Investors and occupiers alike are increasingly aware of the need to improve and upgrade stock to meet sustainability criteria in the pathway to achieving net zero. Half of the respondents within the RICS 2021 Sustainability report claimed that 'green leases' command premium rents, and 30% stated that brown buildings offer reduced rents to compensate tenants.1 Simultaneously, numerous surveys of investors have highlighted a willingness to pay a premium for space with the best green credentials.2
Is There Value-Add in Energy Certifications?
The 'Green Premium' and 'Brown Discount'
The conversation surrounding the extent of any green premium or brown discount has, however, been hindered by data limitations. Hines Proprietary Research conducted an analysis of energy certification within the UK office market to gauge the extent of any green premium. Despite being an imperfect measure for assessing asset sustainability, the BREEAM3 energy certification dataset allows for a level of comparison.
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Taking the 10 largest city centre office markets in the UK, Hines Research was able to split out BREEAM 'Excellent' and 'Outstanding' certified assets with all office assets. On average, the difference in rent between all offices and best certified assets was £4.30 psf, or c.20%, whilst the difference in capital values was £90 psf and c.24% on average. The rent and price premia for the best BREEAM rated assets was evident across all 10 markets
The rent premium, however, has been fairly stable over the past 10 years, as evident in Fig.1, indicating that occupiers have not meaningfully elevated asset sustainability on their list of priorities for some time. The growth in the BREEAM Excellent and Outstanding capital value premium from 2014 to 2019 (Fig. 2), and the larger percentage premium commanded by these assets relative to rents would suggest that investors are more likely to place value on ESG credentials. This may, in part, be borne out of growing concerns regarding liquidity of brown assets and more costly capex requirements should these assets fall outside of minimum energy efficiency requirements were legislation to become more stringent. The growing difference between rent and capital values premia also implies long-term cap rate compression for assets with the highest certification.
A commitment towards buildings which drive the industry standard for sustainability is becoming essential to any successful investment strategy.
A key issue with any analysis based on sustainability or energy credentials is the disentanglement of other, overlapping considerations such as asset quality, age, or submarket from the energy certification. Many newly built, good quality assets also benefit from a high energy certification. However, Hines Research believes Central London's high incidence of certified and non-certified office buildings allows for a more reliable comparison. Focusing solely on newly constructed assets (developed after 2015) and adjusting variables by their CoStar quality rating (ranked from 1-5, with 5 being the best quality), a more direct comparison is possible which accounts for differences of age, quality and location. Importantly, BREEAM Excellent and Outstanding rated properties can be isolated from non-certified properties' average in Central London, given the higher volume of certified properties there. By following these steps, the quality-adjusted 'green premium' for Central London has been around 7% for both rents and values (Fig. 3).
As more office assets are retrofitted, particularly in core markets, it is increasingly important to consider the impact of measures such as energy certification on assets of a secondary quality. Polarisation within the office sector between secondary and prime assets has been a major point of recent discussion, and property data has started to show underperformance of secondary stock. As occupiers become more conscious not only of an asset's energy certification, but also factors such as embodied carbon and emission tracking the distinction between 'brown' and 'secondary' assets could become increasingly blurred. This can already be seen by splitting out Q2 2022 vacancy rates for Central London assets between those with or without a BREEAM certification. (Fig 4). The high rate of vacancy in assets with no BREEAM rating suggests embedded, long term vacancy.
In trying to quantify the 'green premium' or 'brown discount' the example of Central London and UK regional office markets illustrates that those assets without green credentials are likely to face greater risk of value decline, stagnant rents, and obsolescence. Meanwhile, Hines Research suggests that more sustainable office buildings are likely to benefit from greater liquidity and stronger fundamentals and pricing conditions. The emergence of a two-tier market is already underway and failing to upgrade assets in line with sustainable criteria is presenting risks to future office returns. A commitment towards buildings which drive the industry standard for sustainability is becoming essential to any successful investment strategy.
1 RICS World Built Environment Forum Sustainability Report 2021
2 PMA Survey of Investors Views on Net Zero Carbon, JLL Survey of Industry Professionals, April 2021
3 BREEAM - Building Research Establishment Environmental Assessment Method
*Average of Central London, Manchester, Birmingham, Glasgow, Edinburgh, Leeds, Newcastle, Liverpool, Cardiff, Bristol
4CoStar, Hines Research, at Q2 2022
5 CoStar, Hines Research, at Q2 2022