Since its creation in 2009, the Global Real Estate Sustainability Benchmark (GRESB) has become established as the global standard for sustainability reporting for real estate at the portfolio level. GRESB co-founder and chief executive Nils Kok claims that a fast-growing body of evidence is now persuading property investors that sustainability is an important factor in determining the returns generated by real estate assets. Meanwhile, Patrick Kanters, managing director of global real estate and infrastructure at Dutch pension fund manager APG Asset Management, argues that energy efficiency is a factor that long-term investors cannot afford to ignore.
Connecting sustainability and returns
Patrick Kanters: At APG we have set ourselves a goal to cut carbon emissions across our investments by 25 percent by 2020. At the same time, we want to double the amount of highly sustainable investments we manage from €28 billion to €56 billion. Ever since the start of GRESB, we have set very strict requirements that any new real estate investment should contribute to the GRESB survey. Five years ago, those requirements were not always welcomed by our investee companies, but it is no issue nowadays to have that implemented and to have companies commit to sustainability those goals because the evidence is very clear that more sustainable assets generate higher returns or, in many cases, mitigate downside risk. We use GRESB data to evaluate the real estate operators and portfolios we buy to ensure our investments are sufficiently future-proofed. Sustainability will affect their future marketability and our ability to lease them. The way in which valuers take energy performance and other environmental factors into their valuations is still fairly limited at the moment, but we definitely believe they will take that more into account as more evidence comes to the table and as more regulation comes into force that could affect the value of assets.
Nils Kok: Since GRESB started, we have been able to rate about 1,200 funds, joint ventures and separate accounts, providing investors with a high-level view on the ESG performance of these portfolios. There has been an increasing number of academic studies that link the financial performance of real estate, measured in terms of rents, prices and occupancy rates, to the sustainability performance of these assets, so there is more of the evidence that valuers are looking for. At the same time, even though valuers might not explicitly take energy efficiency or sustainability into account, they might do so implicitly, because if, as these studies show, the energy performance of an asset is reflected in rents, occupancy rates and sales prices that will feed into the valuation model as well. The role of capital providers shouldn’t be underestimated either. Larger banks are increasingly asking for sustainability and energy efficiency data in their underwriting, which is a game-changer, because they might be willing to provide more finance for an efficient asset or unwilling to lend against an inefficient one.
Occupier demand for energy-efficient buildings
NK: For medium-sized companies that are not always in a prime location rents are lower, which means that utility costs and service charges relative to rents are much higher, so energy-efficiency is more important. In prime locations where utility costs relative to total occupancy costs are relatively low it is the larger corporates with ESG policies that will drive sustainability.
PK: More and more companies have set themselves targets to reduce carbon dioxide emissions going forwards. Those goals translate into their businesses and renting space is one of the areas where a lot of improvement can be generated, because real estate is one of the largest contributors to CO2 emissions and the use of energy. Tenants also look at other elements related to health and wellbeing. Sustainability is increasingly seen as part of contributing to a successful company. Buildings are around for a long time, but tenants are only around for 10 or 15 years and tenant requirements change so you have to continually adapt to tenants’ demands to mitigate the sustainability risks involved.
NK: There are three risks – market, regulatory and systemic – that as an investor you want to be prepared for. The market is about tenants. Those tenants have changing preferences over time and those are hard to predict, but one can identify important trends. For example, multi-family apartments are not becoming bigger, but it is quality that is becoming increasingly important. The people who rent these apartments want comfort with green attributes and that is not going away. In the office market that trend is reflected in tenants thinking about natural light and air quality, location of transport and amenities, and the design of open space for flexible working. From a regulatory perspective the picture is clearer. In the EU and the US, regulation is starting to require minimum energy performance levels. Systemic risks related to climate change are harder to predict. We don’t know where the next hurricane, drought or flood will hit, but as a building manager you can prepare for that. After the US election, people may begin to think about the political perspective. Will the desire for efficiency change with a different president in the US? I don’t think so. It is not a political issue. It is an economic issue.
Relevance in secondary markets
PK: In certain regions, sustainability has been higher on the agenda than others. Australia is at the top of the GRESB score followed by quite a few European countries. Some other regions might be lagging, but they are definitely catching up fast. The whole world is moving in the same direction. We are an investor in real estate for the long term and you need to future proof your buildings. Maybe tenants in Poland are not screaming for a high degree of sustainability, but it is likely that will change there as it has in countries that might be seen as frontrunners like Australia and also Sweden. In the developed world the challenge is to rejuvenate and improve the building stock. Developing markets are more about new construction and from a sustainability standpoint that is easier to do.
NK: In developing markets sustainability may be not so high on the hierarchy of needs and there is a desire to build fast and cheap, but at the same time you have an opportunity to build well and leapfrog what the developed markets have difficulty with, the existing built stock. In Africa they are not building a network of cables for landlines, they are just putting up cell phone towers. In developing markets you have the opportunity to build something that uses the latest technology. That is not to say that everything being built in China is up to the same standard as buildings that are being built in Germany, but developers are still focused on the topic of sustainability. I often hear from non-core investors or developers in the value-add or opportunistic space that sustainability is not for them, because they only hold onto an asset for one or two years. I actually think it is especially for them, because everybody wants to sell into the core market to a core investor and that investor is often taking a longer-term perspective and is looking to future-proof values.