30 December 2015
Green real estate is proving a winner when it comes to investment returns. Sophie Robinson-Tillett looks at opportunities and trends in the sector
In November, Columbia Threadneedle boasted that its Low-Carbon Workplace Fund had "punched the lights out of" its mainstream benchmark, outperforming by 6.6% in 2015.
"This is the final proof of the concept that you can have a solution for turning existing offices into low-carbon workplaces and make money at the same time," claimed Columbia's head of property, Don Jordinson.
It is a concept that's grabbing the attention of many investors and developers.
Doug Morrow, associate director of thematic research at analysis firm Sustainalytics, which published a report on sustainable real estate in October, says Real Estate Investment Trusts (REITs) "with a higher concentration of green properties are starting to outperform in the markets".
"And mainstream developers are realising the benefits of green building, in terms of higher rental rates and sale prices, for example," he adds.
Axa's Real Assets arm recently pledged that 75% of its direct property investments will be in environmentally-certified assets, prompted by a desire to "create long-term value for clients and investors by enhancing existing assets".
Credit Suisse is hoping next year to reach first close on its Europe Climate Value Property Fund, which seeks to maximise the energy efficiency of its real estate assets.
"The remaining portfolio share for which the energy consumption cannot be reduced in a cost-effective manner is made completely 'carbon neutral', once a year, through the purchase of carbon dioxide certificates," the bank explains.
BNP Paribas' Investment Partners (BNP PIP) Real Estate fund launched in September 2011 and has seen good results. Between launch and the end of November, it delivered an annualised net return of 18.85%.
The vehicle invests in European commercial property, using the European Public Real Estate Association Index (EPRA) as its benchmark. It assesses each real estate company's portfolio based on its energy intensity, greenhouse gas emissions, energy mix, environmental certifications and the management of resources such as water and waste. Its energy intensity is 15% lower than EPRA's, and its carbon intensity is 25% lower.
"We're able to say very clearly to clients that if they put their money in this fund, the carbon footprint will be much lower than the reference index, and they won't lose out financially," explains Felipe Gordillo, a senior analyst at BNP PIP, who says most of the investors in the fund are mainstream institutions.
"That's because the real estate sector is exposed to a lot of regulation," he says, pointing to the French property market, which is subject to rules about energy-efficient upgrades by owners if buildings fall below certain levels. "There are regulatory powers directly impacting the value of these assets, so it is an advantage to be able to select the companies who are in the best position to handle those risks, for material reasons. As a result, mainstream investors are increasingly interested in these products."
One of the biggest barriers to growth in the sustainable real estate space is what's known as the 'split incentive'. This is the idea that many of the outcomes of making property more energy efficient – namely lower energy bills – benefit the tenant rather than the owner. As a result, landlords have often felt disinclined to invest themselves. But even in this respect things are changing, and the ultimate asset owners are recognising that there are more advantages than simply cheaper running costs.
Chrissa Pagitsas, who heads up the multifamily green programme at mortgage giant Fannie Mae, believes there is a fleet of other material benefits to investing in sustainable property.
"We see these properties as having a potentially lower risk profile – evidence suggests that properties with a LEED (Leadership in Energy and Environmental Design) or Energy Star certification have a higher sales value, lower energy costs and higher occupancy rates. Those three metrics alone give us confidence that the property will retain its value, and – if there is a default on the loan – there would be minimal risk if we had to foreclose. That makes them great quality assets for our portfolio."
The programme works much in the same way as Fannie Mae's conventional, multi-family mortgage-backed securities (MBS). A commercial property developer goes to a primary lender for a mortgage on a site; the mortgage is securitised by Fannie Mae and sold on to an MBS investor.
Generally, Fannie Mae Multifamily MBS securitise one loan whose collateral is one property. To qualify as 'green' the property must either have a sustainability certification, or be able to commit to improvements – financed by the proceeds of the loan – of at least 20% in either water or energy consumption. In return, the borrower receives a lower interest rate – 10 basis points lower – than it would otherwise.
