S&I 2018 Meeting Report: Is there more to Sustainability than Compliance and Cost Savings?
(For a print version of this report, click here.)
“Why should we tolerate a diet of weak poisons, a home in insipid surroundings, a circle of acquaintances who are not quite our enemies, the noise of motors with just enough relief to prevent insanity? Who would want to live in a world which is just not quite fatal?”
– Rachel Carson
When discussing sustainability, it’s difficult not to go back to one of the modern age’s environmental pioneers, Rachel Carson, who published Silent Spring in 1962, and convinced the world that commercial progress has very tangible and toxic repercussions. That realization was a first step towards where the institutional real estate industry is now headed: an investment model where sustainability, resiliency, and wellness is key to success.
But accepted non-sustainable building and management practices don’t just change based on faith. Few responsible fiduciaries would knowingly sacrifice a portfolio’s returns for the sake of a large and somewhat ephemeral concept such as making the world-at-large a little less fatal…at least, not without some proof or reasonable conviction that it would benefit the bottom line as well. Institutional investors require the best possible risk adjusted returns for their beneficiaries.
Therefore, sustainability discussions at NAREIM’s January meeting were about more than saving the world – they were also about how to deliver the economic value of sustainability to investors.
Is sustainability profitability knowable?
Because of the wide range of variables, financial, operational, and otherwise, that go into the success of an asset, the profitability of sustainability can be exceedingly difficult to measure. Although there is a plethora of anecdotal evidence, reliable financial equations for the value of sustainability remain elusive…for now.
Jennifer McConkey shared how Principal Real Estate collaborated on a pilot study with the Department of Energy; “to identify research that helps to prove the relationship between sustainability and financial performance.”
When they first examined granular base-level data from LEED and EnergyStar building. “It showed green buildings yield a higher market value, higher net operating income, higher occupancy, higher rents per occupant, lower operating expenses and fewer rental concessions.” Yet, when the same data was observed linearly there were some inconsistencies. This compelled Principal to survey their tenants directly, “which revealed that tenants of green buildings do perceive that they have higher building quality, higher value for the amount paid, better amenities, and better indoor air quality.” However, in a statistic that Ms. McConkey pointed out with some surprise, “34% of tenants surveyed claimed that they were unaware of the sustainability efforts within the building that they occupied.”
Paul Mathew of the Lawrence Berkeley National Laboratory shared similar insights from their green efficiency meta-study that explored sustainability advantages for investors. Mr. Mathews study examined peer reviewed journal publications focused on rent net of concessions in office properties that showed “that green certified buildings carry a rent price premium, but also show mixed results regarding any assurances of high-occupancy.”
Mr. Mathews asked, “How generalizable do we think results that favor sustainability are and what are the barriers to exploration in those efforts? Is the elephant in the room for sustainability correlation versus causality? Is green certification driving value or are favorable markets evaluating certification too highly?” The danger, of course, is that much of the research that paints a favorable profit picture of sustainability could be misstated or even overstated – and therefore invalidate the claims made for sustainability.
Simple calculations of the value are not enough. The industry needs more data, more research, and more rigor from every sustainable investor. Groups such as Principal, Bentall Kennedy, MIT, Maastricht University, Lawrence Berkeley National Laboratory, and others are making terrific strides in assessing their own portfolios and identifying the potential impact of sustainability on their profitability. With broader collaboration between investors, universities, and other research groups, it will be possible to go beyond anecdotal examples to a clear understanding of the drivers themselves.
New areas of sustainability focus
There’s more to sustainability, obviously, than lighting retrofits, window films, HVAC controls, and recycling programs. A growing emphasis is emerging around what developers build with. Amy Erixon of Avison Young described new technologies and materials that improve a building’s overall performance such as, “Reengineered concrete blocks containing plastic barriers and substitutes for iron-ore as well as glass improvements such as electrochromic (self tinting) and heat controlling technology.” At the same time, how something is designed can have an even greater impact. Designing with artificial intelligence and augmented reality can reveal, “more sustainable engineering and design solutions as well.”
