The title statement is the conclusion of Jon Lovell, Director, Deloitte Real Estate Sustainability Services. Jon's full blog article follows below.
"There is no question that sustainability is now a fundamental commercial real estate concern affecting long-term value generation and short-term profitability, especially in the context of mature markets such as the United States, Western Europe, and Australia. The combined demands of occupiers, investors, and regulators are such that tangible benefits can be derived from embedding sustainability into the full investment process, with a range of property value fundamentals — rental growth, yield premiums, total occupancy costs, and the like — increasingly sensitive to sustainability factors.
Critically, value impacts are, and will continue to be, property specific, influenced as they are by local market context, tenant and leasing profiles, and climate conditions. Moreover, it would be a mistake for those operating in secondary and tertiary markets to assume that sustainability is predominantly relevant to prime markets and assets. While there’s no doubt that strong sustainability performance has become a prerequisite for prime market expectations of quality, the narrowing of capital flows to core product in recent years has arguably inflated values to the extent that some of the subtleties of sustainability performance have become hidden in the competition for stock.
Moreover, it is reasonable to expect that rental growth will be more heavily suppressed in properties in which energy and other utility costs are high compared to rental levels. In this sense, sustainability is driving a greater divergence between prime and secondary/tertiary property. That said, these effects remain muted by a deficit in proper in-use performance data across the sector, but we have every expectation that, as this situation begins to improve and reliable data becomes more widespread, the transparency of real estate performance will increase and more informed capital pricing and rental decisions can be made.
Much of the industry’s response to the sustainability agenda to date has been centred on the application of green building rating tools (such as LEED or BREEAM) as proxies for non-financial performance.
Their use is reinforced by attention given to them in global benchmarking initiatives, such as GRESB and the International Sustainability Alliance. This poses two major challenges for the market, and indeed for the rating scheme operators:
1. While competition among green rating scheme operators can drive innovation and quality if handled well, there is also a risk that competitive rhetoric, as we have witnessed in some geographies, becomes a distraction to their purpose of catalysing market transformation.
2. Green rating tools continue to be targeted, in the main, at new construction and refurbishment projects. Clearly, these capital events are hugely important stages in the commercial real estate life cycle, but they are only a small part of the overall sustainability performance story. Commercial property occupiers and operators are recognizing increasingly that the performance gap between new build and refurbishment design expectations, driven in no small part by the requirements of rating tools, are often massively under-realised once buildings are in use. Rating schemes, and the market’s appreciation of them, need to evolve to address this performance disconnect.
Clearly, with implications at every stage of the investment cycle, commercial real estate owners need increasingly to develop robust and comprehensive approaches to sustainability, with Responsible Property Investment as an embedded feature of their portfolio and asset management activities. This requires careful consideration of complex, dynamic issues and engagement with an array of stakeholders throughout the value chain. Evidently, understanding how non-financial (sustainability) performance relates to risk profile, market appeal, tenant retention, depreciation, and obsolescence is critical to resilient asset management and optimized total returns. In our conversations with clients, we find that progress on truly embedded Responsible Property Investment approaches remains limited, save for a small group of market leaders. In most cases, in both institutional and private markets, approaches remain somewhat superficial, and robust disclosure of impacts is still nascent.
However, the tide is most definitely turning, and those that chose to remain agnostic and defensive in their approaches to sustainability will more than likely see their investment returns underperform the wider market. Encouragingly, we are seeing a marked increase from our investment and occupier clients across most commercial real estate market geographies on the need to take a more proactive and comprehensive stance, coupled with strengthening engagement with industry bodies such as the worldwide network of Green Building Councils, which have hitherto been largely representative of the supply side of the market."