By Mark Willers
What is the value of a green building? The issues is starting to become top of mind for many investors and valuers. Here CB Richard Ellis senior valuer Mark Willers steps through the current thinking.
19 November 2010 – As a practising valuer in the Sydney CBD commercial marketplace the issue of sustainability in commercial property valuation is of particular interest to me.
Over the past two to three years the topic has become increasingly important to both property owners and tenants, and although some may argue about the extent of any effect on property pricing, it has become an area that needs serious consideration by valuers.
It is difficult to categorically state which assets require consideration from a valuation perspective due to their sustainability credentials. In the Australian marketplace presently the office sector has the largest uptake by far in terms of sustainable ratings as a sector. The effect of these ratings on property value will largely depend on the following characteristics:
- Location of the asset – CBD or suburban
- Size of the asset – noting that office areas of larger than 2000 square metres are now required to have a NABERS rating in order to transact
- Tenant profile – both in terms of the retention of existing tenants and attracting new tenants.
Valuers are coming under increasing fire for their perceived inability or unwillingness to reflect the value of sustainable design and improvements within their valuation assessments. This article intends to outline some of the issues that valuers face in the commercial marketplace when undertaking valuations of “sustainable” buildings and shed some light on the limitations of the valuer’s role, and how the gap between property owner’s perceptions in the marketplace and valuations might be bridged to some extent.
The current state of play
Green buildings are perceived to be more attractive to occupy from a tenant’s point of view. The features that make them so are often physical characteristics such as better natural light, improved efficiencies, good indoor environment quality, new or improved plant and services.
A number of highly rated green buildings have been through a significant period of capital expenditure and improvements in order to obtain green ratings. These characteristics would command more rent in the marketplace from tenants, green ratings aside, and valuers face an inherent difficulty in differentiating between green ratings and a building’s physical improvements.
The challenge for a valuer therefore is to comment specifically on the positive and negative attributes of a building’s sustainability ratings, explicitly from the normal comparison and benchmarking process with other buildings in the marketplace based on their physical condition, Property Council of Australia grading, location, aspect and age.
It is the author’s opinion that the vast majority of sustainable improvement is already being reflected in the valuation of large commercial CBD and suburban office assets, but is somewhat disguised in the current format of most valuation reports that have maybe not kept pace with the market in terms of the growing importance of sustainability in the commercial property sector.
It is not the role of the valuer to set the market. The valuer should assess market demand and market sentiment and appropriately reflect this in the valuation process. At any one time in the property cycle, various issues and drivers relating to commercial property will be weighted differently by market participants.
If a particular asset is likely to be price affected – be that positively or negatively by sustainable improvements, or a lack of – this should be, and I believe is, being reflected in the valuation process.
The valuer will then need to structure the valuation report in order to explicitly show the factors that have affected the various parameters throughout the valuation and the assessed value. In some instances these may be difficult to benchmark for buildings at the top end of the green spectrum due to a lack of relevant transactional evidence in the marketplace.
Highly rated sustainable buildings may have significant benefits to owners outside of the traditional valuation appraisal. For example, it is not within the scope of a traditional market value assessment to reflect the benefit of improved branding, image and marketing that may result from owning a green building.
This is, of course, unless potential purchasers in the marketplace for that property would reflect these benefits in an improved purchase price, in which case it is the task of the valuer to make necessary adjustments in their valuation assessment and comment accordingly in their valuation report.
What valuers can do
There are a number of areas within the valuation process that valuers should consider when undertaking their assessments. Firstly, a valuers’ information request should be appropriate to the property being valued. In a number of cases this may not have changed substantially over a period of time during which the way large commercial property assets are operated has changed significantly.
As an increasing number of properties become significantly refurbished and repositioned in the marketplace, it may become appropriate for valuers to ask property owners for information such as vacancy rates, lease up periods, incentives and new leasing transactions correlated to specific capital expenditure in the property in order that the valuer can see the impact of capital works within the building.
Does green really cost less to run?