How we design and build can have a profound effect on sustainability – well beyond the lot line. Ms. Erixon emphasized the need to focus on construction practices and materials. “Half of all transportations emissions (roughly 6% of overall emissions) are coming from construction projects. When you do high performance building construction, it carries over into the operations sector. Reducing carbon emissions is connected to everything from trying to improve the carbon input factors and improving the material manufacturing, it’s deployment, and increasing performance overall. As Zero Carbon projects aim for as much as 85-90% emission reductions, we’re sure to see a significant change in emissions and efficiency alike.”
Once a building is delivered, there’s even more opportunity to deliver sustainability. Joseph Aamidor of Aamidor Consulting discussed how the Internet of Things (or IoT) can transform what you know, and therefore what you can control. “Low cost, battery powered sensors deployed throughout a building allows a level of precision in operations never before seen. The management of a building is really the operational side of sustainability.” Whether it’s maintaining optimal temperatures, monitoring air quality, or controlling lighting, it’s possible to work at a far more granular level than ever before. At the same time, “the data can help you rethink how jobs are performed, and which jobs might be changing in efforts to reduce maintenance.”
As these technologies and practices remain fairly new among real estate trends, Mr. Aamidor acknowledged, “The challenge has often been that people aren’t necessarily trained enough to use or even believe in the power of data and technology. But once it’s in place, and you are able to act on it as well as draw insights out of it – improvement can happen quickly. It’s hard to identify how to improve the use of space if you don’t have data on how it’s currently being used. We’re talking about operating buildings in a fundamentally different way.”
Are we accounting for climate risk?
The ultimate threat to the long term viability of a building may be climate change itself. Joyce Coffee of Climate Resilience Consulting pointed out that, “In 2017, 1,500 high thinking individuals at the World Economic Forum in Davos, Switzerland were polled. Four of the five greatest risks mentioned in this poll, in terms of negative economic impact, were climate change related.”
Recent superstorms and rising tides in coastal cities such as Miami, New York, and Boston have provided very tangible examples of what can happen to assets in those cities. Still, the industry’s response to more frequent climate risks is not yet completely figured out. Chris Smy of Marsh USA Inc. explained the need to first understand more precisely our exposure to climate change risk. “Insurance companies are now pricing based on carbon foot printing because this helps them manage their own risk. They know this is going to be a gradual thing rather than an immediate need for an asset class such as real estate that evaluates in the short-term. This means that the owners of the risk have to bridge the gap in capital between first dollar lost and where the insurance company attaches. Discussing Carbon footprint is important, but it doesn’t really manage the risk.”
And the risk is very real and much closer than the industry realizes. No matter what the headlines say our markets are nowhere near to pricing the risk. Ms. Coffee pointed out that, “The National Oceanic and Atmospheric Administration now estimates between 6 inches and 6 feet of sea level rise by the end of this century. As a result, the east coast of the US will likely see two million homes valued currently at nine-hundred billion dollars underwater. And yet, houses in the riskiest markets are actually growing in value – as much as 55% since 2012. Something is clearly wrong with the market.”
Perhaps the markets don’t yet understand that the rise is happening now – not just at the end of the century – and some of the impact will be felt in as little as ten years. Storm surges and record high tides in major markets will easily cause billions of dollars in damage long before the ocean is 6 feet higher. Is the risk and the cost correctly accounted for in the pro-forma for all markets due to be effected?
Some investors are beginning to pay closer attention. Darob Malek-Madani of National Real Estate Advisors discussed a recent analysis of catastrophic risk within National’s portfolio. “We demonstrated that while Miami and Houston metro areas are only 7% of the total portfolio value, they make up 52% of the total risk from catastrophic atmospheric events such as hurricanes, floods, and tornados.” Those metro areas are only the first in line. There’s quite a bit more work to do.
Institutional real estate has made tremendous progress in sustainability in just the last ten years. Sustainable standards, once merely aspirational are truly becoming standard. New approaches to management, design, and construction are transforming buildings inside and out. The way things were always done before is no longer acceptable. But there’s still much to do. More data, more rigor, and better thinking about the future challenges are needed. Based on the discussions at the NAREIM sustainability meeting this year, it’s easy to believe that the industry is ready to get it done.← Spring 2018 Dialogues – Digital Version In Memorium: Jeffrey A. Barclay →