As pressure increases for organizations to reduce their environmental impact, sustainability is shaping the commercial real estate market. Our global real estate research reveals that over seven in 10 investors (71%) expect a property with strong energy performance standards to have a higher resale value than an equivalent property with weak energy performance standards. This ‘green premium’ also reaches beyond resale value: investors recognize that the enhanced value of sustainable properties also encompasses increased occupier demand, reduced void periods, and higher-quality tenants.
Over the coming years, investors predict that this trend will intensify: three-quarters believe that in the next five years, the ‘green premium’ will be the main factor dictating real estate values. Currently, investors are saying that the state of repair, user experience and location of a building are the most important factors to them when making real estate investment decisions.
The top 10 factors that are currently important to firms when making real estate investment decisions
One of the biggest premiums when it comes to green buildings is the much lower level of vacancies
Professor Olmo Silva,
Professor of Real Estate Economics and Finance at the London School of Economics and Political Science
Over half of organizations in our research (52%) have made public commitments to sustainability, and companies now need to take action to fulfill these pledges. Improving the sustainability of their real estate is seen as one of the easier wins in terms of reducing environmental impact. Almost all the corporate occupiers in our research (98%) say that they are currently considering sustainability when making real estate rental decisions. In fact, after availability and cost, sustainability performance is the most important factor when they are making commercial property rental decisions today.
The top 10 factors that are currently important to corporate tenants when making commercial property rental decisions
However, as sustainability standards improve and expectations rise, we can expect a shift from a green premium to a ‘brown’ or ‘gray’ discount: instead of sustainable buildings attracting a premium, buildings that fail to meet standards can expect to suffer a discount, or even become unsaleable.
Businesses and investors are taking sustainability initiatives seriously because it makes fiscal sense to do so.
Matt Cudrin, Partner – Real Estate (New York) at BCLP
Our research reveals that investors are keenly aware of this danger. On average, investors believe that 11% of their firm’s real estate investment portfolio is at risk of being unsaleable due to failure to meet certain sustainability criteria. This amounts to an average of $442 million of investments at risk per firm. The figure is even higher if we hone in on the private equity investors in the sample, averaging $561 million per firm. This risk is impacting investment decisions – 76% of the private equity and institutional investors in our research say that the increasing threat of ‘brown’ discounts and stranded assets will drive greater investment into more sustainable buildings.
However, investment risk is not the whole picture. Investors are also aware of the potential reputational risk; 73% of investors believe that the reputation of their firm will be negatively impacted if they fail to increase the weighting of sustainable buildings within their portfolio.
In UK commercial real estate, the gap between the top of the market and the rest of the market is growing, in terms of asset prices, rent and vacancy rates. Investors expect a significant discount for holding assets that are not premium and that have lower sustainability standards. In London in particular, there is high demand for top-tier buildings with strong sustainability standards in city center locations, while poorer-quality buildings in less desirable locations are increasingly considered unoccupiable and unfinanceable. In between these two extremes are buildings that need significant investment to get them up to standard. Many large corporates are taking advantage of leases ending to both reduce their office space due to increased remote-working, and to find more energy efficient buildings that move them closer to their sustainability targets.
Although most corporate tenants are considering sustainability as a critical factor when making rental decisions, they do not necessarily expect to pay more for a greener property. A third of organizations would not be willing to pay any additional amount to rent a property that met a high sustainability standard compared to an equivalent property that didn’t. And, of those who are willing to pay an additional amount, only 25% would be willing to pay more than 5% of the overall rental value.
Additional amount that corporates would be willing to pay for a property that met high sustainability standards by market
While both investors and corporate occupiers recognize the importance of improving real estate sustainability standards, in a challenging economic environment and against a turbulent backdrop for corporate real estate, the question of who bears the cost is a challenging one. Government incentives are limited, and the cost of upgrading old buildings – particularly office stock – is steep. The relationship between landlord and tenant is critical for more sustainable real estate: how the building is run, used and managed by the tenants has a huge impact on the footprint and energy efficiency of the building.
Real estate lawyers working on behalf of corporate occupiers will often reject sustainability provisions because the clauses are often ambiguous.
Heather Boelens, Partner – Real Estate (Boulder) at BCLP
As sustainability continues to shape real estate, you may be looking to find ways to make your portfolios more energy efficient, moving closer to your sustainability targets while grappling with the costs that entails.
One way to do this is the use of green leases, and BCLP regularly advises clients on green leasing, as well as other ESG considerations.
In the UK, we have produced a detailed guidance paper for our clients on green leasing provisions and clauses to incorporate into their leases against a statutory backdrop in flux, as well as more generic advice as to challenges with EPCs and wider sustainability considerations.
We have also organized roundtables and client specific sessions with investors, landlords, developers, and tenants to discuss the current market position on green lease provisions and the appetite for change as we head towards 2030. To complement this, we developed a green lease matrix. This useful tool maps the relative strength of the various green provisions in our investor clients’ template leases and some well-known market leases to give our clients a better feel for where their provisions sit in the market. We have also been active participants in the working group re-drafting the Better Building Partnership’s Green Lease Toolkit.
We believe that the green lease matrix and our depth of knowledge in this area is unique in the legal market, and that this initiative has the potential to raise the environmental benchmark in the wider commercial leasing market. We have developed a series of deep-dive client workshops designed to capitalize on our experience. In those workshops we take the time to carefully unpick our clients’ ESG strategies, challenges and current positioning, before posing a set of tailored questions to allow us to suggest drafting solutions that will work commercially and practically for that client, on an asset by asset basis, going forward.
US: Heather Boelens
Asia: Andrew MacGeoch
Both corporate occupiers and investors are aware of the sustainable real estate imperative, but closing the gap between intention and action is challenging – and expensive. Our study sheds light on an increasing dislocation in the market: 79% of corporate occupiers say that by 2030 the sustainability of a building will be the most important factor in the rental decision-making process for their organization, but investors believe that on average, over half of their property portfolio (55%) will still be made up of real estate assets that have unknown, poor or average sustainability performance by this date.