Sustainability, carbon reduction, climate change, green energy, ESG (environmental, social and governance) and CSR (corporate social responsibility) are all terms that now feature daily in the mainstream media but which five years ago would have been predominantly the preserve of environmental specialists and special-interest groups.
And while these would all have been key considerations in terms of prime new developments – and particularly office buildings – it is worth considering the impact these factors are now having on property values and on the wider property market.
The vast majority of new office developments, and particularly those in good office locations, have over the past five years or so been carefully designed and built to specifications tailored to meet the best possible LEED (Leadership in Energy and Environmental Design) or BREEAM (Building Research Establishment Environmental Assessment Method) designations.
The institutional and investment-fund owners of such buildings increasingly need to ensure that their portfolio is as environmentally friendly as possible, driven by their own ESG targets but also as their investors opt to invest in sustainable, green product and potentially also to avail of the cost benefits of green finance.
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In addition to the ESG targets of both corporate occupiers and investment fund landlords, employees are also increasingly looking to work for companies with good sustainability credentials, a need that companies must recognise and address given the current competition for talent.
While the main focus to date has been on the design and specification of new buildings, many corporate occupiers now in situ are addressing their own ESG targets and timelines
The combined interests of these various stakeholders is driving a much greater focus on the sustainable performance and green credentials of all commercial property. While the main focus to date has been on the design and specification of new buildings, many corporate occupiers now in situ are addressing their own ESG targets and timelines, which can be challenging to meet.
Real estate can play a key role in their ability to meet these targets, and the expertise to support the occupiers often lies with the landlord. As a result, there is now a growing focus on the efficient operation of buildings, and designations such as the US LEED EBOM (LEED Existing Buildings Operations and Maintenance) and Australian Nabers (National Australian Built Environment Rating System), which has expanded into the UK provide a consistent means of tracking and assessing sustainable building operations, allowing landlords and tenants to assess and compare the ESG performance of their buildings against their peers. Many more sophisticated funds and investors subscribe annually to the GRESB (Global Real Estate Sustainability Benchmark) to compare their portfolio’s performance to that of their peers.
Changes for the better
As green ESG targets become more widespread, we have seen the need for sustainable building performance trickle down from the prime class-A market and US global tech and pharma companies to the next levels of building and occupier. This has led to many changes for the better – showers, bike facilities, LED lights and a focus on energy and water conservation are all becoming far more important for many occupiers and far more common in the market.
While newer buildings are designed, built and costed based on securing the best LEED, BREEAM or WELL designation possible, landlords are now having to take a closer look at their entire portfolios and assessing how they can improve the performance of older stock – and how they can fund any upgrade works needed.
Given the often significant costs involved in more significant retrofitting, long-term secure income will be needed in order for a landlord to justify the level of investment
Retrofitting buildings is not cheap, especially in the current climate. In terms of property values, realistically, there is a rent ceiling for different types of property in different locations – so while the expenditure necessary to secure excellent sustainability designations can be justified in the case of a €65-per-sq-ft prime city-centre office building, there may be far more limited scope regarding the suburban equivalent where the rent ceiling, regardless of specification and green credentials, may be more in the order of €35 per sq ft. A discounted cash-flow analysis will likely be needed to assess accurately the financial feasibility and payback period required to justify the investment needed to upgrade such older or suburban buildings.
Given the often significant costs involved in more significant retrofitting, long-term secure income will be needed in order for a landlord to justify the level of investment and the level of payback required. Where lease expiry or break dates occur before target payback dates, or where tenants would like to see upgrade works, communication between landlords and tenants presents an opportunity to tease out options and solutions that could meet both parties’ needs.
Each case will have to be taken on its merits, but a proactive approach could serve to benefit not only occupiers but also landlords and investors. Lease renegotiation or “regearing” the lease can occur at any time during the contractual term but only by agreement between the landlord and the tenant.
While the parties’ motivation for regearing the lease has traditionally been more typically driven by proximity of the lease expiry or an option to break, bringing together the tenant endeavouring to reduce annual occupational costs and the landlord’s asset-management objective to extend the lease term and improve income security, improving the green credentials of a building may also be a good reason for all stakeholders to initiate and then actively engage in such discussions.
Ken Noble is a director and head of professional services at TWM.
