21/1/2010
By Hoong Wey Woon
Hoong Wey Woon on the possible effects that climate change will have on property investment
With the conference on Climate Change in Copenhagen still fresh in minds and investor demand for real estate gradually returning, it is becoming apparent that there is a need for investors like pension fund trustees to understand the impact that climate change will have on real estate.
Indeed, what Copenhagen has reiterated is that sustainability and carbon reduction practices will be themes that drive the political, social and economic agenda for decades.
So what does this mean for real estate and real estate investing? Crucially, property has been estimated to be responsible for between 30-40 per cent of global carbon emissions - so there is a very real opportunity and need for the sector to play a pivotal role supporting a reduction in greenhouse gas emissions and a reduction in building obsolescence over the long-term.
Defining the economic case
Sustainable Investment (SI) can be defined as investment decisions and ownership practices that incorporate environmental and social issues. Although the ethical case for investing in SI property is easily made, the economic case will need to be addressed.
Evidence
To support this, and what increasing evidence and research is showing, is that sustainable real estate investing can help to create brand value and reputation benefits; enhance capital growth and rental income; lower operating costs; improve tenant retention and reduce depreciation costs compared to non-sustainable buildings.
A study by Nils Kok and Piet Eichholtz, called Doing Well by Doing Good: Green Office Buildings of 7,488 US buildings, found that real estate which met certain green building standards generated higher occupancy by 7.5 per cent; higher rents of 6-9 per cent; and 16-17 per cent higher selling prices than buildings that did not meet the green criteria.
Current Opportunities for Investing in Sustainability in the Property Sector (Hall et al), found last year that although there is an initial two per cent higher cost of construction for energy- efficient and sustainable buildings, the financial benefits over the lifetime of the asset outweigh these additional costs through reduced operating costs of 8-9 per cent, increased building values by an average 7.5 per cent and occupancy rates by 3.5 per cent.
Other studies have found that sustainable buildings can save 25-30 per cent in energy costs compared with buildings that do not meet a green building standard, with a payback of three to five years.
These buildings can also provide significant health and productivity benefits (according to the IPF Summary report, McAllister et al., 2009 and Watson and Katz's 2008, Green building impact report). Meanwhile, property consultant GVA Grimley has found that 79 per cent of surveyed occupiers in the finance and business service sector said that they would be willing to pay more for a 'green' building through higher rents. This view is also supported by research carried out by McGraw Hill.
A recent survey by Aviva Investors also found that 95 per cent of UK real estate fund managers perceived there to be a link between environmental practice and financial returns.
How to invest
With the investment and economic case clearly established, the next question is: How can investors access this market? There are numerous ways to invest in SI equity products, but the investment universe for real estate is much more limited.
The market for SI equity products is well-established. SI equity products make up 17.5 per cent of the total equities asset management industry in Europe having reached Euro 2.7 trillion (about US$3.9 trillion) in 2007. This demonstrates growth of 102 per cent since 2005.
SI equity investment has also delivered financial outperformance. The average SI equity fund outperformed the MSCI World Index by 36 per cent over the last five years.
The SI real estate market, however, is much less mature and the question of which real estate products incorporate SI principles needs to be addressed. Looking at the UK market there is no real route for retail or high net worth investors to invest and only a limited market for institutional investors. Institutional investors have the choice of a few pooled fund products such as the igloo Regeneration Partnership (an Aviva Investors Fund).
Companies such as PRUPIM and Hermes have their own internal portfolios which adhere to SI principles, although these are not accessible to outside investors.
Demand is growing
Demand for SI real estate investment is growing. For example in the UK, the West Midlands Pensions Authority (one of the UK's largest pension funds) has allocated part of their portfolio to SI real estate investment. Their main objective is to invest in assets that generate consistent and strong returns that adhere to SI and good governance practices.
They are not alone: CalPERS and CalSTRS in the US, the Universities Superannuation Scheme in the UK and VicSuper (an Australian A$3.3 billion superannuation fund which awarded a direct property investment mandate to a fund manager on the basis of the fund manager's sustainability credentials) take this type of investment seriously and engage positively within a SI framework.
Developments to date indicate that there will be increasing demand for SI real estate investment products as investors seek to hold a 'future-proofed' real estate portfolio.
SI's importance to increase
There are strong reasons to believe that SI investment in real estate is here for the long run. Two principal reasons are the political and social will to tackle climate change as well as the potential energy crises.
Real estate will remain a prime target for policy action as the UK's carbon disclosure project will increase institutional investors' awareness of their fiduciary responsibilities to address climate change risk in the built environment.
There is also pressure on tenants and investors to behave in an environmentally and socially responsible way. This has not diminished in the recent economic environment and may have actually increased, by placing more pressure on reductions in energy usage. In addition, as governments find that their resources to tackle these issues are finite, they will increasingly look to the private sector for assistance. Therefore there is strong evidence that SI in real estate is here to stay.
A fiduciary duty to consider
It is without doubt that trustees and investors with interests in real estate have a vested interest in the long-term health of the world and its resources.
If SI investment in real estate can deliver equivalent or superior returns or, at the very least, future-proof one's investment, then it is the fiduciary responsibility of trustees and investors to understand the implications of these issues and to seek economic ways to improve the sustainable assets and funds they buy and hold.
Trustees and investors should consider diverting capital towards investment in sustainable real estate and can help set the agenda of long-term sustainable investment.
By doing this they will be undertaking their fiduciary duty to protect the long-term financial futures of their members and investors.
Hoong Wey Woon is a real estate fund manager at Aviva Investors
