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On-Site Renewable Energy Generators, Smart Monitors Among ESG Features Real Estate Investors Place Premiums On

Facing volatility in global energy prices, commercial real estate investors are placing higher value on buildings that lower energy consumption.

The U.S. commercial real estate industry continues to lag other countries in adopting sustainability and near-term carbon reduction practices. But sustainability practices are growing among U.S. real estate organizations due to a combination of financial benefits these practices provide and emerging government mandates.

Real estate investors are driving greater ESG adoption in the U.S., as they understand the advantages it provides in attracting tenants, creating opportunities for greater rent increases and operational savings, and therefore boosting property values.

“Better occupancies and stronger rents translate to higher values, which ultimately drive investor decision-making,” said Aaron Jodka, director of national capital markets research at commercial real estate services firm Colliers.

Rising tenant demand for sustainable practices has also been instrumental in ESG adoption. Capital improvements have a material impact on expenses for tenants and influence the amount they are willing to pay in rent, further driving property valuations, according to Tom Edwards, CBRE’s global president of valuation & advisory services. He points to the installation of solar panels as an example—they drive down operating expenses, which has a positive impact on a company’s net operating income.

“With that in mind, the benefit to the investor will depend on the lease structure, the initial capital expense, the life of the panels, and any government incentives that may help with the initial investment,” Edwards added.

The availability of green bonds, which provide funding for new and existing projects that deliver environmental benefits, is also aiding ESG momentum in the U.S, according to Jodka, who noted that REITs have been especially active in floating such bonds. In 2022, green bond issuance in the U.S. reached $50.9 billion, according to research firm S&P Global. While green bond issuance globally declined on a comparative basis last year along with overall corporate bond issuance, S&P researchers forecast a 30% or greater global increase in issuance this year.

And while there is currently no federal reporting requirement for this in the U.S., the Securities and Exchange Commission (SEC) recently proposed climate reporting rules to streamline ESG metrics for investors. (It’s uncertain whether Congress will pass this measure and whether it could withstand legal challenges, according to Josh Richards, corporate director, ESG, at real estate brokerage and advisory firm Transwestern.)

Since U.S. ESG adoption is still in its relative infancy, there are few nationwide standards for practices, performance metrics or reporting and verification, so many states and local municipalities have been left to design their own.

Today, sustainability features that are believed to deliver the most “bang for the buck” for real estate investors are those that directly reduce operational expenses, according to Richards. Whether this is achieved through technology enhancements and integration of more monitoring equipment or traditional capital improvements, improvements that deliver the most clear-cut cost reductions and incentives for building owners and occupiers, include:

  • High-efficiency lighting and lower lighting power density,
  • High-efficiency plumbing fixtures in lavatories and kitchens,
  • Leak detection systems for both buildings and irrigation,
  • High-efficiency equipment drives and motors, and
  • Building retro-commissioning, which improves how building equipment and systems function together. It improves efficiency and lowers operating costs by cutting back on demand for energy consumption.

Additional sustainability practices that can generate exceptional savings over cost include utilizing federal and utility rebate programs for energy-saving projects; conducting energy audits; deploying on-demand HVAC for weekend and off-peak times, and upgrading the building automation system network, which connects and automates certain functions inside buildings to increase control of temperature, fan systems and ventilation, according to Katie Sakach, managing director of asset services at Transwestern.

For example, an on-demand HVAC system allows tenants to request after-hours HVAC on a real-time basis, providing unlimited flexibility to use their space as needed. “The key energy-saving benefit to the property is that this program allows our tenants to ‘opt-in’ for Saturday hours, therefore, we don’t run on Saturdays unless needed for use by the tenants,” Sakach said. She noted that when this program was launched, it reduced the annual budget for HVAC energy by 10 percent.

Buildings with existing sustainability features that futureproof the asset against needing further investment in this area typically provide the best value for occupiers and investors, according to London-based Emma Buckland, global president of property management with CBRE. Respondents to CBRE’s recent global ESG survey reported both tenants’ and investors’ willingness to pay premiums for features that support their specific ESG goals and almost 70% said focus on ESG intensified last year, largely as a result of higher energy prices and new government regulations. Three-quarters of survey respondents pointed to reduced energy consumption and carbon emissions as sustainability features most likely to impact property values, with on-site renewable energy generation and/or smart technology energy monitoring being most closely tied to willingness to pay more for a property.

The survey, conducted in the fall of 2022, included responses from more than 500 commercial real estate professionals from around the world about ESG strategies they found to be the most impactful. More than 55% of respondents identified themselves as investors, shore of 30% were occupiers and the rest included real estate consultants, architects, lenders, public sector officials and utility specialists. The majority—70%–specialized in the office sector.

“As companies continue to factor sustainability into their real estate decisions, we’re seeing net-zero-ready features, such as heat pumps, on-site renewable energy generation, high-efficiency HVAC replacement and other building optimization technologies contribute to the perceived value of a building and a factor in which buildings companies choose to lease or buy,” said Buckland.

Companies are also increasingly factoring climate-risk considerations into their decisions, such as whether the building has the potential to be carbon neutral or might be affected by a changing climate, according to Buckland. She noted that green certifications are a priority for building owners looking to drive rental rate increases and attract new tenants. “Last year we analyzed 20,000 office buildings and found that LEED-certified buildings command on average a four percent rent premium,” she said.

Tenants are prioritizing building features that improve people’s physical and mental health, including a heightened focus on air quality, according to Buckland. Nearly half of respondents who participated the CBRE survey said they would pay a premium if these features were present in a building they were considering leasing or buying. Other attributes that tenants put a high priority on were inclusive building designs and facilities that support cycling and walking.

Tenants are increasingly driving leasing conversations around sustainability and healthy buildings, including features such as access to outside space and views, on-site fitness and/or wellness centers and above-average indoor air quality, agreed Richards. Building certifications, such as LEED, WELL, BREEAM and ENERGY STAR, now serve as key leasing factors, especially for larger, institutional and multinational tenants, he said. Richards added that green certifications are rapidly becoming a minimum standard for downtown and core assets in many urban markets.

He brought up 77 West Wacker in Chicago, a class-A office building that Transwestern currently leases and manages, as an example of the type of building tenants gravitate to in today’s environment. The building is Energy Star- and LEED Platinum-certified and has a BOMA 360 Designation. Transwestern’s property management team implemented a behavioral program at the building aimed at reducing energy usage that cut energy consumption by more than 50% over the last five years without upgrading HVAC equipment, Richards noted. The team also reduced waste and associated expenses by more than 80% by implementing a recycling program. Meanwhile, features that improve the day-to-day experience for tenants include a basketball court, locker rooms, spa services, a rooftop garden where tenants can recharge or host events and an intelligent building software program with an app that provides a touchless entry process, indoor air quality transparency and tools to communicate with the building management, among other things.

While most tenants appreciate features like solar power, CBRE’s Edwards noted it’s the amenities that employees interact with on a daily basis—EV charging stations, green spaces, bicycle parking and the like—that can be more impactful when it comes to their real estate decision-making. Sakach also cited other green and healthy building features that tenants seek, including living walls, natural light and a quality cleaning program.

Real estate investors look for these features for similar reasons. ESG practices, including transparency around air quality, asset valuation and climate resilience, are becoming central to their decision-making as well, according to Richards. “Whether internally motivated or driven by the regulatory environment, ESG reporting is now a key element of the industry,” he noted, adding that sustainability and healthy building features don’t only drive up property valuations, but represent an opportunity for positive branding and marketing for landlords.

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