With the mainstreaming of the green wave in recent years, the rapidly evolving regulatory environment necessitates real estate companies to comply with increasingly stringent ESG disclosures and reporting rules. At the same time, customers and other stakeholders are calling on companies to improve their ESG performance and transparency.
To meet their net zero commitments, companies are increasingly demanding for improved energy efficiency of their office portfolios, which are considered leased assets and contribute to scope 3 emissions. Some tenants may even request for leased space to be powered by renewable energy, as part of efforts to reduce their scope 2 emissions, prompting landlords to purchase renewable energy through the grid or install solar panels on the roofs of buildings to harness solar energy.
The post-pandemic reopening may have further contributed to the demand for sustainable real estate. Corporates are incentivised to rationalise their real estate portfolios and to prioritise sustainability characteristics to increase efficiency
More ambitious net zero carbon emissions targets implemented in the US and Europe has led the green office adoption trend. European tenants tend to be more aggressive in their net zero targets compared to landlords. Failure to secure the right spaces to support tenant's green strategies could compromise the delivery of their sustainability goals while landlords face the risk of earlier-than-expected asset obsolescence, as existing portfolios become less attractive to potential occupiers
Exhibit 1: There is a stark mismatch between occupier and investor net zero timelines in Continental Europe, with tenants being more aggressive than landlords
Source: CBRE Research
In the Asia Pacific region (APAC), CBRE Research observes that a growing number of office tenants have demonstrated an interest in ESG-compliant properties. Although the momentum of green building adoption is positive, there seems to be a lag between intention and action, as less than 30% of surveyed respondents are currently located in such buildings.
The benefits of sustainable portfolios
Green premium vs Brown discount
According to CBRE Research, highly efficient, green-certified buildings can command a rental premium of anything up to over 20% as compared to less sustainable buildings. In the US, Leadership in Energy and Environmental Design (LEED)-certified buildings generally earn a rental premium of 3.7% over non-LEED-certified peers with similar age, size, renovation, and location. In Europe, green-certified buildings command an average rental premium of 6%. Conversely, buildings with lower energy efficiency and no plans to be retrofitted with green initiatives may risk incurring a brown discount on both their offering rents and valuation.
Exhibit 2: Asia Pacific tenants are willing to pay higher rents for more energy-efficient buildings
Source: CBRE Research’s 2023 Asia Pacific Investor Intentions Survey (January 2023)
As corporates gravitate towards occupying buildings that support or even accelerate their commitment to decarbonisation, the tenant pool for buildings that are not green-certified will continue to shrink. Consequently, the magnitude of brown discounts for such assets are likely to increase.
Lower vacancy risk
Green certification can be a significant factor in lowering vacancy risk. There are two mechanisms by which this effect may be transmitted.
Government support plays a significant role in accelerating the pursuit of greener buildings, especially as development and retrofit costs may be exorbitant. Real estate companies and landlords looking to improve the quality of their portfolio can take advantage of these incentives to subsidise their costs while also meeting increasingly stringent regulations. In the long run, the costs of running greener buildings may also be lower; for instance, greater energy efficiency may translate to lower utility bills and lower replacement CAPEX going forward.
Exhibit 3: Governments worldwide may adopt a carrot-and-stick approach in the push towards more sustainable built environments
Source: CBRE China Research’s Building Sustainability into Cities (December 2022); CBRE Research’s 2023 report on US Building Performance Standards in 2023 and Beyond (October 2023); internal estimates
Sustainability-linked loans are gaining popularity amongst REITs and real estate developers. Borrowers could enjoy lower interest rates if they are able to meet pre-determined sustainability performance targets – an attractive proposition in the current "higher for longer" interest rate environment.
REITs and landlords with greater operational control over their properties may find it easier to obtain sustainable financing and meet related environmental targets. To promote collaboration and accountability, landlords and tenants may choose to enter into green leases, where both parties agree to sustainability-linked targets and measurable key performance indicators as part of the lease agreement.
Socially conscious real estate
The social aspect of ESG has traditionally lacked environmental considerations, owing to a lack of clear definitions and scope, and challenges around the measurement of impact and social value. The Covid-19 pandemic was a watershed moment for the social pillar, having shone a spotlight on the gaps in our social fabric with regards to both physical and mental health, and inequalities.
With social value potentially being the next frontier in the real estate sector’s ESG transition, social building features may play a growing role in valuations in the long run.
All in all, the preference for sustainable real estate is expected to continue to grow hereon. There remains a runway for landlords globally to green and future-proof their assets, and those who proactively differentiate themselves by doing so may enjoy benefits. On the other hand, buildings with lower energy efficiency and no plans to be retrofitted with green initiatives may risk incurring a brown discount on both their offering rents and valuation.