Climates are not created equal

Sustainability has become a key metric for global investors, but varying climates and certification standards make it tough to compare assets across markets.

Certain combinations of climate and market circumstances can make it more challenging to develop and own sustainable buildings that also benefit the bottom line. It is also a challenge and therefore a cost to design and manage buildings that can cope with extremes of heat, cold and humidity while using minimal energy.

Sustainable building design and technology, while still evolving, has reached the point where a ‘green’ building can be created for any climate. For example, net-zero energy buildings have been constructed in climates as diverse as Colorado and Arizona in the US, and in the heat and humidity of Jakarta, Indonesia.

Cost concerns

A net-zero energy building is where the total amount of energy used on an annual basis is roughly equal to the amount of renewable energy created on the site or, in some definitions, by renewable energy sources elsewhere. However, the cost of construction can be greater in markets with less temperate climates.

Gregory Kovacs, design director at architect Benoy, says: “The capital cost premium for green buildings can be significantly higher in a market like Singapore than in Germany or the UK. However these figures vary based on typology and project size. The increased construction cost of green buildings often comes with a longer time for project delivery as well, both due to the relative novelty of some of the building technologies and materials required. The effect of these factors of course gradually decreases as the local industry becomes more and more familiar with them.”

Consequently, many of the occupiers of net-zero buildings are government tenants, NGOs or also the owners. In a multi-let commercial building it is harder to align the commercial interests of landlord and tenants with the aim of maintaining net-zero performance. Asset owners are increasingly negotiating ‘green leases’ to account for this, but demand for these is limited at present.

Brad Dockser, chief executive and co-founder of Green Generation Solutions, says: “Net-zero carbon buildings have been constructed in a wide range of climates. However, those in more extreme climates are typically developed for NGOs or owner-occupiers with a specific commitment to sustainability rather than multi-let buildings owned by investors. They also tend to be small-scale buildings to date.”

For example, Jakarta boasts an office building that adheres to the rigorous Passivhaus standard, which requires considerable investment in insulation and passive heating/cooling measures, without the use of conventional air conditioning. However, this building is the Austrian embassy and no commercial building in Indonesia meets the same standards.

Climate variations are not the only differences between global markets and arguably not the most significant. Billy Grayson, executive director at the Urban Land Institute’s Center for Sustainability and Economic Performance, says: “Differences in climate are less significant than differences in market fundamentals. In the largest global markets, the costs of adding sustainable features are broadly similar.”

For example the cost of energy varies widely between cities, even in the same country, which significantly affects the return for energy-saving building design and management. Another factor is how developed the market is and whether local tenants are prepared to pay an adequate premium for the best buildings. In many developing markets, green buildings are aimed at multinational corporates rather than domestic businesses.

However, Dockser says private equity investors need not be concerned about whether sustainability measures pay off during their hold period. “An investor’s time horizon ought not to be a barrier to sustainability. If an owner invests in measures which are proven to reduce energy costs then the improvement to net operating income can be capitalized when the building sells or is refinanced.”

The resiliency factor

Furthermore, measures that do not necessarily have an immediate effect on NOI can be valuable. An increasingly important factor for real estate investors is resilience; that is, how an investment copes with changing market circumstances, which could include legislation, tenant trends or climate change itself. Dockser argues investors should consider the ‘brown discount’ for unsustainable buildings as much as the ‘green premium’ for sustainable investments.

In a number of US cities, for example, new buildings and major renovation projects are required to achieve green certification. In the future, energy-efficiency requirements for existing buildings are likely to increase. Grayson says investors need to consider “future mid-term obsolescence,” particularly in markets where local and national government is keen to promote sustainability.

Resilience is an important factor for investment manager TH Real Estate. Sustainability manager Richard Hamilton-Grey says: “TH Real Estate has launched a number of products under its ‘Resilient’ series, which specifically factor in climate change vulnerability as part of the filtering process used to identify a focus list of cities to invest in.

