In early November, the Paris Climate Agreement, signed by nearly 200 nations last December to combat climate change through carbon emissions reduction, came into effect. Real estate groups are now, of course, asking how meeting the agreement will impact their property businesses going forward.
The most forward-thinking property investors, however, have long been asking: “What are the benefits to sustainable real estate practices?” Doug Poutasse, executive vice-president and head of strategy and research at US-based real estate investment advisor Bentall Kennedy, a subsidiary of Sun Life Investment Management, tells PERE how property investors might bolster returns through sustainable best practices.
PERE: Firstly, is there proof that sustainable real estate investment and management works?
Doug Poutasse: We really wanted a definitive answer to that question – so we commissioned independent academic research in 2015 that involved the study of our nearly 300 office properties across North America. This study published in the September 2015 Special Real Estate issue of Institutional Investor’s Journal of Portfolio Management found that properties that ranked high for sustainability generated higher rents, had higher tenant satisfaction scores, had higher renewal rates with fewer rent concessions – and not surprisingly used less energy.
It’s no surprise that when you have a property with high tenant satisfaction scores, you’ll have a property that’s more desirable, with higher occupancy rates and higher rents. As a result, the property generates a higher level of income, and a more stable stream of income.
PERE: What mistakes have you seen by managers or investors when attempting to implement improved ESG practices?
DP: I think the first mistake I see is people who don’t try to implement anything. For all of the reasons I just mentioned, I think this is short-term thinking that runs contrary to a long-term sustainable investment.
But for those who do implement, it’s important to look at things holistically, and not just focus on the environmental upgrades themselves. If you focus solely on the ‘things’ – new bike racks, new lighting, new recycling bins, new air systems – and leave out the people, you’ve missed a huge opportunity.
You can’t just layer upgrades on a building, like icing on a cake. You need to weave them into the fabric of the property, and that means engaging the tenants in the process. It starts by giving them a voice and listening to what they have to say, and providing training and education so that they understand their role in making the changes work, and how they and the environment can benefit.
Otherwise, you’ll see empty bike racks, empty recycling bins in office kitchens, and a lot of employees wondering why the lights keep going off.
One final mistake I see is property owners who only implement practices that have large and immediate paybacks. If they don’t see a payback within five years, they won’t do it. I think it’s important to play the long game, and consider changes that can help make the investment more durable long-term.
PERE: Does a long-term approach mean sustainability needs to extend beyond buildings to the actual locations and communities?
DP: Absolutely. We’re looking for long-term growth and value, and sustainability has to extend to the communities in which the properties are located. A LEED Silver office building that’s only accessible by car and doesn’t have nearby amenities is not, in our opinion, a sustainable investment. We’re looking for locations with sustainable demand and sustainable economies – and that goes far beyond an environmentally-friendly building.
PERE: What are some of the additional factors you look for?
DP: We look for a number of things. For office, residential, and even some retail investments, we look at areas accessible by alternative forms of transportation, beyond a car. So areas that are well-served by transit, or easily accessible by walking or biking.
We’re also looking for high-barrier-to-entry primary markets with innovation cores – or secondary markets with growing millennial demographics. These secondary markets are often areas within cities where revitalization is occurring. Areas with high concentrations of young people are the areas that lure growth companies. Times have changed, and we’re seeing innovation companies moving to where the workforce lives, not the other way around.
We also look at the building itself, of course. We want to ensure there’s an opportunity to enhance sustainability, such as through improvements to water or energy efficiency, or other actions that elevate the profile of the building as better living and working, and overall sustainability.
In short, we want to make sure that our property investments are serving a demand that’s durable – one that has a better chance of surviving changes that may loom in the future that we don’t know about today.
PERE: What would be the roadmap for property managers who want to make improvements?
DP: Every location and property is unique – so there’s no universal roadmap for improving ESG. But there are a few best practice approaches that I think are essential for success.
The first is one I just mentioned – to actively engage with the tenants and their employees. They’re the ones in the building day in and day out, so when we begin the upgrade process, we start by asking tenants how we can improve their experience. Then we’re very proactive in incorporating those changes whenever possible into our plan for improvement – and educating tenants on their role and on the benefits. This in itself goes a long way to improving tenant satisfaction scores.
Another best practice is what I call connecting the dots. An example: if you put in bike racks, you also want to ensure there are good clean showers for people who’ve biked 20 kilometers to work in the summer heat. So you need to think through, ‘If I make change A, I’ll need to implement change B for this to be effective.’ It’s really just putting yourself in the occupant’s shoes and visualizing the experience from their perspective.
A final best practice is to not let ‘expense thinking’ get in the way of ‘revenue thinking.’ Too often, upgrades are staggered over several years to avoid a big hit to the expense side. Again, that’s often short-term thinking that ignores the increased revenues that flow from higher tenant satisfaction and the higher renewal rates and rents that result. In most cases, it pays to spend the money upfront and get the whole building singing from the same ESG song sheet. If you upgrade it right, the increased revenue will follow.
In an independent study of Bentall Kennedy’s North American office portfolio improved property performance was found to be strongly correlated to green building certification and effective, sustainable operational practices
The study of nearly 300 office properties across North America included lease-level data, such as rents, rent concessions and lease renewal rates, as well as building-level information, such as occupancy rates, tenant satisfaction scores, energy and water consumption. Key findings – from both Canada and the US – that can drive higher returns include:
• Net effective rents, including the cost of tenant incentives, averaged 3.7 percent higher in LEED certified properties in the US than in similar non-certified buildings.
• Rent concessions for LEED and BOMA BEST buildings in Canada were on average 4 percent lower than in similar non-certified buildings.
• Occupancy rates during the period were 18.7 percent higher in Canadian buildings having both LEED and BOMA BEST certification, and 9.5 percent higher in US buildings with ENERGY STAR certification than in buildings without certifications.
• Tenant renewal rates were 5.6 percent higher in Canadian buildings with BOMA BEST level 3 certification than in buildings with no BOMA BEST certification.
• Tenant satisfaction scores were 7 percent higher in Canadian buildings with BOMA BEST level 3 and 4 certifications than in non-certified buildings.
• Energy consumption per square foot was 14 percent lower in US LEED certified properties than in buildings without certification.
From a property management standpoint, these sustainability factors can be put into action through upgrades, retrofits, operational improvements and tenant engagement on sustainability initiatives.
Bentall Kennedy, a Sun Life Investment Management company, is one of the 30 largest global real estate investment advisors and one of North America’s foremost providers of real estate services. The information provided in this article is not intended to provide specific advice, and is provided in good faith without legal responsibility.