Asset Management: Environmental Issues in RE Management

Contamination and Liability

Has a risk assessment been carried out?

Who is responsible for remediation?

Is the asset contaminated?

Who is liable for third part damages?

Type of Exposure:

Current Usage

Liabilities assumed under warranties and indemnities

Historic pollution

Questions that need to be asked:

Whether there is pollution of controlled waters

Who knowingly permitted the pollution?

Whether there was significant harm

Who is the appropriate person for responsibility?

Investment risks of contamination:

Value Impact:

Cost Impact:

lending collateral

stigma and uncertainty

redevelopment potential

Liquidity

lettability

fines imposed

civil claims for damages

clean up costs

potential loss of tenant

additional management costs

RE managers response?

Tenant 'signals'?

Lease clauses

can the tenant absorb potential costs?

Environmental impairment liability insurance

Conduct a risk assessment

The 'mainstreaming' of sustainability in commercial RE investment management:

  1. Sustainability has become embedded in corporate reporting
  1. Sustainability considerations have become increasingly entrenched in investment and development processes
  1. Measuring, monitoring, and managing energy consumption/carbon emissions etc. of existing stock has increased and improved considerably
  1. Sustainability is an increasingly important consideration in stock selection and asset and property management
  1. Certification and bench marking organisations are well established e.g. GRESBE
  1. A range of industry associations are promoting and guiding
  1. A high proportion of new commercial stock is environmentally certified (BREEAM)
  1. Regulatory and professional bodies have continued to engage with the issue

Lorenz (2008). The mainstreaming of of sustainability has come about because it's a self perpetuation issue.
Owner/End User:
"we demand and occupy sustainable buildings because they are cheaper to run, increase our well being and improve our image"
Designers & Constructors:
"we design and construct sustainable buildings and environments because that's what our clients want and what society expects"
Developers:
"we develop sustainable buildings because they are easier to sell, achieve higher prices and are much more resistant to obsolescence"
Investors:
"we invest in sustainable buildings because that's what occupiers want and because they give better returns and have higher value growth potential"

The 4 stages of issue maturity:

Emerging Business strategy: compliance Period: 2000-2006?

Consolidation: Business strategy: integration Period: 2006-present?

Latent Business strategy: defensive Period: 1990s?

Institutionalised Business strategy: promotion Period: Present -

  • Activist aware of issue
  • Weak evidence base
  • Issue largely ignored by business community
  • Political and media awareness of issue increases
  • Emerging body of evidence but evidence still weak
  • Business experiment with approaches to engage with issue
  • Emerging body of business practices and specialists professionals
  • A range of sector-wide voluntary initiatives emerge
  • Increasing acceptance of need for regulation
  • Voluntary standards are created and collective action emerges
  • Legislation and/or business norms become established
  • Embedded practices become a normal part of business-excellence model

The next stage of issue maturity?

Enhancement? Business strategy: Strengthening

  • Rationalisation of initiatives, associations etc. ‘Winners’ govern, ‘losers’ wither?
  • Incremental growth in scope and scale of activities to improve sustainability of portfolios?
  • Incremental improvements in organisational processes and procedures?
  • Industry’s capacity deepens and co-ordination improves
  • Issue decreases as a potential source of competitive advantage?

Environmental Performance to Financial Performance

Key transmission mechanisms:

lower void costs

increased rental income

reduced depreciation

reduced risk premium

It's more difficult to quantify the potential effects than it is to identity them

Research questions that are being asked:

Returns to tenants

Costs to developers

Returns to investors

management costs and operating expenses

rental growth and depreciation rates

vacancy rates and void costs

lease incentives, time-on-market and liquidity

income and capital returns

Reputation/Brand/Image? Cost savings? Productivity?

What are the additional costs of developing 'green'buildings? What is the cost-benefit trade-off?

Value Determinants?

Environmental performance is just one of many, often interlinked, determinants of a real estate asset’s value. It may be relatively minor compared to other determinants. Whilst there are statistical methods, it is difficult to isolate the unique effect on value of environmental performance due to data and other modelling issues.

Operating Costs Determinants?

Environmental performance is just one of many, often interlinked, determinants of a real estate asset’s operating costs. It may be relatively minor compared to other determinants. Whilst there are statistical methods, it is difficult to isolate the unique effect on operating costs of environmental performance due to data and other modelling issues.

Evidence

  • The evidence here is thinner and less convincing and is almost exclusively drawn from the US.
    • Most US studies find a negative relationship between energy and utility costs and environmental certification.
    • (Especially for Energy Star buildings in the US) There seems to be an “operating expense puzzle”! A number of studies have found that Energy Star buildings have higher levels of operating expenses.
    • In contrast to a number of previous studies, Devine and Kok (2015) found that Energy Star buildings consumed more energy per square foot than non-certified buildings.
    • Reichardt (2014) found that operating expenses are 10.4 % to 10.7 % lower in buildings with net leases
    • Fuerst, Van der Wetering and Wyatt (2013) found no relationship between EPC and service charge for a sample of 417 offices in UK.

Fuerst (2015) looked at the relationship between returns and GRESB score for 442 REITs across the globe.

  • Found no significant effect of GRESB performance and unadjusted total returns.
  • Found a significant positive effect of GRESB performance and risk-adjusted returns (Sharpe Ratio).
  • Found a significant positive effect between Return on Assets and Return on Equity and GRESB performance.

Eichhotltz, Kok and Yonder (2012) calculated the share of LEED and ES assets for US REITs over the 2000–2011 period.

  • Found that the greenness of REITs is positively related to three measures of operating performance – return on assets, return on equity and the ratio of funds from operations to total revenue.
  • Found no significant relationship between the greenness of property portfolios and abnormal stock returns, suggesting that stock prices already reflect the higher cash flows deriving from investments in more efficient properties

'Green' Management:

Modify how the building is operated

Modify the behaviour of the building's occupiers

Modify the building

Operational Environmental Management

monitoring and reporting

actions

annual plans and targets

capital works

policies and processes

communication

Practices and Equipment

Optimal coverage of above

‘Green’ procurement of materials and service providers

Optimal timing of heating, air-conditioning, escalator and lighting provision.

Can produce lower management costs, service charges , irrecoverables, tenant satisfaction

Practical Measures

installation of decentralised water heaters

increased awareness of waste issues

insulation of tanks and piping

use recycled materials

regular servicing of heating and air con

information, guidance, etc.

Barries

discount rates

misaligned allocation of costs and benefits

inertia - behavioral issues

risk aversion

imperfect information - awareness

skills shortage

costs -direct or indirect - new or old

dispersed authority