2 March 2012 – The Royal Institution of Chartered Surveyors today (Friday) launched a new document that will change the game for sustainable property valuation. Sustainability and the Valuation of Commercial Property, written by Mark Willers of CBRE and John Goddard of John Goddard & Co, with technical assistance and review by Bryon Price of AG Coombs, Stephen Hennessy of WT Sustainability and Davina Rooney of Stockland, is a guide that sets new standards in valuing sustainable property.
In this article, Mark Willers explains the thinking that went into its development.
Are green buildings worth more? Numerous academic research papers over recent times have shown that highly green rated properties yield greater rental and capital returns to their owners.
But does the valuation profession truly understand the potential future risks to the cashflow performance of some buildings due to green issues and related tenant demand for green space?
- See the original article Enter the new green valuer, from RICS
Often it is difficult to decipher how and why the impact of sustainable works have been considered within valuation report rationale, and it is this perceived disconnect that led the Royal Institution of Chartered Surveyors (RICS) to produce a Best Practice Guide entitled “Sustainability and the Valuation of Commercial Property (Australia)”.
It is not long, maybe 4-5 years, since sustainability was often considered an expensive way to look good (or in some cases mad). Yet today NABERS and Green Star ratings are routinely discussed by property professionals who are not considered to be “sandal wearing, muesli chewing, bike riding pedestrians”.
The take up of these relatively new sustainable benchmarks has been greatest in the office sector. Rating labels, and The Federal Government’s Commercial Building Disclosure (CBD) regime, which requires building owners to display a NABERS rating prior to any transaction of office space in excess of 2000 square metres, have enabled tenants and investors in the marketplace to compare products based on new criteria. Yet despite this, commercial valuation rationale has remained relatively unchanged over the same period.
There has been some change.
Most major valuation firms now include a sustainability section within their reports when valuing major commercial buildings. These vary in length and complexity, from a paragraph to 2-3 pages, dedicated to the topic.
The wording can be generic and often misses the point – that being to inform the reader how undertaking sustainability related works, or not undertaking them, will likely affect cashflow performance during the horizon of the projected discounted cash flow (DCF).
The RICS Royal Institution of Chartered Surveyors guide is not intended to provide a template that can be used to value all green buildings. The intention of the guide is to raise some key issues, themes and topics that may well require consideration by valuers during the valuation process.
The guide sets out how sustainable performance in commercial property is measured, and how valuers should use this information to assess the performance, and potential future performance, of commercial buildings. It sets out numerous issues that may prevent, limit or expedite sustainable refurbishment of properties.
The guide also addresses numerous areas within the valuation process where sustainability may have an effect on pricing, and offers insight into the kind of questions that should be asked of building owners and managers, in order to help valuers assess future cashflow risk relating to sustainability issues.
The 10 year cashflow
We, as Australian valuers, attempt to project income and expenditure 10 years into the future, we predict how this income and expenditure will grow or contract during this period, and we then categorise the risk of receiving this cashflow, not only at today’s date but also at the point of hypothetical sale in 10 years’ time.
As a result we have the perfect tool to reflect future allowances and cashflow issues. In doing so we need to understand how our assumptions interact with each other, make allowances and predictions that relate to each other, and clearly report these issues.
For example, consider a situation where significant capital works, including an extensive upgrade of airconditioning plant, have been allowed for in Year Two of a cashflow.
This would most likely result in a decrease in electricity consumption once the works are commissioned and bedded in.
Should this be reflected within the growth rates applied to electricity? Do these works future proof the building against the potential for electricity costs to rise in excess of CPI and as such would they warrant a firming of the terminal yield to reflect the decrease in risk profile? If the works were not undertaken is the opposite true?
If the tenants want green, what’s the impact?
If the tenant profile of a building – both sitting and potential tenants, which may include government departments, major blue chip and offshore tenants – is influenced by green ratings and performance then at each expiry and renewal the building’s green ratings at that time will need to be considered.
Expenditure allowances also may need to be timed in order to undertake sustainability related works to aid tenant retention.
If comparable buildings in the market have significantly higher ratings will this influence tenants at expiry?
If the subject property performs more efficiently than its peers, would this lead to a higher tenant retention rate for corporate and government tenants, and is this being demonstrated in retention rates within the subject property to date?
The way in which commercial property is managed has become much more sophisticated over recent times.
Institutional property owners employ various experts in order to extract the greatest return from their investments. Valuers cannot be experts in every field and we need to utilise the expertise of those most familiar with the buildings we are valuing in order to assess any future risks that may affect an investment horizon.
The RICS guide provides various themes for consideration when undertaking valuations of those assets that are considered to be price affected by sustainability, and valuers are encouraged to discuss these issues directly with sustainability teams in order to gauge property owners’ strategies, potential for future improvements and efficiencies, and the scale of investment that will be required to achieve such improvements.
Such information sharing should allow valuers to understand more clearly the cost, benefits and risks associated with undertaking sustainable improvements in the future, and allow them to assess the impact of undertaking (or not undertaking) these works more effectively.
Although the majority of buildings may not yet be price affected by sustainability, for some buildings the issue could be critical.
Duty of care
Where this is the case, valuers have a duty of care to understand, address and highlight any issues that might affect future cashflow performance and investor demand.
In the most extreme cases, this area could affect almost every cashflow assumption, from the growth rate applied to utilities over the 10 year cashflow horizon, to renewal probability, lease up periods, capital expenditure and terminal yield.
The way that we value buildings in Australia provides a great platform for us to be clear and transparent in our assessments. Dialogue between valuers and sustainability teams should help facilitate a better understanding of the true impact of sustainability on commercial property valuations.
Mark Willers | Associate Director, CBRE, valuation and advisory services