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Can real estate go from villain to hero?

In a rapidly urbanizing world, real estate plays a critical role in the impact that city development has on the environment and on urban sustainability.

Although measurement is complex, the real estate industry is responsible for around a fifth of all CO2e emissions, new construction consumes some 40% of raw materials globally, and buildings generate a significant proportion of waste and consume much of the earth’s fresh water.

More than this, the built form – what is built where – is fundamental to the efficiency of a city, determining movement patterns, the need for transport, demand for infrastructure and much more.

The impact of real estate is magnified by the scale of urbanization. By most projections, over 60% of the world’s population will live in cities by 2030, requiring 250 million new homes and offices, shops, industrial space, schools, hospitals and other built forms.

If we are to achieve the testing targets set at COP21, to keep global warming below 2°C and, ideally within 1.5°C, then the real estate industry must make a substantial contribution to that global effort.

Yet the sector has under-performed relative to some other sectors when it comes to sustainability efforts: for example, in the Dow Jones Sustainability Index, it trails behind industrial conglomerates, transport, metals and mining, professional services and construction materials sectors. What can be done to move the sector from being a problem to being part of the solution?

It would be wrong to suggest that the real estate sector has ignored climate concerns. There has been notable progress in new construction with an estimated 40% of new commercial real estate buildings being “green” – that is achieving rated environmental sustainability status – a dramatic increase in just a decade from the 2-5% levels of the early 2000s.

In part, this has resulted from the improved availability and lower cost of sustainable construction techniques, making it more cost effective to achieve a green label. In part, it reflects tighter regulation, building codes that include energy efficiency and emissions targets and the impact of carbon pricing. But, in significant measure, the change reflects both a growing awareness of corporate responsibilities and a realisation of the growing business case for adopting sustainable development and investment strategies. Can this be harnessed to allow the real estate sector to make a positive contribution to a sustainable future?

Why context is key

Work by the World Economic Forum’s Future of Real Estate and UrbanizationCouncil points the way by focussing higher up the valuation chain on investors, owners and managers of real estate assets. This approach shifts the emphasis away from new build and the construction process to a more holistic view of the investment portfolio.

This is vital since, in developed economies at least, new construction represents a relatively small proportion of the built environment. To meet environmental targets, we have to manage and improve the efficiency of the existing stock as well as creating new more sustainable space.

The portfolio approach brings another critical benefit – it focuses on the buildingin its urban context rather than on the technical elements of “green construction”.

  • Efficient management of building operation by exploiting the digital revolution through use of building information models in asset management and exploiting smart building technologies;
  • Owners and tenants cooperating through green lease structures to incentivise and optimise building efficiency and resource usage;
  • Shifting portfolios towards more sustainable asset structures, via repositioning, retrofitting and redevelopment;
  • Embedding real estate activity within a wider urban sustainability through cooperation with city governments and other urban stakeholders.

Such an approach shifts away from the “green building” to a more collaborative, strategic view of urban sustainability and the role of real estate in the urban environment. But why should private firms and investors adopt such an approach? The work of the Council suggests that they should because it is in their business interests to do so.

The business case for sustainable real estate

There is growing evidence that more sustainable real estate assets deliver bottom line returns. Research from many different countries and using a variety of methods demonstrates the existence of both price and rental value premiums in commercial real estate: investors will pay more to acquire greener assets; tenants pay more to occupy those assets. Moreover, more sustainable buildings have lower vacancy rates and landlords face lower running costs.

The gains seem to outweigh the additional costs of creating more sustainable space (costs which are reducing with technological advances and with scale economies through widespread adoption, in any case). Many in the industry remain sceptical about these findings, but they reflect and are driven by changing attitudes to the environment and sustainability:

  • In the investment channel, an increasing proportion of investment funds have ethical/green/sustainability filters to their investment policies: less sustainable buildings will increasingly be excluded from their acquisition policies, as will developers or real estate managers who do not operate sustainable policies. These latter will also be unable to access burgeoning green debt funds. Higher capital costs and less demand for less sustainable product will damage performance and capital growth;
  • In the occupier channel, tenants gain from greater building efficiency and lower operating costs, with benefits shared between tenant and landlord; more profitable occupiers are less likely to suffer financial distress creating more rental stability and lower vacancy rates;
  • Increasingly, the best and most mobile employees (particularly amongst the millennials) are demanding to work for firms and organisations that are committed to sustainability and in environmentally-sustainable workplaces – an effect operating all along the value chain.