It is often considered that the most significant benefit of sustainable improvements is a reduction in building outgoings and future capital expenditure requirements. It would appear however that, at least to some extent, sustainable buildings require more intensive supervision and asset management, which may translate into higher property asset management costs, and may partially offset any reduction in energy and utility usage.
A more rounded, long-term assessment of the cash flow capability of a property should be prepared. Areas for consideration include:
- Rental growth – higher green rated buildings may outperform lower green rated buildings in the future as the pool of tenants with substantial corporate social responsibility/sustainability requirements grows and the pool of tenants with minimal CSR requirements diminishes.
- Renewal probability – it is widely regarded that sustainable buildings provide a superior working environment to non-sustainable buildings and as such existing tenants may be more attracted to stay in highly rated green buildings. There is little or no direct quantitative evidence in the market place as yet to suggest to what extent this is the case.
- Terminal yield – as green design becomes more commonplace, so the cost of green initiatives reduces and the number of buildings adopting green initiatives increases. Where a building has high green ratings at the date of valuation it will likely be more able to keep pace with its peers at the end of a valuation cashflow.
- Capital expenditure – over time, an increasing number of buildings will be newly constructed or retro fitted to include sustainable design. As a result, capital expenditure will be required in order for a property to keep pace with its peers in the wider marketplace.
- Lease up period – as the pool of tenants in the marketplace with substantial CSR requirements increases it may be the case that highly rated green buildings become more attractive to these tenants and lower rated buildings become less so. As a result, it may become increasingly difficult to find major blue chip tenants willing to lease space in lower green rated buildings in the future.
- Outgoings – there may be potential for increased efficiency in the future depending on the scope of any capital works allowed.
The extent to which any of these particular items are relevant to the valuation of a particular asset will depend on the market positioning of that asset, tenant pool and the motivation/requirements of would be purchasers at the date of valuation.
The issue of sustainability in the commercial property marketplace has become significantly more important over the past few years. Large commercial assets are now managed and operated in a more sophisticated fashion, and the pool of information in the marketplace about sustainable design is ever increasing. This has empowered tenants to make choices based on the sustainable characteristics of a property.
Given that a number of larger corporate and government tenants now have stringent corporate social responsibility policies and require minimum green ratings in order to occupy space, sustainable design, and a sustainability rating, can have a direct impact on the pool of tenants that a particular property can attract and as a result the net income stream for that property.
The formalisation of energy reporting under the federal government’s Commercial Building Disclosure regime will serve to increase the volume of information in the marketplace and further empower tenants to choose to occupy green buildings if they so wish. As capital expenditure begins to flow through property budgets in the improving property market, a number of landlords will be looking to retain or attract those very tenants that require threshold green ratings in order to occupy space.
Rather than considering that all green buildings will obtain a yield improvement or that all non-green buildings will be assessed to have a yield penalty, it is my opinion that the green credentials of a particular building will have a much more individual effect on the pricing and demand for that asset going forwards, and that any premium or reduction in pricing will depend entirely on the individual property’s characteristics.
Property valuation reports need to clearly reflect the valuer’s underlying assumptions in assessment of value. It could be argued that a number of valuation report templates for larger commercial assets, be they CBD or suburban, have not kept pace with the extent of change that has occurred over the previous few years in terms of sustainable improvements. Clearer and more explicit reporting by valuers would help to bridge the gap between what property owners see to be a disconnect between green property improvements and related expenditure, and valuation assessments.
As the market for highly rated green commercial buildings matures and the volume of leasing and sales transactions increases, it will become easier for valuers to accurately analyse green property transactions. This will allow valuers to benchmark more accurately market requirements in terms of return and core valuation parameters such as internal rate of return, capitalisation rate, and terminal yield.
Until such time, these core rates of return will need to be benchmarked against the more general commercial marketplace and valuers will need to satisfy themselves that they have accurately assessed the forecast cashflow, and future risk profile of the asset which they are valuing.
Mark Willers is a senior valuer with CB Richard Ellis