Sustainable Property: A Premium Product?

A WORKING PAPERSarah Sayce & Anna Sundberg

Presented byAnoriza Mohd AinoERES Conference 2009

Stockholm 24 – 27 June 20091

The Agenda

• Understanding Sustainability • The Project• What’s Out There? – The Nature of the

Sample• Linking Sustainability to Value: What is the

Real Evidence• Conclusions

2

Understanding Sustainability

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A Long History

• Roots can be traced back to two seminal works:– Carson’s Silent Spring (1962)– Schumacher’s Small is Beautiful (1973)

• Mainstreaming of TBL approach dates back to Brundtland’s Our Common Future (1987)

4

But Today• Widening recognition that sustainability is

here to stay– Sustainability continues to form a major part of

policy-making and regulation worldwide– Corporate response seen through rapid growth in

CSR and environmental and social reporting• Theoretically, this should translate through

markets to increased demand and value of property assets

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Sustainability and Property

• Sustainability concerns gaining pace within industry

• But markets slow in reacting• Perceived Barriers include:

– Limited understanding of the benefits– Inflated costs involved in building and fit-out

• But research nowadays to improve this

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Sustainability and Property

• Recent research suggests that the cost argument may not be the case (Cyril Sweett, 2009)

• Commentator claim many benefits to be had:Investors– Higher returnsOccupiers– Operational savings– Well-Being and Productivity

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But What is ‘Sustainable Property’?

• Interaction between property and legislation/regulation

– Over and Above Compliance• Founded on performance of buildings in

relation to environmental efficiency• However, social impacts and occupant well-

being now increasingly understood and considered

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The Project

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The Price Problem• Growing evidence and actions to show

expectations that sustainability issues may underpin investment performance in future

• Theoretical links discussed in a number of studiesBUT

• Does not answer the question: has the link between sustainability and value in property been established

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Aims of the Project

• Establish the extent to which, if at all, literature supports an observable link between sustainability credentials and prices in commercial property

• Inform practice as to the strength of the current evidence base

• Indicate future direction in respect of sustainability and value

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So What Have We Done?

• Comprehensive literature review– Commissioned academic peer-reviewed journal articles– Professional press reports– Research reports from real estate consultants– Conference papers

• Collected through online searches and worldwide direct targeting of academics and professionals

• In excess of 100 articles chosen for further consideration and analysis

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So What Have We Done?

• RPI literature generally excluded:– Only widely cited work e.g. Pivo & McNamara included

• Commentaries on empirical studies discarded to avoid distortion

• Most articles post 2000• Environmental valuation theories generally excluded

• Literature analysed against a set of criteria developed by Research Team and RICS Steering Group to develop quantitative findings

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What’s Out There? – The Nature of the Sample

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Literature Types

• Predominant literature: Conference papers, Professional press and academic journal papers

• Commissioned work mainly supported by industry (RICS in particular)– Suggests issue not of importance to in the drive for wider

behavioural change15

Literature Types

• Significantly more conference papers than refereed journal articles – Emergent subject – protracted journal lead times– Care taken not to double count

• Sustainability frequently reported in professional press– However, frequently publications based on anecdotal

evidence and commentaries on work elsewhere

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Publication Date

• Growing awareness and consideration of value argument supported by findings– 2005 shows first signs of significance of value/sustainability field

• Professional press earliest to discuss issue, with journal articles following later

• Only over the past year have papers begun to test for empirical links

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Country of Study

• Potential skew acknowledged as only publications in English were considered but…..

• Mostly originating from US/UK and Australia– Only 18% outside of these regions– Unsurprising due to transparent and mature investment

markets in these areas ergo, data is available

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Primary Audience

• Most did not specifically indicate readership• Research Team judged audience on content and

indications• Majority aimed at practitioners• Surprising few addressed professional bodies despite

the key role they play in shaping opinion19

Considering the Value Issue

• Less than half had value as a key consideration, and even fewer solely tackled the contention

• Mainly focussed on development costs and wider business case

– However, no significant progression in the latter argument since Sustainable Construction Task Group (2000)

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Type of Evidence

• Very little transactional data found• Intention surveys (attitudinal) do not provide evidence of

real value• Significant amount of literature presenting theoretical case

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Sustainable Terminology

• Central issue – what constitutes a sustainable building

BUT• Many connotations and contested territory• No clear single definition emerged• Complications with ‘green’, ‘sustainable’ or both• UK and Australian mainly ‘sustainable’ with the

US tending to use ‘green’22

Sustainable Attributes

• Characteristics behind the term more important that the ‘label’

• Energy efficiency seen as the major consideration for all

• Little differentiation between what is meant by the terms– However findings show that those adopting

‘sustainable’ consider a wider range of issues

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Sustainable Attributes

• Characteristics behind the term more important that the ‘label’• Energy efficiency seen as the major consideration for all• Little differentiation between what is meant by the terms

– However findings show that those adopting ‘sustainable’ consider a wider range of issues

