Interest in sustainable investing in property is picking up, despite a lack of empirical evidence in Europe so far that sustainable buildings have higher capital values or rents than resource-guzzling alternatives.
“This topic is getting a lot of traction with investors,” says Jean-Francois Le Teno, AXA Real Estate’s head of sustainability. “We would have been happy to start major changes two years ago, but our clients are only asking for it now. I guess it would be the same for other asset managers.”
Bill Hughes, Legal & General Property’s managing director, and chairman of the UK’s Green Property Alliance, agrees. “European institutional investors are all over this issue,” he says. “We are moving into a world where it’s a fiduciary responsibility rather than a luxury.”
But so far, few institutions have voted with their feet as far as specialist green funds are concerned. In November, analyst Verdantix reported that 15 UK and US funds have been raised in the past 10 years to invest in repositioning commercial buildings through green retrofitting, with committed equity of just under $3.5bn. The UK share is tiny: four funds, with committed equity of somewhere around £200m-£300m.
The number of institutions that have invested via this route is also modest. One reason for this is that interest started to grow just as the market crashed and several ideas for green funds were scrapped as fund raising became so difficult.
Private investors interested in this area have invested in other ways, via private equity or companies like Topland, which have looked for ways to invest in green technology. Last year, Topland bought a stake in renewable energy company Esco NRG, a supplier of commercial-scale solar panels.
“It’s a good idea to set up specialist funds,” says Hughes. “As a fund manager, you would position yourself as a green fund or an improver fund if you were a start-up. But we have a £10bn portfolio; if you’re very prescriptive about what you buy [at this scale], you constrain growth.”
Tim Mockett, a co-founder of Climate Change Capital’s first property fund, says its strategy is definitely not about sacrificing returns. The fund has bought a few core, well-located buildings and is working on improving their energy efficiency.
Proof of underperformance
However, Mockett admits there is no proof that UK greener buildings generate higher returns for investors. In fact, IPD’s inaugural 2010 Sustainable Property Index, sponsored by the Investment Property Forum and law firm K&L Gates, showed UK sustainable buildings underperforming; at the first consultation release in November, their two- year return to Q3 2010 was -14.8% compared with -10.8% for less sustainable buildings.
IPD head of sustainability Christina Cudworth says the results should be taken with a large dollop of salt, as “we need a bigger sample and better data”. Although IPD had combed a database of almost 1,000 properties, this yielded only 69 that could be considered sustainable.
Verdantix’s November report makes the same point: “Given the modest take-up in green investment and development, performance data are not as deep as for other real estate investment products.”
One factor that produces agreement about the value of sustainable strategies is fear of the ‘O’ word: obsolescence. Investors, asset managers, and – thanks to the Carbon Reduction Commitment – more tenants see improving energy consumption as cost-effective risk management.
Given the unprecedented fall in values in the last cycle and at best patchy capital growth prospects, the property industry is focused on preserving income. Investors take seriously anything that could preserve value and income and make their investment more marketable than the next one.
AXA’s Le Teno says that with this in mind, AXA is taking three approaches to becoming a more sustainable investment management business. One is to measure the energy efficiency of as many of its 3,000 assets as it can, tackling what Le Teno calls “the low-hanging fruit” first. AXA aims to have smart meters to measure energy efficiency in 300 buildings this year and thinks it will make sense to install around another 700, with the UK a priority because of the CRC.
Its second approach is to work with its investors and tenants. “We tell tenants: ‘We’d like to reduce your energy bill, to measure it, then decide on an action plan,’ and they are very pleased,” he says. “These are not big costs, which is why we use the term ‘low- hanging fruit’. The payback is seen in one or two years and we make 30-50% savings.”
The third part of the strategy is to participate in research. “We would be interested to see if there is a value increase in some European markets or whether, as we think from our smaller sample in the field, there is a reduced discount on older properties,” says Le Teno.
BNP Paribas Real Estate Investment Management aims to measure the energy efficiency and compliance of all the assets it manages by the end of this year. Associate director Mark Sealey says: “There are a huge number of measurement matrices, a lot of which are very complicated. So we have created a simplified version for investment management across Europe to rate all our assets’ energy efficiency and whether they comply with local building regulations and so on.
