financial benefits for investors?

Transcription

1 November 2018 Green buildings: what are the November 2018 financial benefits for investors? Green buildings: what are the financial benefits for investors? For Investment Professionals only For Notice to investors in Australia. M&G Investment Management Limited (MAGIM) and M&G Alternatives Investment Management Limited (MAGAIM) have received notification from the Australian Securities & Investments Commission of the Class Order [CO 03/1099] exemption and are therefore permitted to market their investment strategies (including the offering and provision of discretionary investment management services) to wholesale clients in Australia without the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth). MAGIM and MAGAIM Investment Professionals only are authorised and regulated by the Financial Conduct Authority under laws of the United Kingdom, which differ from Australian laws.

2 Executive summary Investor shift towards energy efficiency and emissions regulation accelerating Certified buildings can generate higher distributable income, despite higher operating costs 2 Margin discounts offered by active green lenders accretive to overall fund performance Green buildings can exhibit lower systematic risk through more stable income Should investment managers adapt underwriting assumptions for certified buildings?

3 Introduction With the built environment responsible for almost 40% of energy consumption in the EU, 1 real estate investors around the world are increasingly committing to more sustainable practices. Our study evidences that a portfolio of certified buildings experiences relatively higher operating expenses, but can also generate higher rental income and higher cash flows for distribution to investors. We also highlight a growing trend among European lenders taking an active interest in sustainability through green lending initiatives, by providing a margin discount of up to 20bps to borrowers provided they commit to reducing energy usage within their buildings. We believe lower interest rate expenses could further enhance a fund s distribution yield. Lastly, we argue that a certified property portfolio carries less systematic risk, reflected in more stable occupancy rates and lower variation in operating expenses. Our results are based on the M&G Real Estate universe of continental European assets. 2 The continued shift towards certification Green certification was first introduced in the 1990s, yet nearly three decades later the real estate sector is still learning about the financial implications. Figure 1: Environmental certifications are used globally. According to the CBRE 2018 International Green Building Adoption Index, 19% of the 11 global markets monitored are now certified as green (equating to 21 million sq m). 3 This marks a significant increase compared to 6% in 2007, and reflects the shift in investor focus towards energy efficiency and tighter regulation on emissions. Canada is leading the global real estate industry, with over 50% of the office stock in both Vancouver and Toronto now certified. In Vancouver, the city s Greenest City 2020 Action Plan has set a target that all buildings constructed from 2020 onwards will be carbon neutral in operations. Clearly, this has placed pressure on developers and investors to rethink their building specifications and investment strategies, but it has also seen occupier demand for green buildings strengthen, as employers attempt to attract and retain staff with a better working environment. In Europe, Stockholm has gained an international reputation as a business headquarters, attracting operations of several multinational corporations, including US online sales giant Amazon, Spanish engineering and infrastructure firm COMSA, and Finnish smart green walls innovator Naava. 4 The Swedish capital was recognised by SparkLabs Global Ventures as ranking fourth globally in providing a supportive environment for tech start-ups in According to the CBRE 2018 International Green Building Adoption Index, tenant environmental awareness has matured in Stockholm and influences location choices with tech tenants increasingly more prepared to pay a premium to occupy a certified building BREEAM (UK) 1998 LEED (US and Canada) 2002 HQE (France) CASBEE (Japan) 2008 DGNB (Germany) N.B. Countries in brackets refer to the certification country of origin. 1 Source: European Union. 2 Stabilised assets in the M&G European Property Fund only. Excludes developments. 3 Main green rating schemes by country: Germany (DGNB and LEED), Netherlands (BREEAM-NL), Sweden (LEED), France (HQE, BREEAM or LEED), Sweden, Poland and Luxembourg (BREEAM). 4 Invest Stockholm, Why Companies Like Amazon Love Stockholm, May 23, Bernard Moon, Top 10 start-up ecosystems in the world 2016, November 5,

