Understandably, as valuers we are frequently asked questions as to the impact of climate change and sustainability on the valuation of CRE investments. Some of the broadest questions are relatively straightforward to answer while other more technical ones are less so.
How do sustainability considerations affect the value of my CRE investment?
Valuers track the behaviour of market participants very closely and sustainability considerations are driving both occupier and investor behaviour. For occupiers a building’s green credentials are increasingly high on the agenda. In general terms the larger the occupier organisation, the greater the likelihood of well-developed ESG policies and the greater the impact on leasing decisions. Such organisations importantly tend to offer the best covenants. Evidently, if the occupier demand is there, such considerations impact the developer and therefore the pricing of land.
Similarly, many investment funds have published ESG aims and indeed have attracted capital on the basis that it will be deployed in sustainable investments. With such considerations driving stock selection and acquisition decision making it is not difficult to understand that there is an effect on yield. Furthermore, the increased availability of green loans provides a pricing advantage to those investors that can secure them.
In simple terms, therefore the sustainability credentials of a building affect the demand for the space and therefore the rent a tenant is prepared to pay. The rent tenants are prepared to pay directly affects the value of land for development and an increasingly ESG conscious buyer pool affects the yield that investors require. Securing green finance also affects pricing and value.
One of many components that feed into rent and yield
In our market there are two elements of the valuation calculation; the rent and the yield. Both are proxies for a whole series of considerations including, but not limited to: location; size; configuration; lease term; covenants for rent and covenant strength; sector; lot size; lease structure; age and obsolescence. Sustainability is just one of the components or factors that feed into rent and yield. As such the question to the valuers become much more difficult when one attempts to quantify the precise amount (in pounds, shillings and pence) that the presence or absence of green features adds or detracts from value….
Undoubtedly the heritage of the “all risks yield” approach in the valuation industry and the fact that the obsolescence of a building is reflected implicitly in the yield has not helped the isolation and quantification of a green premium or brown discount. It is clear that many sustainability issues will impact the rate of obsolescence and therefore value depreciation.
Building performance data collection and consistency
If this is correct, then we need to move to a more explicit valuation methodology to isolate the green drivers of value. A more explicit approach requires more data as to the characteristics and performance of assets against defined and consistent sustainability criteria. Yes, we have EPC data, however EPCs are recognised as a blunt instrument and have been dogged by the inconsistency of ratings…. LEED BREEAM and other accreditations can be helpful but are difficult to compare and often relate to a historic point in time. The absence or presence of an accreditation may not be the best measure of sustainability at a valuation date… or just be part of the overall picture. The Taskforce on Climate-Related Financial Disclosures continues to work on achieving regular, consistent climate-related financial risk disclosures for investors, lenders, and insurers, but this remains a voluntary scheme. Whilst it is increasingly seen as a common framework for corporate reporting there is still more work to do in relation to publication of granular data for particular investment portfolios or individual assets. The UK Green Building Council is also doing a good job of providing a framework in which the sustainability commitments within the corporate sector can be understood in the context of a building and GRESB assessments allow some degree of comparison between peer group real estate companies that in part includes individual building metrics. However, as the various acronyms imply, there are a plethora of different metrics and ratings out there all examining ESG considerations in different ways.
Industry defined disclosures
The RICS Guidance note on sustainability and property valuation from 7 years ago advises valuers “to expand their basic data collected to include a record of any sustainability factors, even if they do not currently impact on value”. This advice is a noble attempt to expand the data available in the market and many firms embarked on sustainability checklists to be completed on inspections. However, the consistent data sets have simply not emerged and it feels like the time to return to the issue of data collection to enable a direct comparison between assets. There must be the opportunity for valuers and institutional owners of real estate to build on prior progress to devise and commit to a common set of defined disclosures on every property to include agreed metrics under the following categories:
Resistance to climate change; resource use; nature and biodiversity; health and wellbeing; and social impact.
Only then will we be able to start to unpack the rent and yield proxy and be able to isolate and quantify value attributable to sustainability considerations.