“The climate change vulnerability assessment considers three key aspects: the exposure of a location to climate change; the sensitivity of an area to climate change; and an analysis of the adaptive capacity of that area to be resilient to the impacts of climate change – for example, the capacity of national institutions, and the legislative environment.”

This strategy suggests that not only could unsustainable assets suffer, but also certain markets, such as coastal cities potentially subject to flooding. In these markets, local and national government responses to a market’s environmental challenges could be as important as the challenges themselves.

A certification conundrum

As market conditions and climates vary around the world, so do green certification bodies. This creates a headache for global investors that wish to benchmark the sustainability of their portfolio. Sustainability is a key metric for Dutch pensions group APG, where all prospective real estate investments must meet required criteria for cost, projected returns, sustainability and risk. As a global manager of real estate, APG wants to assess the sustainability of its entire portfolio, but variances in certification make this impossible at present.

Derk Welling, senior responsible investment and governance specialist at APG Asset Management, says: “The past decade has seen huge growth in certification schemes. GRESB [the Global Real Estate Sustainability Benchmark] recognizes 200 schemes worldwide, but there are around 600 in total. This makes it hard for investors to assess sustainability across a global portfolio; for example, how does a LEED Platinum rating compare to a BREEAM Excellent rating?”

Different certification regimes around the world tend to rate buildings in the context of the local climate. However, Welling believes that some multi-jurisdictional certification schemes do not take sufficient account of varying climate. He says: “You cannot assess the sustainability of an igloo in the same way as you would assess a pyramid. Likewise, we would not expect an office building in Hong Kong to use the same amount of power as one in Amsterdam.”

APG would like to see GRESB take a lead role in ensuring that certification standards are comparable internationally while still taking local differences, which might include factors such as energy costs as well as climate, into account.

For APG, the sustainability bottom line is that a building must be “Paris-proof”; that is, it must meet the objectives set out in the 2015 United Nations Framework Convention on Climate Change, widely known as the Paris Climate Agreement. Signatory nations have committed to limiting the rise of global temperatures to less than two degrees higher than those in pre-industrial times and curtailing carbon emissions to net zero by 2050.

Welling says: “To date we do not have a target at portfolio level with regard to net-zero carbon. However, in conversations we have with external managers we do challenge them to think about setting long-term targets. To date, our key condition to all real estate investments we make is participation in the annual GRESB Real Estate assessment with the aim to achieve a four- or five-star GRESB rating.”

Hamilton-Grey says TH Real Estate faces similar challenges in assessing investments in different markets: “Different real estate markets around the world have different blends of sustainability certification adoption. This can be driven by both occupational market and investment market characteristics. For example, despite LEED certification originating from the US, we see a large take-up of this type of certification in Frankfurt, given the occupier base. This also sits alongside the German-originated DGNB certification and BREEAM-DE.

“There are significant differences between the certificates in terms of content, as some are geared towards country-specific standards, guidelines and building practices. For example, DGNB accounts for economic aspects such as lifecycle costs, whereas LEED doesn’t. Each of these certifications have certain strengths and challenges.

“Despite the presence of a wide variety of local building certification programs, internationally recognized green building certificates tend to be more widely adopted in the commercial real estate market. Tenants and investors need such standardized measures of environmental performance.”

New metrics

A further challenge is the growth of new sustainability metrics, such as those for healthy buildings, very much en vogue currently. For example, the International Well Building Institute offers WELL certifications for assets that provide a healthy environment for occupiers. However, APG’s Welling says he is “not a fan of single issue certification” and would like to see a more holistic approach.

Furthermore, as Hamilton-Grey notes, certification is currently linked with building design more than operations. “For TH Real Estate, the operational efficiency of a building is just as important as the designed performance of a building, since it is the operation of the building that will impact on energy usage and tenant experience, and therefore potential impact on NOI.

“Therefore, although we recognize the importance of design-based certification methods, we think it is also important to adopt operational certification methods, since it is the operation of the building that will be the true test of its real resilience on the transition to a low carbon economy.”