“Our rating tool has been set up at occupier/asset management level but has been adapted to take account of local practices. It means, for example, that a UK fund manager can look at another country’s assets on a similar basis. It will help us to make buying and selling decisions and identify the high-risk assets.” BNP Paribas REIM has already looked at 540 properties, in the UK, Italy and France.
Legislation drives change
“People want to take a proactive approach to this and there is a big push from investors,” Sealey adds. “It is difficult to point to tangible, immediate value, but they can see this evolving over quite a short period of time, driven by legislation.”
This has happened in Australia, where government regulation has driven change. IPD and regional partner PCA produced a Green Investment Index there with a bigger, more robust data set, based on the country’s Green Star ratings for new build and NABERS – not a spoof on the TV soap, but the National Australia Built Environment Rating System, which measures existing properties’ performance. The index benchmarks rated assets against unrated.
Last year, the number of rated assets shot up to 71% of the A$51bn of office assets (by value), for example (see graph). The index, published in February, found that in the two years to the end of 2010, Green Star office buildings had yields that were 40 basis points lower on average and a 400bps higher return. NABERS-rated offices also had higher returns and lower yields.
There is interesting research in the US, too. Verdantix says Deutsche Bank’s investment underwriting standards include collecting data on pay-back patterns from green refurbishments, for example on multi-family housing projects, to under-stand and price such schemes better.
“Sustainability has an economic value for real estate in many ways,” says Hughes. “It is not measurable now, but in the next five years that will change. At some point it will come through in performance and valuers will see it. It is not in the price yet, but it’s not a question of if, but when.”
UK pension funds give green light to retrofitting vehicles
In the US, CalPERS, CalSTRS and the Texas Teachers retirement fund have disclosed allocations to funds with a green retrofitting theme, according to analyst Verdantix. In the UK, the West Midlands Metropolitan Authorities Pension Fund has allocated funds to the Bridges Ventures vehicle and igloo, while Merseyside Pension Fund has invested in that vehicle and Climate Change Capital’s fund.
Other UK pension fund investors in The igloo Regeneration Fund – the UK’s oldest ‘green’ fund – include Aviva Life & Pensions UK; Environment Agency Active Pension Fund (advised by Aviva); Barclays Funds Investment; Derbyshire County Council; Lincolnshire County Council Local Government Pension Fund; RSPB Pension & Life Assurance Fund; and South Yorkshire Pensions Authority.
Besides the four UK funds (see table below) there are a handful of green funds on the continent: BNP Paribas REIM’s French team launched the pan-European Next Estate Income Fund last year, which will buy recently developed offices with sustainable development ratings. BNP Paribas has invested €50m of seed equity. The leveraged fund targets a 9% return and 5% income distribution.
Threadneedle fund kicks off carbon-cutting refurbs
Launched last year, The Threadneedle Low Carbon Workplace Trust aims to raise £350m from institutional investors to buy and refurbish up to 50 buildings. It bought its first four properties in January, for £42.5m: Premier House in Twickenham; Mansel Court in Wimbledon; Grove House in Hammersmith; and The Billings in Guildford.
After the fund’s development partner, Stanhope, has redeveloped them, they are expected to have a value of £54m. Occupiers will pay market, not premium rates, and will benefit from lower energy consumption.
Thames Valley Housing Association has prelet Premier House on a 15-year lease with 2.5% annual fixed rent uplifts and will apply for the Carbon Trust’s Low Carbon Workplace Standard after the refurb, which aims to reduce emissions by 50%. The standard is one way of ensuring long-term management of buildings to monitor occupational performance.
The LCW fund offers investors exposure to development and investment. Each risk category has a different return on equity, development profit being projected at a 15% internal rate of return, while the investment portfolio valuation aims to outperform the IPD Quarterly Index by at least 1% annually.
The structure of the remuneration package for LCW’s partners is based on both successful financial and carbon management. In the development stages, the development management and carbon advisory fees will be based on a percentage of the overall development costs.
Similarly, during the investment stages, LCW will be awarded an investment management and carbon advisory fee based on a percentage of the portfolio’s gross asset value, excluding developments.