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Rating Systems

• Some studies link sustainability to rating systems e.g. BREEAM

• But…Standards evolve and whilst relevant on issue it may not be on transaction

• And…unable to pull on performance under individual criteria• However, major accreditation schemes still provide simplest

surrogates• Authors rely on the method to link value but most recognise

its shortcomings25

Linking Sustainability to Value: What is the Real

Evidence

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Discussing Value• ‘Value’ used in literature in many ways• Seen by valuation community as ‘value in exchange’ as per

the International Valuation Standard (2007)BUT

• Market value is only one definition and value can reflect a range of monetary and psychological ‘values’

• A perfect market ‘should’ reflect these but property is seldom perfect

• Despite this, the aim of the project is to examine evidence of how the market does behave not how it should

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The ‘Added’ Value Links

• Literature postulates many reasons for creating an ‘added’ value case for sustainable property

• Many connections have been explored to support the contention

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Capital & Rental Value

• Most direct evidence – observed change in yields/rents

• Three main categories of papers– Transactional Evidence– Perceptions & Opinion Studies– Theoretical Cases

• Although all provide some evidence, transactional evidence is the firmest, but….

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Transactional Evidence

• Slim pickings – only three major studies– All large-scale studies based in the US– All claim some level of rental differentiation between certified

and non-certified buildings• Miller et al (2007) – deemed inconclusive due to sampling• Fuerst & McAllister (2008) – important but could be ‘hot

market’• Miller et al (2008) – rental differentiation occurring but

not tenants paying more for sustainability but tenants paying less for unsustainable

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Real Evidence??• Robust evidence emerging for offices in some areas of

US that certification creates rent differential• Preliminary in nature• Only really a case for the US, not universally• Based on externally certifications e.g. LEED

– Not consistent– No differentiation between levels

• Based on initial lettings but ‘true’ sustainability is a test over time

• Too few capital transactions for defensible conclusions

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A Matter of Opinion• Opinion studies for a significant proportion of evidence

base– Author Opinions– Literature/Market Experience Based– Surveys

• Surveys by consultancies; Atisreal, GVAGrimley, JLL• GVAGrimley – sustainability now part of investment

agenda but limited efforts to quantify• Atisreal (2008) – UK based study of 125 organisations

– Likely to present lower risk, improved liquidity and potentially premium value

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A Matter of Opinion• Corenet Global/JLL (2008) – global reach finding that over

60% would pay up to 10% premium for LEED/BREEAM– No indication of rating level required– Not actual evidence of differential– Lack of supply an issue – perceptions of premium could be

founded on scarcity not intrinsic greater value• Dixon (2009) – UK leasing criterion

– Although sustainability a desired factor, traditional selection criteria more predominant

• All well and good but….the road to hell is paved with good intentions

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Well in Theory…• Theoretical case presented by many – exploring

relationships that should be emerging• Take the stance that occupational demand will change over

time– Direct impact on rental values– Feed into value line via risk and depreciation

• Attempts to develop a preliminary quantification of the impact of certain criteria on investment worth

• The potential to reflect sustainability in valuation methods, mainly DCF, commonly tackled – Critical role of valuation profession in influencing the market

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Well in Theory…• Investor side has been widely investigated theoretically

– ‘Future Proofing’ – performance moving forward– Risk to future income flow, depreciation and liquidity– Funding and finance effects– Universal investor (Pivo & McNamara (2005))

• Whilst not resulting in a price differential today, seen as reasons for future– Changing occupier behaviour– Increasingly stringent legislative environment

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The Occupier Case• Worth more simply based on the occupier business case

– Improved employee well-being and productivity (Kats, 2003)– Operational costs - lower outgoings ergo tenant can pay more rent

(Robinson, 2005)• Dependent upon two key factors:

– Valuers perceiving such qualities as sufficiently tangible to reflect in valuations

– Tenants understanding and having sufficient evidence of these advantages

• Business case more readily proven in the owner-occupier sector– Balancing initial outlay with whole-life cost benefits

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Too Narrow??• Value recognised in literature as that within transactions

BUT• Widely accepted that buildings have significant economic

buildings on a larger scale to ‘external stakeholders’

• Emerging RPI initiatives may shift investor response to the third party interests

• Only then may we see these feeding into market practice and exchange value

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Conclusions

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Conclusions• A seeming abundance of literature – but very much ‘he said

she said’– Boils down to very little

• Undisputable that sustainability is increasingly important– Although still perhaps a luxury rather than essential

• ‘Business case’ still a major foundation for pricing sustainability• Intention is not actuality• Dearth of transactional data – but emerging in some markets

(mainly US)– No substantive evidence of direct value differential, only rental

premium

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So…does sustainability command premium value

• Paucity of transactional data to support the case• What constitutes a sustainable building?

– Still no firm understanding and consensus– Rating systems as surrogate all well and good but major

limitations

• Early evidence that the theoretical case is beginning to manifest in US office markets

For other markets, the evidence is not yet thereFor other markets, the evidence is not yet there40