17 October 2011 ­– Special Report: The carbon tax is a game changer for the way the property industry will present its financial reports. But then, property is already moving in that space.

Australia’s per capita carbon emissions might be the highest in the OECD but Australia’s top property companies are regarded as among the greenest in the world. Australia is also leading the way in integrated reporting, where companies provide more information than what’s in their annual reports,  and disclose more information about their environmental performance, social impact, and how they are improving their governance. That is now the future for property fund managers.

It means that property industry accountants will be doing more than just crunching numbers. That will change accounting and a carbon pricing regime will speed up the change. It is also creating entirely new industries in the property sector with companies paying good money to appoint building managers.

World leaders are Australian
The Global Real Estate Sustainability Benchmark (GRESB) report for 2011, put together by Berkeley and Maastricht universities’ academic Nils Kok, found that Australian property funds in the listed and private markets lead the way internationally for global best practices in sustainability management for energy, water, waste and greenhouse gas emissions. It revealed that six of the top 10 property companies in sustainability practices were Australian.

They were: the Commonwealth Property Office Fund, the Investa Office Portfolio, the GPT Group, the GPT Wholesale Office Fund, the Private Property Syndicate (PPS) run by Colonial First State Global Asset Management and Lend Lease’s Australian Prime Property Fund Commercial.

These companies, according to the report, are the world’s leaders on sustainability management.

“Australian property investment funds turned out to be the environmental world champions,’’ the report said. “Coverage of the Australian market was strong in last year’s survey, but has improved further this year, especially among private funds, with the 2011 survey reporting the environmental performance of 23 funds, up from six in 2009.”

The report finds that Australian property companies, unlike their counterparts overseas, have developed managerial systems for sustainability. For example, 70 per cent had implemented tenant behavior programs compared with 43 per cent globally. More than two thirds had variable compensation, meaning they got bonuses, for sustainability management. It also revealed that 70 per cent took environmental factors into consideration in the valuation of buildings.

More than resources efficiency
“In advanced markets, sustainability will go beyond resource efficiency alone, and social factors may receive more attention. For example, health and well-being improvement programs have been implemented in the portfolios of eight Australian property funds. This is evidence of an increased attention towards productivity in buildings, a focus area where other regions may follow,’’ the report says.

That said, the report found there was still significant room for improvement, particularly in the area of implementing environmental policies, reporting on performance indicators and reducing consumption. The implication is that implementation of environmental policies (“green walk”) in Australia tended to lag policies (“green talk”).

The only way to close that gap is for companies to create integrated reports. This is not about making annual reports longer, they’re already too long.  It’s about reports that incorporate environmental and social factors, and link these to the financials.

Think for example of the garbage found in some annual reports with phrases like “our people are our best asset” and “sustainability is key to our business”.  Only integrated reports can spell it out and make it clear that the company is being honest with its stakeholders and investors. Integrated reports bring the financial accounting principle of “materiality” to sustainability reporting.

In the financial world, the Generally Accepted Accounting Principles state: “information is considered material if its omission or misstatement could influence the economic decision of users taken on the basis of the financial statements.”

According to Australian accounting standards (AASB 1031), “information is material if its omission, misstatement or non-disclosure has the potential, individually or collectively, to (a) influence the economic decisions of users taken on the basis of the financial statements; or (b) affect the discharge of accountability by the management or governing body of the entity.”
What does the environment have to do with a company’s performance? Think about the performance of BP after the $US40 billion Gulf of Mexico oil spill disaster in 2010. That was about “materiality” for BP investors.

Already some Australian property companies are producing integrated reports.

Dexus, one of the largest real estate investment trusts listed on the ASX for example, has incorporated its security holder review and the corporate responsibility and sustainability report, into one annual review which not only covers financial performance but also environmental data as defined under the National Greenhouse and Energy Reporting System, or NGERS.

In its latest report to June 30, 2011, Dexus claims it has achieved a 15.3 per cent reduction in energy usage over the last three years and that this enhanced the quality of its office portfolio under its 4.5-star NABERS Energy rating program. It also claims to be rolling out resource efficiency improvements and tenant satisfaction programs.

GPT, which has boasted number one ranking for two years in the Dow Jones sustainability index, also has a report that covers financial and non-financial issues.

Matthew Bell

Ernst & Young
Matthew Bell, the executive director of climate change and sustainability services at Ernst & Young, says integrated reports could not be dismissed as just public relations. “It’s difficult for integrated reporting to be a PR exercise because it’s actually about greater disclosure so that doesn’t necessarily lend itself well to public relations other than to companies who are doing the right thing,’’ Bell says.

The benefits of integrated reporting are clear: investors and stakeholders get more information. The company also makes itself more attractive to prospective employees.

