Written By: Paul Cooper
An opportunity to invest in a high quality asset class with strong long-term growth potential. Paul Cooper of Sarasin examines the prospects for sustainable real estate.
Buildings are responsible for one third of the world’s greenhouse gas emissions and so they represent the largest and most cost effective way of mitigating those emissions. “Big picture” benefits such as climate change mitigation, energy security, resource conservation, job creation, improved occupant health, productivity and economic activity, long-term resilience, and quality of life are priority issues for governments around the world. Green Building Councils have been established in more than 90 countries to work with each section of the industry to raise the profile of green buildings as local and national priorities.
The above sentiments were expressed in the excellent March 2013 report by the World Green Business Council entitled The Business Case for Green Buildings. In the report they laid out the case for sustainable real estate. Green buildings “work” because each party to the transaction gets something from it. The developer is attracted by the prospect of a quicker sale and/or the chance to realise a higher sales price, the owner should enjoy enhanced rents and increased occupancy rates, while the tenant is persuaded to pay more for the lease because of the lower operating costs and the prestige of being in a green building. There is also increasing evidence of an improvement in workplace productivity and health.
Even without the “carrot” described above government attitudes are hardening and they are increasingly happy to wield a sustainable “stick” if necessary. What started out as voluntary disclosures have in many cases been made mandatory, and going forward, the prospect of fines or a ban on marketing unsustainable buildings has been raised. The forces for change can be felt across the globe; for example, the Minneapolis city government has made it mandatory for private commercial buildings to report and publicly disclose their energy performance from June 2014 (depending on their size). All UK listed companies will be required to report their carbon footprint on a global basis from 2014 and the Chinese government would like green buildings to account for 20% of all new buildings in urban areas by 2015. Evidence is mounting that a poor rating from one of the leading green rating agencies can have a seriously detrimental impact on the realisable value of a building.
With such a strong tailwind it may be surprising to learn that the investment community has been slow to recognise the enhanced investment potential of sustainable real estate companies. After all, many leading real estate companies have been discussing the merits for some time. Regrettably, while companies such as Land Securities and British Land have been forthcoming about sustainable issues for a number of years, the same cannot be said for some other parts of the world. The United States, for example, paid very little attention to sustainability until fairly recently, though they are now making progress at a rapid pace. Asia remains a laggard and it is still problematic to find companies with a positive attitude towards sustainability who are willing to provide information on their approach to the wider investment community.
For this reason, historically, it has been difficult to construct a globally diversified sustainable real estate fund; difficult but not impossible. Sarasin has been managing sustainable real estate funds since 2009. We have, as a consequence, built up a large database of valuable information on the sustainability of the sector and its most important constituents. Our rating methodology addresses both environmental and social issues across a number of areas, with each company assessed in absolute terms and relative to its peers. Energy efficiency is of course a key issue, along with other resource matters such as water and waste management. Attention is also given to responsible land use, the environmental and health impact of the building materials sourced, as well as ensuring that minimum labour standards are applied by subcontractors and developers. We also consider the working conditions of the tenants, the need for additional public infrastructure and appropriate consideration for elderly or disabled persons.
In fact, the whole value chain is studied, from the architectural design of the buildings, to the sourcing of the materials, to the impact of the completed buildings on the local environment. Each company is rated on 13 separate criteria, with a 60% weighting attached to environmental issues and 40% to social issues, and only companies with an above average rating can form part of our sustainable real estate buy list.
I am pleased to report that it is becoming easier to construct a truly diversified portfolio of sustainable real estate assets as companies around the world are becoming more cognisant of sustainability issues – and the “bar” is rising as a result. This means that companies must continually improve for fear of losing ground against their peers and potentially, as a consequence, falling out of our investable universe. This has happened on more than one occasion in the recent past. Companies in Asia, while still below the standards set in Europe and the United States, are also improving, and this exciting opportunity is no longer out of bounds for sustainable real estate funds.
In general, the larger, higher quality, listed real estate companies and REITs have been leading the sustainability race. While this is changing, to some extent it remains the case that a sustainable real estate fund is likely to have a bias towards higher quality securities. Although this is in our view a strength rather than a weakness, it can lead to periods in which sustainability lags the wider sector. This is especially the case during strong bull markets when smaller, lower-quality companies typically lead the market higher. Nevertheless, as long as a focus on sustainability directs us towards the best buildings with the best tenants managed by the best people we are happy.
The emergence of listed real estate as an asset class in its own right rather than simply being part of the equity universe has propelled the sector to new highs. Investors are buying into the concept of spreading their real estate holdings across the world and the benefits this brings in terms of diversification, flexibility and liquidity. The highest-quality real estate companies have in general lagged this rally, and as a consequence investors have an opportunity to support companies on the leading edge of environmental and social issues while at the same time taking advantage of what is in our view an attractive investment opportunity.