic of 2006, with politicians and companies eager to declare their green credentials.

The increasing awareness for conducting business in a sustainable manner will shape the market over the next few years. Environmentally friendly strategies will become a main target of both developers and investors. In addition, the development and investment in ecological warehouses, or so-called ‘green sheds', will become a measure of corporate social responsibility (CSR), and investment funds may provide the impetus needed to encourage improved energy performance in logistics properties.

Green sheds are increasingly becoming the focus of investment strategies of both developers and investors. The following article provides a brief overview of European legislation and looks at how sustainability issues might impact logistics warehouses' values in furture.

Conducting business in a sustainable way is becoming more important and improving environmental awareness is prompting both manufacturers and logistics service providers to address the ecological impact of their activities. Although the rapid growth of freight transport contributes positively to the economy, it also harms the environment by causing congestion, noise, and pollution. The transportation sector's dependency on fossil fuels resulted in a clear objective of the European Commission to boost a better distribution of traffic towards more environmentally friendly, energy efficient and safer transport modes.

Rail transport, inland shipping, and short-sea shipping are promoted, particularly for long-hauls and congested traffic corridors. This environmental consciousness is not only related to the way companies organise their logistics processes or the modes of transport they use to transport goods (eg rail versus road), but also concerns guidelines and laws with regards to distribution warehouses.

Changes in the perception of importance of conducting business in a sustainable way have been coupled with policy changes. In Europe, several environmental policy initiatives are in the process of being introduced. Some of these will have significant impact on the European property industry.

The Kyoto protocol provides a framework for all new legislation relating to climate change. In order to help reach national targets, the EU has issued the Energy Performance of Buildings Directive (EPBD). This aims to cut greenhouse gas emissions in both residential and commercial property. The member states have until December 2008 to apply the requirements.

The most significant impact resulting from this directive will be the introduction of energy certification for commercial and domestic buildings, which will allow investors, owners and occupiers to compare the energy performance of one building with another.

Certification will provide a performance profile for every building and, depending on implementation, for every end-user. Certification will be granted at construction, sale or lease, making assessment a continual process.

Initially, CSR will drive demand. Energy efficiency will evolve as a niche market, attracting large-scale specialised warehouse developers, with environmental policies such as Gazeley and Prologis. However, demand for low-energy-use buildings is expected to gradually feed through to the rest of the market. Certification will become a measure of CSR and key investment funds may provide the impetus needed to encourage improved energy performance in the logistics property. In the long-term, demand will create an extra premium price for energy efficient logistics buildings.
As policies and attitudes change, so will the market. For investors, sustainability presents a new form of risk depreciation - if they are not investing in green now, will their buildings be obsolete in 10 years' time?

If energy costs continue to rise, the cost savings from occupying energy efficient space will begin to drive demand more. There is no consensus on how the extra costs will impact the building of a low-energy-use building. According to the Department for Offices and Communities in the UK (formerly known as a Office of Deputy Prime Minister), the costs associated with implementing the proposed building regulations for industrial and distributional facilities will be £7/m2.

However, there will be a divergence between large-scale and small-scale developers. The sheer scale of Gazeley's or Prologis's developments allows for the dispersal of additional capital costs. Small-scale developments will have higher build costs, and additional costs will be harder to disperse.

For existing stock, and in particular old stock, introducing energy efficient improvements will be costly. In particular, air tightness has been identified as a key element for improvement in industrial buildings. For very old warehouses, the added cost of improving a building's envelope performance may make demolition more cost-effective than refurbishment.

Cost issues will diminish as certification becomes more commonplace. Those who have a long-term investment interest in energy efficient buildings will have greater incentive, compared to short-term investors.

According to recent research conducted by DTZ Research and Gensler (2006), businesses are "willing to pay 10% more in rent for more efficiently designed and constructed buildings", (Gensler, 2006).

The major driver of investors for energy efficient buildings is linked to the potential returns they offer and whether these are sustainable. Changes to occupier demand and increased demand for energy efficient buildings will increase their attractiveness, and as a result, those buildings will generate higher returns. Buildings, which are not developed by sustainable standards, might face accelerated obsolescence, since they are likely to become less desirable to tenants. Assessing the sustainability of a logistics asset, by only focusing on the bricks-and-mortar is a misjudgement.

However, the manner in which incoming and outgoing goods flow is facilitated is also important. Ultimately, no industrial building can be truly perceived as sustainable, but a direct access to one or more environmentally friendly transport modes such as inland waterways and rail improves the sustainable quality of the area and building.

The impact of sustainability on rental and capital values has yet to become visible. An increase in sustainability awareness will generate larger demand, and we could expect to see stronger rental growth and higher capital values for sustainable buildings. In addition, because of the scarcity of the stock existing warehouses are likely to experience lower tenant turnover and shorter void periods.

Investors may need to expend capital on improving the ‘unsustainable' stock in the market. However, ‘sustainable' assets are currently less illiquid than their unsustainable counterparts, and we could expect a two-tier market to emerge. Energy efficient buildings will become a prime space.

Planning arises as an additional incentive - irrespective of legislation and regulations - for investors and developers to invest in energy efficient buildings.

It is increasingly difficult to gain planning permission for large projects in the UK and western Europe because of insufficient available land. The low-energy-use building approach will become more vital in achieving successful planning.