Even if real estate market players do not accept the case for improved returns from adopting more sustainable policies and strategies, the case that such an approach reduces risk is surely unanswerable. Portfolios are exposed to regulatory risk (for example from stricter building codes), to energy price shocks, to policy changes and to major shifts in tenant and investor demand.

Thus a sustainable investment strategy can de-risk the portfolio, improving risk-adjusted returns. As an illustration, the UK Energy Act will impose strict energy performance requirements on commercial space: owners will not be permitted to let buildings fall below a threshold EPC, creating loss of income and imposing costs of upgrading or redevelopment for those that have not reacted.

At the urban level, contributing to neighbourhood and city-wide initiatives helps to create more resilient, sustainable spaces, greater efficiency of transport and infrastructure and a more liveable environment.

Such places are likely to be more successful: the best and most dynamic firms, the best and most dynamic workers will want to locate there and the providers and owners of real estate will, inevitably, capture part of those benefits. Dynamic cities will adopt sustainable strategies and they will want the real estate firms to participate in that and collaborate with them.

Finally, there is a policy dimension. Aside from individual and collective responsibilities towards a sustainable future, by adopting a proactive strategic approach to environmental improvement, the real estate sector can help shape city, national and international policy, regulation and legislation.

Major real estate developers, owners, investors and managers, participating fully in the shaping of policy, can bring their knowledge and expertise to ensure a greater effectiveness in delivering (privately or in partnership) a sustainable built environment.

Failure to do so risks having regulation, policy and standards imposed from outside, by governments and by other participants, producing potentially sub-optimal outcomes and generating new risks. The sector needs to be part of those policy discussions, it needs to be at the table.

The next steps

The Future of Real Estate and Urbanization Council, in its discussions on how the real estate sector could contribute to a more environmentally sustainable urban future crafted a set of principles to shape industry policy at a strategic level.

Many existing standards and policies are focussed tightly on physical building performance and measurement and do not fully embrace the policy dimensions nor the local and urban context in which those buildings sit.

The principles, by contrast, are intended to be embedded into organisational decision-making and to focus on the wider implications of the role and contribution of real estate in the city and its surrounding regions. They are set out below:

Five sustainability principles for the real estate industry

Across the lifecycle of individual portfolios and as key business objectives, and as organizations committed to environmentally sustainable practices for the built environment, we will:

1. Embed adherence to best-in-class sustainability standards in all aspects of our real estate operations, with board level responsibility for monitoring and disclosing our sustainability performance.

2. Ensure that our decisions contribute to improvements in environmental sustainability at the local and urban levels, working cooperatively with tenants, city governments, planners and other stakeholders in achieving our targets.

3. Commit to continuous improvement in the environmental performance of construction and development activities, our real estate operations and our asset management policies.

4. Track the environmental performance of our real estate assets and operations on a continuous basis, to assess our ecological footprint, and our exposure to risk from natural shocks, environmental regulation and the economic impacts of climate change.

5. Identify explicit targets for improving our environmental sustainability performance including specifically in our commitment to minimize emissions of greenhouse gases and to increasing our use of renewable resources.

Critical elements here include the commitment to ensure that sustainability lies at the heart of business decisions at all levels of the organisation; the call for cooperation and partnership in achieving environmental improvement in the local and city context; and a targeted approach to improvement of environmental improvement.

Many firms and organizations are, of course, already closely aligned to these principles in their business practices. Their importance comes both in shaping internal policy and as a signal to others within and outside the real estate sector of a real commitment to improvement.

As and when prominent real estate firms mark their commitment to wider urban sustainability through the actions of their organisations, we would hope that a virtuous circle can be achieved:

  • Investors will seek out firms and funds committed to the principles
  • Tenants will seek to let from owners and managers committed to the principles
  • Best employees will seek to work for firms committed to the principles
  • Cities will seek to partner and work alongside organisations committed to the principles
  • Competitors, seeing the business advantages, will commit to the principles

This can create a snowball effect, such that commitment becomes a de facto industry standard, endorsed by the major professional bodies and trade associations in real estate and widely adopted by the leading firms and players. Of course, this brings no real tangible benefit if the commitment is mere rhetoric, empty words with no real policy impacts.

As adoption increases, so there needs to be measurable and transparent ways to demonstrate those real effects. But the importance here is that these are not tick box standards imposed from outside the industry: they represent a significant strategic and policy level shift from within the real estate sector. Instead of representing part of the problem, the real estate sector becomes an active and critical actor and shaper in creating a dynamic, successful and sustainable urban future.