Research has shown that upgrading the average non-green building to a green building would increase its capital value by some $5.5 million

by Lynne Blundell

FAVOURITES – 4 July 2009 – The merit of investing in sustainable buildings would seem to be a no brainer – lower energy consumption, good design and, hopefully, a more pleasant, productive workplace. But for one of the most sophisticated property sectors in the world where more than 70 per cent of institutional grade commercial property is in listed trusts, the Australian investment sector has been slow to target sustainable property as a specialist area of investment.

There is just one standalone fund dedicated to sustainable buildings – the Drapac Sustainability Fund, and it contains only one 6 Star building in Melbourne. On the listed side, while there are a number of property funds with a sustainable overlay, there are none purely focused on green buildings. So is this a sign that the investment sector doesn’t believe in the earnings potential of sustainable property?

According to Adam Murchie, director of capital and funds with Drapac, the problem is not a lack of interest but an absence of research and evidence of the value of sustainable buildings.

“Clearly when it comes to the built form there has been a massive growth in sustainable buildings. But in terms of investment funds, there is a sustainable overlay in a few property funds but none [apart from Drapac] that have been pigeonholed into a sustainable property fund.

“There is plenty of interest but a lot of investors are grappling with what it really means in terms of results to invest in a sustainable building,” says Murchie.

A large part of the problem is the lack of research-based evidence that investing in sustainable buildings is profitable. Currently, building owners and investors are operating on gut instinct when it comes to green buildings – it intrinsically makes good sense. However, this goes against the modus operandi of the investment sector.

“We’re caught between a rock and a hard place right now – we want the investment analysts to be forward looking when looking at this sector but the very nature of an analyst is to look to the past for results.”

Adam Murchie: “We’re caught between a rock and a hard place right now – we want the investment analysts to be forward looking when looking at this sector but the very nature of an analyst is to look to the past for results.”

Central to the whole issue, says Murchie, is the way sustainability has been equated with altruistic goals such as saving the environment. There needs to be much more emphasis on the financial gains to be made by companies moving into a 5 or 6 Star building because of the increased productivity of its workforce.

Once there is solid evidence of the value of green buildings to a tenant’s bottom line it will be reflected in rents. This is currently not the case and the building in the Drapac Sustainability Fund is a case in point – a 6 Star building located opposite Melbourne’s Victoria Market, it will rent for $320 a metre – cheap for such a good building says Murchie.

Growing demand for research

But there is change in the wind. The demand for evidence is mounting, driven by the Australia’s biggest owners of commercial property, the superannuation funds. And research is coming in from the US market.

Earlier this year two major industry funds, HESTA and VicSuper, launched a new initiative to encourage and promote Australian research that takes into account the impact of environmental, social and governance (ESG) issues on investment returns.

Called ESG Research Australia the initiative involves a group of super funds and fund managers allocating a percentage of their brokerage to brokers that will undertake research on ESG. This essentially rewards brokers for focusing on sustainability and is designed to increase awareness of the importance of ESG to investment returns.

HESTA executive manager, Rob Fowler, says HESTA and other super funds in the group believe that good ESG-inclusive research will improve long-term returns for their members. “Yet very little ESG-inclusive research is undertaken in Australia.”

ESG Research Australia focuses on championing and tracking local ESG-inclusive research as a means to draw ESG issues into mainstream investment review processes. The initiative also exhibits a clear linkage with the UN Principles of Responsible Investing (UNPRI).

“Recent economic turmoil has seen many fund managers reduce or remove their ESG teams,” says Fowler. “So now is a crucial time for the industry to explicitly show its support for ESG, and to recognise the impact of ESG issues on investment returns.”

In another sign that super funds are determined to have sustainability properly factored into the investment process, the Australian Council of Superannuation Investors (ACSI) has commissioned environmental research that will be used to make decisions in the listed space.

ACSI represents 42 super funds in the not-for-profit superannuation fund sector, including industry funds, with a total of $250billion worth of funds under management. It provides independent research to its members on ESG risk of the companies in which they invest.