But he concedes that putting these reports together is no walk in the park for accountants. “It’s very difficult because we have had hundreds of years of financial reporting and to be fair there is still no international consensus on what that should look like so it’s very hard to see how a simple cookie cutter approach can be used to allow all companies from range of industries to report in a way that truly meets the needs of all stakeholders,’’ Bell says.

Ernst & Young has a team of 30 to 40 nationally working with property companies. Team members are principally engineers, scientists and people with legal and policy backgrounds. There aren’t too many accountants. Ernst & Young’s clients include Westfield, Mirvac, GPT and Dexus.  Ernst & Young helps them prepare integrated reports, provides assurance on the reports by auditing them, and gives advice on sustainability practices.  It is a growing part of the business.

Bell says the trend to integrated reporting will change accounting. “Within the next 10 to 15 years, the profession will go through a change as organisations seek to make greater disclosures of their non-financial information,” he says.

He says the non-financial details go to the heart of a company’s intangible assets, which now dominate its valuation in the market. “If you go back to the 70s and look at the share price, around 30 per cent would have come from intangible values and 70 per cent would have been the asset itself,’’ he says. “There has been a large change over the last 30 to 40 years and there is now an almost inverse relationship. Around 30 per cent is now linked to the asset value and 70 per cent is intangibles and it’s hard for companies to put a value on those intangibles.

“They have recognised the importance of those non financial aspects for the value of the organisation. So the investment community has been a driver for how companies report these matters and the property space has picked up on that.”

Basically, the shift to integrated reporting and sustainability is about investors seeking long term returns on their investment, particularly superannuation funds, he says.

He believes one reason why Australian property funds are ahead of the game is because of the unique conditions here. “Australia has always been a little more resource constrained so therefore more intelligent in the way we use things like water,’’ he says. “They have also genuinely recognised the business benefits from addressing the non financial aspects of their operations. They have always taken a longer term view than other companies.”

He says that the superior performance of Australian property companies is likely to attract more overseas investment. “It’s probably not helped at the moment by a high dollar but if you follow it logically through to its natural conclusion, it would be more attractive to investors. Ultimately, that’s the goal of any management team in an organisation. You would think in essence that’s where it would naturally head.”

He says the carbon tax could accelerate the drive to integrated reporting. “It probably has been the sharp end of the wedge in terms of driving more integrated thinking in terms of financial and non-financial links,’’ he says.

James Dunning

James Dunning, a partner at PricewaterhouseCoopers in charge of the firm’s real estate practice, is certain the carbon price will drive more integrated reports. It will create more links between environmental factors, sustainability, energy usage and profit numbers.

“It will cause a lot of interest in the real estate industry,’’ Dunning says. “What you will see is that the cost of supplies will potentially increase. Therefore that will get the attention of your CEOs, your CFOs, your executive management teams and they will have to work out what impact that is having on their broader underlying profit numbers, the broader way they approach and do business, and what impact it will have on their suppliers.”

Dunning says Australia is leading the pack for one very good reason: its real estate industry has always been a global leader and trend setter.

“With listed property trusts, Australia is one of the most highly securitised countries from a property perspective compared to any other country,’’ he says. “The ownership of property in listed vehicles is higher in Australia than anywhere else in the world, providing our retirees with an income.”

That means there would be more investor pressure on property companies to take a longer term perspective. “If you have better efficiency from a building, it will give you a competitive advantage,’’ he says. “There is a growing recognition that tenants are requiring it and if you aren’t seen to be doing things in the sustainability space and improving the efficiency of your buildings, you would naturally be reducing the number of tenants.”

He says the push for sustainability and better reporting is creating more demand for good building managers.

“There is a whole new industry being created around that which is driving demand,’’ he says. “You have to pay these individuals a lot more money because they have greater skills.”

senior director, Nick Ridehalgh says the carbon tax will definitely see more companies producing integrated reports. “I think the carbon tax is a very clear monetisation of the issue IR is trying to articulate,’’ Ridehalgh says. “If you are a carbon intensive business and you don’t take account of the cost of carbon, then over the medium to long term you’re going to have a difficulty in surviving. The carbon tax is pricing a non-financial input into your business – it’s pricing your impact on the environment and use of scarce resources. It is also therefore adding an additional cost to your products and outputs.”

He says it will also change the way accountants approach a problem. “By way of an example – you have to decide between purchasing two pieces of equipment. One costs $110,000, and the other costs $100,000. Traditionally, you would buy the cheaper one. What integrated reporting is asking you to do is think more broadly – beyond the financial cost. If you look at the $110,000 option more closely, you will see it has a better energy rating and is fully recyclable…it is made in a modern factory with good OH&S history (social capital) using latest technology with a low fault rate … As you can see, as you start to think through the medium to long term impacts of the decision across all the capitals, suddenly the $110,000 option looks much better over the life-span of the asset.”

For accountants in the property industry, the carbon tax will change the way they prepare their clients’ reports.

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