"The green component is a new layer for Fannie Mae," explains Pagitsas. The programme launched in 2010, completing its first deal in 2013. "The business has certainly been growing," she says, pointing to the $140 million of green MBS completed by the end of 2014.
"There's always demand for Fannie Mae's MBS, but with this we're reaching new investors and borrowers that had never thought of us as offering a green product."
Investors are increasingly pivoting towards sustainability in general, so there'll be a growing push for real estate companies and building owners to take greater steps to measure sustainability, Doug Morrow, Sustainalytics
And research released by industry body Global Real Estate Sustainability Benchmark (GRESB), suggests that more fixed-income investors are on the lookout for sustainable real estate opportunities. Debt funds, according to the report, are developing a "growing appreciation" for the environmental, social and governance profiles of real estate investments.
"Integrating sustainability into real estate lending has certainly not been standard practice," says Sara Anzinger, manager of real estate debt and fixed-income at GRESB. "The equities side is roughly a decade ahead in this respect, so it's a logical progression that investors would now want the same on the debt side."
This growth is reflected in the spate of green bonds issued to finance energy efficient buildings in the past 18 months. Australia's Stockland, Dutch bank ABN Amro, data-centre operator Digital Realty and a slew of municipalities in the US are just some of those who have tapped the nascent market in order to fund the construction or retrofit of green real estate.
"The development of the green bond market is good news for the property sector," says Gordillo. "But if you look at many of the green bonds that have been issued so far, they haven't had much additionality and impact – in other words, they haven't demonstrated that they're supporting projects that wouldn't otherwise find finance, and are having a positive environmental effect."
Impax devises methodology for quantifying 'green alpha' in buildings
UK-based environmentally themed impact investor Impax Asset Management has devised a "ground breaking" methodology for quantifying the 'green alpha' from improving a building's energy efficiency.
However, as BNP PIP spelled out in a report earlier this year with the Energy Efficiency Financial Institutions Group, these kind of innovations are crucial if the space is to take off (see box).
And Gordillo is optimistic that some of the issues around additionality in the green bond market will change as the asset class matures and issuers and investors become more literate in key metrics and industry standards.
"One of the benefits of real estate, compared to many other sectors, is that there is already a lot of quality data and information available, which makes it much simpler to make an informed investment decision."
Pagitsas agrees that investors are slowly becoming more sophisticated about the subject. Currently, Fannie Mae doesn't differentiate between properties with differing sustainability ratings.
"That's down to the ultimate investor – it's market driven – and I don't think they're differentiating yet, but they are getting there."
There is a general consensus that the subject is finally becoming mainstream, partly because of changes to policy around the world, but also because of changing investor demands.
"Investors are increasingly pivoting towards sustainability in general, so there'll be a growing push for real estate companies and building owners to take greater steps to measure sustainability," says Morrow. Indeed, last month Dutch pension fund PGGM committed to mapping the carbon footprint of its entire real estate portfolio.
"This kind of measurement is becoming more common, and is usually a precursor to bigger decisions, so I think the PGGM announcement is a harbinger of more to come."
The US Department of Housing and Urban Development's Federal Housing Administration (FHA) in August gave a potential boost to the country's Property-Assessed Clean Energy (PACE) programme – through which property owners receive financing to make their buildings greener – by agreeing to insure PACE mortgages provided that the loan sits below the site's mortgage in terms of seniority.
And, with buildings accounting for around 40% of global energy consumption and 30% of global carbon dioxide emissions, the COP21 climate negotiations are expected to lead to further pressure on investors, developers and policymakers to take the subject more seriously.
"It's one of the first sectors regulators will need to change – you cannot put in place an environmental policy at country level, or a climate agreement between countries, that won't tackle the real estate sector," says Gordillo, adding that more regulation is inevitable as a result, meaning low-carbon products "will increasingly have an advantage over conventional products".