What this means for your asset management strategy and potential value implications

How much will it cost to make our building carbon zero?” is a question we are increasingly being asked by fund and asset managers who are challenged by their fund’s admirable commitments which form policy. It isn’t just the funds. ESG (or Environmental, Social and Governance) and ‘net zero’ are increasingly prioritised themes guiding investment and corporate behaviour. Beyond being simply the ‘right thing to do’, there is now growing evidence that a strong emphasis on ESG fundamentals enables companies to differentiate themselves, gain a competitive advantage, and accrue financial benefits. There is also a flip side which our landlord clients are beginning to experience but to fully understand this it is important to consider the occupier perspective. It comes as no surprise that nearly 50% of the companies making up the FTSE 100 (representing annual revenues of over £700bn) have committed to achieving net zero emissions by 2050, with many other companies setting themselves ambitious targets in other areas of ESG.

ESG is often conceptualised as the three central pillars of sustainability. These pillars are aligned with the UN’s Sustainable Development Goals:

With real estate responsible for almost 40% of global CO2 emissions, and with the built environment impacting upon the daily lives of each and every one of us, inaction on ESG is simply no longer an option for property owners or occupiers. Whilst many landlords recognise the importance of improving their own corporate sustainability credentials, many do not fully appreciate the relationship between simply making corporate commitments, and the practicalities of achieving their targets. It is imperative that the real estate sector moves from simply making corporate commitments to physically changing buildings, and via that, changing the occupier experience.

One thing is clear: a greater scrutiny of on-site processes and quality assurance procedures will be implemented going forward.

The Occupier Perspective

Tackling climate change and improving workplace health and wellbeing are rapidly rising to the top of every occupier’s agenda. Occupiers are increasingly looking for buildings that help (rather than hinder) their ESG and net zero ambitions. This is a key point: the real estate choices an occupier makes will either facilitate their net zero carbon journey or impede it. Given this reality, we are seeing increased focus and specificity from occupiers concerning the ESG credentials of real estate options they are considering. A plethora of certification options exist that are often considered as short hand for the sustainability performance of a real estate asset:

However, it is often not clear within these various rating systems what is actually most in-demand from/of use to occupiers. In some ways, the use of certifications as a proxy for sustainability performance has clouded rather than clarified what the occupier actually wants/needs. The bigger question is, when it comes to the physical manifestation of strong ESG performance in a building, what does the occupier want to see? Whilst it is impossible to generalise too widely, from our extensive work with occupiers, the following are most important:

  • A building design that minimises energy demand through orientation and thermal storage
  • Building integrated renewables. Smart lighting and HVAC systems, based upon widespread sensor usage, that respond to occupancy patterns
  • A building mobile app allowing customisation of temperature, light and other internal environmental conditions
  • E-mobility solutions ‘built-in’ that will meet the demand for electric vehicles, not just today but over at least the next 5 years
  • Internal green spaces and external ecological corridors
  • As close as possible to real-time data customised to the occupier’s requirements, requiring ‘backbone’ building data infrastructure

Clearly the above cannot be delivered without a major prioritisation of innovation as a theme guiding the landlord’s approach, alongside an understanding of how the occupier wants to experience and interact with their building which is vastly different from what has historically been the norm. Beyond the physical design, how a building is marketed is key. No longer are we dealing with Finance Director, HR or the Property Director; our client now comes in the form of a steering committee which represents the aspirational diverse nature the firm is seeking to be. It is common ground that inclusive firms who have a diverse board perform better, so we now have to find ways to articulate the benefits of accreditations and the UN to Sustainable Development Goals (SDG) in lay terms to influence and inform our clients.

The Landlord Perspective

Landlords should consider the extent to which their buildings, and perhaps most immediately their refurbishment and redevelopment plans, incorporate the elements above. Connectivity, sustainability and amenity are the three key priorities our landlord clients have identified. We have developed a three-tier approach to assist landlords in their asset management strategies or as part of a bidding process when acquiring property which is designed to align with ESG policies.

Tier oneA desktop review: an initial view to assess potential CAPEX, opportunity and challenges required to improve buildings, focussing on addressing:

  • The impact of climate change
  • Improving thermal efficiencies
  • Upgrading building services
  • Incorporating renewable technologies and greener energy procurement
  • Greater connectivity with building management systems to make buildings more intelligent

Tier two – A detailed feasibility building on the themes of tier one, undertaking detailed feasibility studies, pre-accreditation assessments, understanding more about the building and how interventions can be implemented with or without tenants in occupation. Liaising with agents and valuers to develop a marketing strategy and establish which accreditations to target.

Tier three – The implementation phase; procuring and delivering the project works. Innovation requires not just thinking about the market as it is today or in a year’s time; it requires thought about what experience they should be offering occupiers in over five years’ time. This is necessary to manage risk and to differentiate real estate assets in a post-Covid world, where there will need to be a reason for people to come back into the workplace. An innovative and sustainable workplace environment will be a real driver for spending time in the office. Regulatory demands continue to increase – just look at the most recent MEES tightening consultation – but there is a significant market advantage for landlords, from looking well beyond compliance through to how ESG will shape and inform the occupier experience. As Steve Jobs famously said:“Innovation is the only way you win.”

Implications for old building stock

Having worked through the bidding process with a number of active investors, it is clear that there is now an adjustment on pricing to reflect the move towards carbon neutral. The cost of building works required to improve the efficiency of buildings to reduce energy consumption and carbon emissions is above and beyond typical budgets allowed to improve appearances.

BRE has calculated the cost associated with accreditations can add 4-5% on to construction costs. The net impact is that values may decrease on buildings which fall behind modern standards, and with rents already showing signs of adjusting as a result of excess supply caused by changing working patterns emerging from Covid, the flight to prime has never been more keenly felt.

How can we help?

Knight Frank’s team of dedicated ESG advisory specialists have extensive experience in the fields of real estate and how ESG is changing both landlord and occupier behaviour.

We work hand in hand with our Building Consultancy and Project Management colleagues to deliver innovative yet practical solutions on the ground in our clients’ buildings.