As the dust begins to settle on the social and macroeconomic upheaval of the past two years, the megatrends that will define the future of the environment, society and business have come into sharper focus. Emerging from a ‘wait-and-see’ holding pattern, private real estate professionals are now moving forward with vigor and confidence, channeling capital to create the properties of tomorrow.
What do these look like? Resilience is a key word here. Given the urgency of the net-zero challenge and its growing importance to tenants, there is universal acceptance of the need for buildings to significantly lower their carbon emissions to manage the risk of becoming stranded assets. Optimizing spaces for health and well-being is also now high on the list of tenant requirements, particularly in the office sector. Add to that the growing demand for transportation connections, leisure amenities and co-working/co-living facilities, and the opportunities for value creation are immense.
While it would be remiss to disregard any market uncertainty – a certain amount of crystal-ball gazing will, naturally, always be required – these are the key trends that managers, investors and tenants are backing in droves to get ahead of the curve. All this requires a more operational approach to asset management, which could involve more flexible leases, greater investment in technology or higher capex for repositioning – all underpinned by closer collaboration with tenants and end users.
The green attraction
With the built environment responsible for around 40 percent of global carbon emissions, according to the World Green Building Council, reducing energy demand from existing properties – and embodied carbon in new constructions – is critical, both for meeting the targets of the Paris Agreement and for increasing the long-term value of an asset.
This is largely because demand from occupiers has changed. With companies all over the world committing to their own emissions targets, buildings with certified green credentials are attracting the best tenants. Properties without the right energy efficiency certification, however, are at risk.
“If your product does not meet that requirement, it is probably filtered out of the process, and won’t get shortlisted,” says Peter Holden, managing director and co-head of private real estate asset management at Zug-based manager Partners Group. “That has implications for rents because there is demand pressure from occupiers who want sustainable buildings, which leads to rental premiums being paid.”
Beyond the improved value proposition of a low-carbon building, there are still hurdles to jump before an asset owner can embark on a net-zero pathway. Among them is the fact that not all tenants are as preoccupied by sustainability efforts, with many deterred by the costs of decarbonizing and monitoring environmental impact.
However, since tenants get the direct benefits of going green, keeping an open dialogue is important, argues Peter Epping, global head of ESG at manager Hines. “It takes honest discussion and collaboration to see where we can add a small amount back to the rent, because in the long run that will make the property more valuable to the owners and the tenants,” he explains.
The net-zero challenge
Also chief among the challenges involved in positioning real estate assets for net zero is the term ‘net zero’ itself. According to a 2022 report by the Investment Property Forum, entitled Pathways to Net Zero Carbon Emissions in International Real Estate Investment, there has been a proliferation of net-zero carbon initiatives in the industry in the past five years, creating a “convoluted picture” for the market. This is because there is significant variety in how net zero is both defined and applied.
Leading share of respondents citing the creation of longer, more stable income streams as the main factor behind asset repositioning, per JLL’s 2021 Investor Survey
The IPF report cites a medley of similar-sounding but vastly different terms, namely ‘zero carbon,’ ‘net zero carbon ready,’ ‘net zero carbon’ and ‘absolute zero,’ and points out that some industry frameworks apply these at the building level, while others do so at the corporate level. Furthermore, some strategies are designed to meet investor requirements, while others are there to create value.
In short, two businesses could use the same net-zero label, but follow very different decarbonization pathways. This further complicates the race to avoid ESG obsolescence, especially as environmental legislation becomes more stringent.
Rental premium per square foot achieved by healthy v non-certified offices, per a Massachusetts Institute of Technology study of 10 cities in the US
Real estate software company Yardi’s industry principal for energy, Joseph Consolo, says the obsolescence risk is a very real one – and not just for existing buildings. “It is also possible that some buildings are obsolete before they have even finished construction,” says Consolo, who argues that investors and developers should think more closely about the materials and equipment used during the construction process. If not, “you could have a building that has had a significant negative impact on the environment before it has even begun to operate,” he explains.
Since owners of older buildings are therefore unable to resolve the issue of embodied carbon, the focus is mostly on operational carbon. This is where refurbishment, tenant engagement and leveraging technology and data will make all the difference.
In response to the megatrends shaping the future of how we live and work, asset repositioning is an increasingly common value creation strategy across all sectors of the real estate market.
According to the 2021 Investor Survey by professional services firm JLL, which polled over 250 senior property professionals, the creation of longer, more stable income streams was cited as the most important driving factor behind asset repositioning by the largest proportion (60 percent) of respondents. This suggests asset owners are thinking long term about optimizing asset values to get ahead of the curve.
The environmental, human and social impact, on the other hand, was the key motivation for only 17 percent of survey respondents.
It is important to note that repositioning activities cover a wide spectrum of development and capex requirements. In sectors hit the hardest by the pandemic’s impact, such as retail and office, market participants are seeing full-scale repurposing – though often with a modern, future-proofing twist. The Emerging Trends Europe Survey 2022, conducted jointly by PwC and the Urban Land Institute and published in Emerging Trends in Real Estate Europe 2022, suggests the majority of retail and office buildings due to be repurposed in the next five years will become mixed-use buildings. This reflects the growing demand for multi-functional properties that blend retail, leisure, work and residential spaces in one asset – an exercise in maximizing future relevance and a trend accelerated by the lifestyle changes brought about by covid-19.
Complete repurposing is, however, the most expensive repositioning play of them all. Renovating, refurbishing and upgrading features, while still requiring high capex, is less capital intensive. Asset owners across all property sectors are seeing opportunities to boost short- and long-term value in this way.
A healthy perspective
The heightened focus on health and well-being post-covid is also shaping real estate repositioning strategies, in more ways than one.
The life sciences market, for example, is enjoying solid growth following the success of a global covid-19 vaccination rollout. In China, where new economy developer DNE Group operates, the higher level of health awareness and importance is driving a greater emphasis on rehabilitation and R&D, creating “a serious opportunity for investors exploring this space,” says Sun Dongping, the firm’s founder and chief executive.
In properties not directly related to health goods and services, meanwhile, the trend for ‘healthy buildings’ is gaining momentum. Air and water quality, ventilation, green elements, quiet spaces for reflection, humidity and noise – all are considerations for occupier health and well-being, which has moved into the limelight in office and residential sectors in particular.
A 2020 report by the Massachusetts Institute of Technology found that healthy office buildings studied across 10 cities in the US attract a rent premium of between 4.4 and 7.7 percent per square foot over non-certified healthy spaces. Certification bodies such as Fitwel have sprung up in recent years to formally recognize health credentials in the property market.
That tenants are placing greater importance on the health-affecting qualities of a building is another example of how investment performance is increasingly dependent upon success in two key areas: the active operation of an asset, and understanding and engaging with its occupiers.