4 While Europe is some way behind Canada in terms of its green credentials, no more than a decade ago certified buildings made up less than 1% of stock in most major cities. Today, green buildings make up 18% of stock in Frankfurt, followed by Stockholm (13%), Amsterdam (11%) and Paris (9%). 6 Figure 2: Percentage of certified buildings by city % Certified buildings (area) City Type Vancouver BOMA / BESt / LEED 29% 52% Toronto BOMA / BESt / LEED 15% 51% Sydney NABERS / Green Star 1% 47% Melbourne NABERS / Green Star 1% 29% Warsaw BREEAM / LEED 1% 21% M&G Real Estate s certified buildings account for a quarter of its European investments (% AUM). 8 Their ratings range from Good to Excellent. Efforts are in progress to increase the share of green buildings to 50% by Our findings have shown that the certified share of M&G European assets achieve a higher rental income (+53bps). We also found that certified buildings experience higher operating costs (+31bps), likely because smart buildings tend to feature sophisticated technology in exchange for greater ambient control. On balance, we find that the rental revenue premium compensates for the increase in operating expenses, resulting in a higher distributable income to investors (+19bps). Figure 3: Yield premium: certified vs. non certified buildings Manhattan LEED 0% 20% Frankfurt DGNB / LEED 0% 18% Stockholm BREEAM / LEED 1% 13% Amsterdam BREEAM / LEED 0% 11% Paris HQE / BREEAM / LEED 0% 9% Yield premium: certified vs non-certified buildings Rental income/ % NAV Operating expenses/ % NAV 53bps 31bps 19bps Distributable income/ % NAV London BREEAM / LEED 0% 9% Source: M&G Real Estate, November Source: CBRE, International Green Building Adoption Index The bottom line what are the performance benefits? A key concern of real estate fund managers in relation to sustainability efforts is the impact on a portfolio s bottom line. So, do environmentally sustainable properties offer financial benefits to investors? The analysis that supports this idea is set out below. The hypothesis was also tested in recent academic work using underlying data from US REIT cashflows split into certified and non-certified buildings. 7 We sought to replicate the study using data drawn from the projected cashflows of our European property portfolio. Margin discounts offered for energy efficient real estate As commitments to sustainable real estate practices have increased, it is no surprise that real estate lenders have become more active in this area. According to the UN Environment s Inquiry which surveyed major European banks, eight out of the 10 banks questioned have already adopted some form of green lending for commercial real estate. Despite this activity being in its infancy, the lending departments of banks have been more active than any other banking department. Banks have increasingly recognised the importance of sustainability in protecting against obsolescence and value loss, thereby reducing risk for both borrowers and lenders alike. To address this issue, a new strategy of green tagging 9 has emerged, leading Europe s major banks to scale-up financing of energy efficient real estate. 6 CBRE, International Green Building Adoption Index Devine and Yonder, Decomposing the Value Effects of Sustainable Real Estate Investment: International Evidence, Assets under management. 9 Systematic process whereby banks identify the environmental attributes of their loans and underlying asset collateral as a tool for scaling up sustainable financing. 4

