_Commercial property & ESG: Green credentials must be reflected in property valuations
Green premiums
The Central London office market has always been at the forefront of the ESG movement – and Knight Frank’s Active Capital research has evidenced a green premium: average premiums of over 12% on rents for BREEAM New Construction Outstanding-rated office buildings in London, and 10-11% on the sales price for those with a BREEAM Very Good and Excellent rating (compared to equivalent unrated buildings).
Right now, offices in prime markets are the focus, but there's a consensus that green credentials will eventually impact asset values across all property markets. It's also expected that the impact on values may tip from premiums to a 'brown discount' as green buildings become the norm.
Challenges for valuers
In the meantime, the valuer's role is more challenging, thanks to limited transactional evidence outside prime markets and multiple definitions as to what constitutes a sustainable building. Many certifications are available, including BREEAM, NABERS, LEED and WELL, covering various issues/themes from carbon emissions to health and wellbeing. They have varying criteria and weightings, differing prominence depending on the geography, and are not directly comparable with each other. This offers limited transparency and no standardisation when analysing comparable transactions to inform valuations.
Even if valuers try to look at carbon emissions as a straightforward way to compare assets, our nascent industry provides us with a vast range of benchmarks with differing methodologies and metrics. But there is hope on the horizon, with the industry working collaboratively to adopt a standardised energy-use-intensity metric that will be recognised by all.
Data collection & green clauses
For investors, data collection will be a concern. This is key not only for climate-related reporting, but obtaining green certifications and informing strategy. Unfortunately, many leases do not provide for disclosure and landlords may be heavily dependent on tenant cooperation. If tenants won’t share, the landlord is stuck with data from the landlord-controlled area only, which clearly doesn’t provide an overall picture.
As such, many investors are pushing tenants to accept green lease clauses, but case law does not support this as 'fair modernisation' at present. In fact, many green lease clauses are unlikely to be enforceable. Where they are, this may impact the rent achievable if deemed to be onerous.
What next?
Clearly, there's a desperate need for clarity and standardisation including production of standardised metrics, and industry acceptance. If landlords and tenants can't agree workable lease clauses for data sharing, there may be a requirement for government regulation. The formation of the Green Technical Advisory Group last year (aiming to bring standardisation along the lines of the EU taxonomy) is a welcome step.
Meanwhile, there's no question that the property industry is recognising the value of sustainability and making genuine attempts to reduce its carbon footprint. Alongside this, there's ongoing discussion on valuation approach to ensure the impact of ESG is appropriately reflected.
But it’s not just a matter of process. To produce a reliable valuation, a valuer must understand tenant and investor decision-making and how evidence from comparable transactions can be applied to the property. Openness and transparency on rationale and input is imperative here – including disclosure of specialist information such as legal advice on landlord and tenant questions, information on specification and environmental issues, upgrade options, and plans/costings for upgrade works. As the market evolves, collaboration with valuers in a spirit of transparency will be vital.