While ESG initiatives have played a significant role in Europe’s Real Estate landscape for decades, they have recently gained traction in the United States. An increase in state and federal legislation like the new rules proposed by the SEC regarding climate-related disclosures has investors calling for enhanced reporting requirements from owners and managers. This push has sparked debate over the value of ESG programs, with some championing the integration of sustainability in investment decisions while others remain staunchly skeptical. Sustainability measures are increasingly impacting every stage of the commercial real estate (CRE) lifecycle and CRE investors have the opportunity to create long-term value and build more resilient portfolios by prioritizing sustainability across the life of the investment.
When securing financing, prioritizing ESG measures can unlock lower-cost capital, meaning lower interest rates, longer repayment terms, and higher loan amounts. It pays to be green.
Specifically in the U.S., Fannie Mae and Freddie Mac, government-sponsored enterprises, offer green loans with lower interest rates and higher loan amounts (up to 5% in loan proceeds) than traditional financing options. These programs prioritize projects that aim to increase energy and water efficiency and offer incentives for green certifications such as LEED and ENERGY STAR.
Do the incentives outweigh the initial costs? Energy benchmark reporting required by lenders to participate in green loan programs is costly and time-consuming. Green financing may not be right for every deal but it’s worth assessing the potential capital benefits. Fannie and Freddie's incentives can often offset or defray the initial monetary investment and some improvements already included in the development plan may qualify a project for this type of financing.
It is important for managers to prioritize increasing an asset’s Net Operating Income (NOI) during this phase. NOI is a measure of profitability and directly impacts an asset’s valuation and future sale. Sustainability initiatives have the potential to positively impact NOI through lower utility costs, reduced maintenance fees, insurance premium discounts, and tax benefits. Sustainable features also increase the longevity of the asset as it will be able to adhere to stricter energy requirements proposed by cities and states. In a 2022 paper, CBRE stated, "Green buildings will command higher rents and higher capital values while incurring lower monthly operating and maintenance costs. In the U.S., Energy Star-certified buildings consume 35% less energy than non-certified properties,” (CBRE, ESG and Real Estate: The Top 10 Things Investors Need to Know).
More frequently, renters are also emphasizing the importance of energy-efficient homes and offices. Tenants are willing to pay a ‘green premium’ for a sustainable office or apartment. Per JLL’s 2022 global report, Return on Sustainability, “green certifications result in a rent premium of 6%.” With trends of longer lease terms, higher rental rates, and increased tenant retention, greening your property can improve top-line growth. Investors must assess the return on investment on a case-by-case basis as sourcing sustainable materials and adopting ESG technology comes with a substantial upfront cost. A centralized data platform can help CRE investors effectively draw out and scale actionable insights to inform decisions, reduce costs, and drive higher valuations.
Disposition, sell or redevelop
When it is time to sell an asset, green buildings have the potential for a higher valuation. By executing value-add sustainability measures during the operations stage, investors can increase overall asset value and maximize their return. Buildings retrofitted with green components are expected to depreciate less quickly and are more likely to meet the evolving demands of tenants, investors, and regulators. In November 2022, Hines UK released a sample breakdown of the growth in property values for those with higher certifications. The takeaway: green buildings enjoy higher valuations and marketability.
Implementing sustainability measures can positively impact each stage of the investment lifecycle while also mitigating regulatory risks and improving brand value. Investors today are taking a more active role in ESG performance and disclosures, increasingly integrating ESG criteria into their investment strategies. Managers and owners must understand how sustainability can optimize their properties’ financial performance. ESG isn’t just a buzzword; it can be a game changer in a disrupted CRE market, offering real and resilient payback potential.