5 (%) Figure 4: Real estate green lenders are industry leaders Commercial Real Estate Corporate/ Large Business Retail/ Mortages Debt Capital Markets M&A and Advisory Source: Which banking departments already use a definition of green. UN Environment Enquiry, Green Tagging: Mobilising Bank Finance for Energy Efficiency in Real Estate, December One of the first major schemes was the 1 billion green lending initiative by Lloyd s Banking Group, launched in May It aims to incentivise borrowers through a margin discount of 20bps on purchases over 10 million, with the borrower required to deliver on a number of green commitments. These include reducing energy intensity in buildings, engaging with tenants on sustainable behaviour and providing energy performance data to the lender. Other lenders have now followed suit in evolving and growing their green practices and are likely to play an integral role in responding to the growth in investor demand for certified buildings. Both Berlin Hyp and ABN AMRO now offer discounts similar to Lloyd s on loans for green buildings, while ING have stated that as of 2018, they will only provide finance for office buildings in the Netherlands that meet Green Energy Label requirements. 10 Mainstream green lending remains in the early stages, and further collaboration between the real estate and banking sectors is needed to standardise products. This should lead to greater market transparency and develop the evidence that greener buildings can be accretive to overall fund performance. If major lenders continue Risk Small Business Lending (SMEs) Equity Capital Markets Fintech Public Affairs and Regulation to offer both competitive and discounted financing for certified green buildings, real estate portfolios with a larger share of sustainable assets are likely to incur lower interest expenses overall, thereby further enhancing a fund s potential distribution yield. Green buildings tend to exhibit lower systematic risk If certified buildings are typically associated with higher rental values and lower tenant incentives, this also lends itself to a more stable income profile that is less sensitive to changes in economic conditions. Historic data based on M&G Real Estate s European assets is not yet sufficient to prove this hypothesis, but recent analysis using US REITs suggests that certified buildings are often more resilient to market-wide shocks. 11 This is reflected in more stable occupancy rates and a lower variation in operating expenses. As such, portfolios with a higher share of sustainable real estate are likely to have lower systematic risk. At the property level, this creates a number of additional questions around the role of the investment manager and assumptions used to underwrite green and nongreen buildings. While the more conservative approach is always best practice when appraising real estate assets, should the present value of future cash flows for certified buildings incorporate both lower incentives and lower void rates than that of non-certified buildings? Academic literature has already argued that sustainable buildings are associated with lower tenant incentives and re-leasing costs over time. 12 It is probably too early to conclude, given the current limited depth to performance data, but should green certification across Europe reach the levels already seen in Canada, this is likely to be a major determinant of value for future real estate acquisitions. 10 UN Environment Inquiry, Green Tagging: Mobilising Bank Finance for Energy Efficiency in Real Estate, December Devine and Yonder, Decomposing the Value Effects of Sustainable Real Estate Investment: International Evidence, Devine and Kok, Green Certification and Building Performance: Implications for Tangibles and Intangibles,

6 Conclusion In this study, we reviewed the financial benefit to investors of owning certified green buildings relative to non-certified buildings. We also observed that lenders are gradually assessing collateral on energy efficiency, offering reduced margins for more efficient buildings. The combined effect of higher rental income and lower interest rate expenses achieved by certified buildings (% NAV), benefits investors in the long term by generating higher distributable yields despite higher operating expenses. Next steps This is our first attempt at identifying the bottom line drivers through which sustainable practices contribute to real estate fund performance. However given the limited green sample available, we aim to repeat the study with a larger certified universe, namely our UK assets under management. The types of analysis we aim to follow: Rating level: We aim to identify the financial metrics distinguishing as Good, Very Good and Excellent buildings. This analysis will test whether the certification score is reflected in a fund s performance. Rating type (New Build or In-Use): Certifications across Europe are further split by rating type including New Build, reflecting the quality of green specifications of a new or recently renovated building. Alternatively, certifications can be of the In-Use type, reflecting the quality of the building services (Part 1) and on-going sustainable practices by both property managers (Part 2) and occupiers (Part 3). This analysis may have implications on strategy; is it more financially beneficial to invest in the specification of Excellent New Build buildings or in an Excellent In-Use building, where the operators/tenants develop action plans, manage, monitor, evaluate and improve its sustainability? Sector: We aim to identify which sector among certified retail, offices, industrial or residential assets offers the best financial benefits to investors and why. Assessment criteria: With each certification covering different environmental impact reporting requirements, we aim to assess whether the financial performance of certified buildings is reflected in the selected standard assessment criteria (See Figure 5). Figure 5: Certification assessment criteria BREEAM (UK) LEED (US and Canada) DGNB (Germany) HQE (France) Assessment criteria Management Health and well being Energy Transport Water Materials Waste Land Use and Ecology Pollution Innovation Sustainable site Water efficiency Energy and atmosphere Materials and resources Indoor environmental quality Innovation and design process Ecological quality Economical quality Socio-cultural quality Process quality Site use Eco-construction Eco-management Comfort Health Target Buildings New building Extension Existing building Major renovation Shell and core New building Extension Existing building Major renovation Shell and core New building Extension Renovation New building Renovation In-Use Scoring Unclassified Passable Good Very good Excellent Outstanding Certified Silver Gold Platinum Bronze Silver Gold Passable Very Good Excellent Exceptional Source: M&G Real Estate, November

