Commercial Real Estate Needs Sustainability Performance Reporting
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A rapid, relentless rise in the sustainability-related expectations of real estate investors, regulators, owners, and occupants of commercial buildings has marked the last decade. Their expectations make sense; real estate is simultaneously the world’s largest asset class and one of its most regulated and polluting. But it is also the least changed among the world’s great industries. Transportation, agriculture, and finance have been radically transformed, primarily by technology but also regulation, in the last 10 years, whereas real estate functions much as it always has. This has left a yawning gap between real estate stakeholders’ expectations and landlords’ capacity to meet them. Contrary to popular belief, this gap does not stem from landlord complacency or from developers whose only animal instinct is to raze, renovate, and rent. It’s far more practical, and solvable, than that.
There are 87 billion square feet of commercial real estate in the United States. These buildings’ owners fall into two categories: those whose primary business is owning real estate for profit from asset appreciation or rental income, and everyone else. Of all this square footage, some 60 percent is in possession of those who control real estate on a large scale, typically with assets worth hundreds of millions of dollars. It is this group that is most exposed to regulatory and market forces and that also has the wherewithal to do something about it. This is where it gets interesting.
The above owners lease their buildings to tenants. Tenants who often pay their own utility bills. The owners also buy and sell buildings on a regular basis, trading assets every 18 to 60 months. In both instances, the merits of investing in energy abatement and therefore carbon reductions, using less water, or otherwise deploying sustainable materials in their projects are complicated by the fact that the beneficiary of these investment is often the tenant or future owner, not the landlord today. This dilemma is referred to as the “split incentive”. Much angst has been expressed about this bifurcation of cost-benefit. And while there are ways around the split – from clever “green” leases, to enforcing entirely different lease structures – the simple math on lease rollovers or asset dispositions means these tactics will not permeate the market in time to meet today’s stakeholder expectations. Are we doomed?
No. We’re just pushing a boulder uphill unnecessarily. We can change all this by highlighting the split instead of asking landlords to mend it directly. We do that by bringing transparency to the costs and potential rewards of resource efficiency, then letting the market do the rest. Here’s how.
Imagine a prospective tenant actually understood, in dollars and cents, the energy, carbon, water, and waste implications of leasing from a particular building. Imagine if a prospective buyer had a fully quantified understanding of the regulatory and operational risks of a ‘brown’ building. Imagine these costs and risks where presented in a uniform manner and available on demand for any building of moderate size or value. Could we not then manage (tenants by voting with their feet, buyers with their offering price), what’s been measured? Think this is crazy? It’s already happening.
ENERGY STAR Portfolio Manager is arguably the most successful program ever introduced by the US EPA. It allows buildings to receive a score for energy performance and receive rewards for superior energy performance in the form of certification. The score is free. Certification is annual and costs a modest thousand bucks, plus or minus a couple hundred. Thanks to research by Dave Pogue at CBRE, Dr. Nils Kok at Geophy, Dr. Norm Miller at the University of San Diego, among others, we now know ENERGY STAR scores are positively correlated with rental rates and asset values. The better the score, the higher the premium (or lower the discount). Major investors like BlackRock, CalPERS, and Norges are representative of attitudes across global real estate investors who know and apply this simple relationship between more sustainable buildings, lower risk, and higher reward. So, if markets do in fact work once they have an accurate measure of sustainability performance, the question becomes whether we can make that performance measurement both comprehensive enough to capture all material aspects of sustainability, while also making it easy enough for most buildings to do?
We can. Software and enabling hardware technologies are being deployed at scale to do just this. Landlords who see the carrot in sustainability like Prologis, Boston Properties, Clarion Partners, CBRE Global Investors, Prudential, and many others with far less visibility than these giants, are already measuring, benchmarking, and disclosing their sustainability performance. The remainder face the stick of regulation: 27 legal energy and or water disclosure regimes exist in the US already covering tens of thousands of commercial buildings. This is up from only one ten years ago.
Since capital is relatively free to move and real estate portfolios are increasingly global in scope, this problem isn’t limited to the US. After all, commercial buildings play a commensurate economic role and contribute comparable environmental impacts in every country on Earth. The solution, however, remains the same and it looks like this: free software enabling a uniform global regime of building sustainability benchmarking. Whether you call it the CarFax or FICO for buildings, doesn’t matter. What does, is that we measure what matters. The market will do the rest.
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I applaud this effort to scale a holistic sustainability performance rating system! However greater transparency metrics results in winners and losers (lack of a better term) in the eyes of stakeholders. My question, or in this case vision, will there be any strategic improvement resources provided to those under performing buildings and facility owners/Managers for correction action?
Jason, good question: what, if anything, can/should we (the scoring system) do to help the “losers”..? The short answer is nothing.
Those who are “bad or relatively less good” will compete in the market for tenants, procure debt and equity investment, or require maintenance in the context of their overall circumstances and business goals. That may mean they do not ultimately care (or care very little) about being “less good” on sustainability because, for example, the asset is fully leased on a long term basis and the landlord is not incentivized to change anything, or the asset is highly competitive for other reasons like great location and amenities so can rely on these attributes to be successful despite a relatively poor sustainability score.
An analogy might be a car: some people will still buy a sports car despite poor MPGs because its look and performance are what the driver desires. That same driver, though, will now face higher insurance premiums and gas costs, and poorer safety features . They may or may not care…
The better answer is to look to EPA ENERGY STAR’s approach: they will score a building and reward good performers with the option to get a certificate that validates their performance. (Relatively) poor performers do not get that benefit. What all buildings, good or bad, get from ENERGY STAR is a resource of tried and true methods of improving performance. This catalogue is not software driven i.e. automatically displayed/targeted to each building based on its individual circumstances inside ENERGY STAR’s Portfolio Manager, so there are technical opportunities to make the more of a feedback loop. Fortunately, there are a number of energy management technologies that function in this fashion today and I am optimistic we will more intelligence and scale from them in due course. Hope this helps!
Hi Matt, All great points on highlighting our top performers that represent a small percentage of commercial building portfolios. From a broader strategic perspective, I was eluding to how a scoring system may become the catalyst to incentivize the remaining 85% of the built environment to disclose their sustainability metrics. This not only grows stakeholder awareness of the benefits of sustainability transparency, but also continually raises the bar and prevents complacency from top performers in the marketplace.
The scoring system works for all buildings regardless of size or type and is free, so does not preclude assets from participating other than the expense of entering data (though manual burden is real). For those assets not affected by investor pressure or tenant demand, regulation may be the only way to drive efficiency all the way down into the market.