ACSI CEO, Ann Byrne, told The Fifth Estate that new research being purchased from Riskmetrics Innovest would provide more information on the link between ESG factors and performance in the listed sector.

“As a general rule when purchasing [direct] property most funds will factor in sustainability in terms of the long term viability or risk of the investment. But we want to broaden the concept of sustainability into the listed area where there is a much greater concentration on financial issues. Many argue this creates short term thinking and super funds are long term investors.”

According to Byrne, many companies are not aware of how important ESG factors are to investors. This is evidenced by ACSI’s recent survey of the sustainability reporting of the ASX top 200 companies. Between January 2008 and March 2009 only 51 companies issued standalone sustainability reports and of these only 25 per told investors about the report.

Research on the financial performance of green buildings in the US has shown they not only attract higher rents but capital value increases significantly.

A study by researchers at Maastricht University, the Netherlands, and John Quigley of the University of California, Berkeley, found the aggregate premium for all buildings rated under the two US green rating schemes is around three per cent a square foot compared with otherwise identical buildings. When looking at effective rents – rents adjusted for building occupancy levels – the premium is even higher, above six per cent. The researchers were also able to look at the impact on the selling prices of green buildings, and here the premium is even higher, at around 16 per cent.

The report, published by the Royal Institution of Chartered Surveyors (RICS), concludes: “This really is quite significant – what it implies is that upgrading the average non-green building to a green building would increase its capital value by some $5.5 million.”

The researchers went even further, showing the link between rent premium and a building’s actual energy performance. They found that buildings that outperformed in terms of energy also outperformed financially. For instance, an increase of 10 per cent in the site energy utilisation effciency of a green building is associated with a 0.2 per cent increase in effective rent – and this is over and above the six percent premium for a labelled building. The research also showed that a US$1 saving in energy costs from increased thermal efficiency yields a return of roughly US$18 in the increased valuation of an Energy-Star certified building.

Amanda McCluskey: “In many ways the need for branded sustainability property funds is defunct as so many property investment managers are now putting the principles of sustainable investment into their mainstream investment practice.”

The Australian market has yet to catch up in terms of research based evidence for sustainable building performance. But this, and the absence of specialist sustainable property funds, does not mean that Australian funds managers are uninterested in sustainable property.

On the contrary, says Amanda McCluskey, sustainability manager for Colonial First State Global Funds Management (CFSGFM), the concept of sustainable investing is so widely embraced by Australian funds managers that specialist funds have become almost irrelevant.

“In many ways the need for branded sustainability property funds is defunct as so many property investment managers are now putting the principles of sustainable investment into their mainstream investment practice. And property owners are very conscious of the need to future-proof their buildings.

“It is a better outcome for the whole of the industry to adopt sustainability than to just focus on a few buildings,” says McCluskey.

While she believes there is some merit in having funds that include only 5 or 6 Green Star rated buildings, such as the Drapac fund, McCluskey says it is logistically difficult in the Australian market, because of a limited supply of available properties.

The market in the US can carry such funds but what hasn’t happened there, or in the UK, is the same penetration of the United Nations Principles of Responsible Investing (UNPRI) that has occurred in Australia.

“There are more signatories to the UN principles of responsible investing in Australia than in any other country,” says McCluskey. “The nature of our investment sector means that a large part of the direct property sector is owned by superannuation funds and because of their long term nature of their investments they are very interested in sustainability. There are also more super fund signatories to the UN principles here than anywhere else in the world,” says McCluskey.

It is in the listed sector that sustainability is yet to be adequately embraced. And that is largely because investment analysts have traditionally focused on short term results, not future potential. This is slowly changing and will accelerate with the availability of quality research showing the financial benefits of factoring sustainability into investment decisions as well as the effect on the productivity and profit of companies operating out of green buildings.

“There just hasn’t been research available to show things like productivity increases from staff in sustainable buildings as yet. Building owners are upgrading buildings because it is good business practice – it is pure common sense. You don’t have to have evidence of every aspect before making business decisions – at some point common sense has to prevail,” says McCluskey.

lblundell@thefifthestate.com.au