7 Case study: Greenwalk 23,800 sq m office building, in the city s western business district, acquired for million Let to Phillips, the global technology company and various multinational insurance companies Excellent rating on both HQE and BREEAM In-Use, creating competitive advantage over other buildings in submarket, and helping occupiers to comply with their own Health, Safety and Environmental Management requirements 2017 environmental achievements include reduction of energy consumption by 10.9% and CO2 emissions by 12.2%, compared to three years ago 7

8 Contact Vanessa Muscarà Associate Director: Property Research +44 (0) Alex Lund Senior Associate: Property Research +44(0) Richard Gwilliam Head of Property Research +44 (0) Stefan Cornelissen Benelux +31 (0) Lucy Williams UK and Ireland +44 (0) Robert Heaney Nordics robert.heaney@mandg.co.uk Costanza Morea Italy costanza.morea@mandg.com Florent Delorme France +33 (0) florent.delorme@mandg.fr Alicia Garcia Spain alicia.garcia@mandg.com Manuele de Gennaro Switzerland +41 (0) manuele.degennaro@mandg.com Chris Andrews Australia +61 (0) chris.j.andrews@mandg.com (Please note that this website has not been reviewed by the SFC and will contain information about funds that are not registered with the SFC.) For Investment Professionals only. This document is for investment professionals only and should not be passed to anyone else as further distribution might be restricted or illegal in certain jurisdictions. The distribution of this document does not constitute an offer or solicitation. Past performance is not a guide to future performance. The value of investments can fall as well as rise. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and you should ensure you understand the risk profile of the products or services you plan to purchase. This document is issued by M&G Investment Management Limited (except if noted otherwise below). The services and products provided by M&G Investment Management Limited are available only to investors who come within the category of the Professional Client as defined in the Financial Conduct Authority s Handbook. They are not available to individual investors, who should not rely on this communication. Information given in this document has been obtained from, or based upon, sources believed by us to be reliable and accurate although M&G does not accept liability for the accuracy of the contents. M&G does not offer investment advice or make recommendations regarding investments. Opinions are subject to change without notice. Notice to recipients in Hong Kong: The contents of this document have not been reviewed by any regulatory authority in Hong Kong. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. Notice to recipients in Singapore: All investment products detailed in this presentation may only be invested by Accredited Investors or Institutional Investors as defined in section 4A(1) of the Securities and Futures Act, Chapter 289 of Singapore (the SFA ) and in accordance with the conditions of, any other applicable provision of the SFA and its subsidiary legislations. All forms of investments carry risks. Such investments may not be suitable for everyone. The information/research herein is prepared by M&G Real Estate Pte. Ltd. (Co. Reg. No G) or foreign affiliated companies of M&G (collectively known as M&G Group). MGS is currently regulated by the Monetary Authority of Singapore and currently holds the following licenses: 1. Capital Markets Service License under the Securities & Futures Act (Singapore) in: a. Fund Management. b. Dealing in Capital Market Products Collective Investment Schemes. 2. Exempt Financial Adviser License under the Financial Adviser Act for: a. Advising others by issuing or promulgating research analysis or research reports on Investment Products; and b. Advising on Investment Products Collective Investment Schemes and Securities. This information/research prepared by M&G Real Estate Pte. Ltd. is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update. M&G Investments and M&G Real Estate are business names of M&G Investment Management Limited and are used by other companies within the Prudential Group. M&G Investment Management Limited is registered in England and Wales under numbers with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Investment Management Limited is authorised and regulated by the Financial Conduct Authority. M&G Real Estate Limited is registered in England and Wales under number with its registered office at Laurence Pountney Hill, London EC4R 0HH. M&G Real Estate Limited forms part of the M&G Group of companies. M&G Investment Management Limited and M&G Real Estate Limited are indirect subsidiaries of Prudential plc of the United Kingdom. Prudential plc and its affiliated companies constitute one of the world s leading financial services groups and is not affiliated in any manner with Prudential Financial, Inc, a company whose principal place of business is in the United States of America. NOV 18 /