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Sustainability and real estate investment performance

Dr Paul McNamara OBEHead of Research, PRUPIM

Co-Chair, UNEP FI Property Working GroupSPR RESEARCH BRIEFING - London, October 1st 2009

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Agenda

Property – a key part of the problem and the solution

Can investing responsibly in real estate enhance performance?

Approaches to responsible real estate investment

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Property and Climate Change

Source: UJNEP SBCI (2006) , pg 5

Being a significant part of the problem….

…makes property a significant part of the solution

Share of the built environment in resource use

Share of the built environment in pollution emission

0 20 40 60 80 100

Water effluents

Solid waste generation

CO2 emissions

0 20 40 60 80 100

Land

Water use

Raw materials use

Energy use

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Property – a key contributor to climate change mitigation

Source: IPCC, 2007

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So – it is hardly a surprise that property is a key focus of attention

European & UK Government bodies

Activists/Opinion

Formers/NGOs

Tenants

Community

Business Partners/

Suppliers

Property Investors

Investors/

Shareholders

Customers/

Policyholders

Employees

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The twin paradoxes

“98% of the debate has focussed on 2% of the problem”

“Those with the power don’t have the knowledge….and those with the

knowledge don’t have the power.”

The need is to see this as an investment issue relating to existing stock

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Can investing responsibly in real estate enhance

performance?

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Behaving ResponsiblyEnhances Fund

Performance

Behaving ResponsiblyHas No Effect on Fund

Performance

Behaving ResponsiblyHarms Fund Performance

Fiduciary DutyFiduciary Dutyto act this wayto act this way

““Moral” Duty toMoral” Duty toact this wayact this way

DilemmaDilemma

Consider three possibilities….

Can we find a logic for this?

Can we invert this logic and find things to do that don’t affect fund performance?

Sadly, many start here…

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RPI can have a positive effect on property values and returns

Factor Investment Implications Underlying effectsTenants prefer green buildings Rental differentials emerge

between green and non-green buildings

Green assets quicker to re-let

Rental growth higher, depreciation lower

Shorter interruptions to cash-flow, lower risk premium

Green buildings are cheaper to run

More money available for rent Rental growth higher

Impending government regulation and legislation

Greener assets de-risked through better tenant retention/attraction

Reduced risk premium

Other investors prefer ‘green’ buildings

Green properties quicker to transact Greater liquidity, lower opportunity cost and risk premium

• Green assets likely to have lower yields, higher values over time

• As differences in value emerge, green assets should outperform

The more it matters, the more values and performance will be affected

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Early evidence of possible benefits

Results for buildings with Energy Star ratings

Variable Impact of being ‘green’

Rent per square foot +3%

Effective rental income (adjusted for prevailing occupancy levels)

+6%

Sale prices +16%

Source: Eichholz P, Kok N and Quigley J (2009) Doing Well by Doing Good? Analysis of the Financial Performance of Green Office Buildings in the USA, RICS Research Report, London, March 2009, pp 9 and 28

• Total sample of 9,998 office buildings throughout the USA – 893 “green”

• 1,816 offices sold between 2004 and 2007 – 199 “green”

• Rental information on 8,182 – 694 “green”

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But is knowing about the effects the same as being responsible?

Sustainability is changing the entire context for property investment

Successful investors need to at least understand how sustainability will affect asset pricing and prospective performance

Responsible investors will go further and look for economic ways to work with assets and tenants to improve the environmental and social credentials of assets and, thereby, protect or enhance future returns

Responsible property investment is quintessentially active

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Approaches to responsible real estate investment

“investment where social, environmental or ethical considerations are taken into account in the selection, retention and realisation of investments, and the responsible use of rights…......…attaching to investment” (Mansley M., 2000, pg 3)

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Responsible Investment

‘Engagement’ Screening ‘Best in Class’ Enhanced Analysis

Positive Negative

Direct Action Indirect Pressure

Forms of Socially Responsible Investment

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Relationship between Investor and Invested Asset

Property as a ‘Binary’ (Tertiary?) Asset

Property as a Concatenation of Time-limited Investments

Differential Liquidity and Transaction Costs

Property as a ‘Legacy Asset’

Five differences between property and equities

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Three forms of ‘Engagement’ in Property

Engagement with the Tenant (occupiers)

Engagement with the ‘Legal Structure’ (leases)

Engagement with the Built Structure (buildings)

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On Site New building Refurbishment Property management

“Situation” Benefits of landlord expenditures can accrue to the

tenant. Timing, scale and nature affected by the lease

Engagement with buildings

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Leases are socio-cultural in nature

commonly grants occupation rights more restrictions can reduce attractiveness (rent and

value)

Green leases/Memoranda of Understanding

obligations on both tenant and landlord, agreed at the outset and enforced through the term of the lease.

Engagement with leases

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Occupiers are crucial to the environmental and social impact of a property.

The lease greatly determines what can be achieved

‘Informal engagement’ with tenants No ‘voting’ rights, as in equities Dialogue to persuade or educate tenants how to utilise

their premises in a more environmentally responsible way.

Engagement with occupiers

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Limited and uniform investable stock

creates risk for investors

Tenant screening

What to do about mixed occupied assets Rights to occupy and assign Capital already invested

Limited availability of data – on buildings or tenants

Difficulties with Screening in Property

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Conclusions

Property is a major element of both the problem of, and the solution to, increasing CO2 emissions A very major user of resources generally and conduit for CO2 emissions The lowest cost per unit impact on the problem

Setting aside increasingly stringent government regulations – ‘green’ property investments should perform better Higher net income growth at lower risk

Savvy investors will profit from this knowledge; responsible investors will strive to ‘do well by doing good’ – especially through improving existing stock