The focus on green premiums is short-sighted

Three new reports address the upside of being ahead of the net-zero curve. Far less attention is paid to the price of falling behind.

It was hard to escape the net-zero carbon headlines in private real estate last week. LaSalle Investment Management announced it had joined the Net Zero Asset Managers Initiative, while Aviva Investors revealed in its latest Real Assets Study that 52 percent of insurers and 50 percent of pension funds have similarly committed to achieving net-zero emissions in their portfolios before 2050.

Meanwhile, BlackRock, the world’s largest asset manager, released a paper titled Net Zero: A Collaborative Way Forward on the impact of net-zero initiatives on the UK property sector. The report, which highlights the competitive advantages of taking early action on decarbonisation, notes the rental and price premium for net-zero carbon buildings, estimating a “green premium” of approximately 10 percent for office assets.

Also out last week were two other research reports with data on green premiums. In its 2022 market outlook, DWS notes that while overall demand for office space has declined because of increased work-from-home activity, demand for modern, environmentally friendly office space has risen significantly. In fact, expected annual returns for such properties in core European cities were 7-9 percent, representing a premium of 3.5-5.5 percentage points above the average returns for the sector.

In its own analysis of office buildings, Dallas-based real estate adviser CBRE reveals that properties with sustainability certifications command significantly higher rents in continental Europe than their non-certified counterparts. On average, green-certified office buildings have an average rent premium of 21 percent compared with non-certified assets over a five-year period. In Copenhagen, Barcelona and Amsterdam, the premiums are as high as 29 percent, 27 percent, and 26 percent, respectively.

Tenants are willing to pay such rent premiums for sustainable buildings because of the related benefits, including lower operating costs, better corporate reputation and greater comfort, wellbeing and productivity for employees, according to the CBRE research. On the flip side, the analysis also points to “the considerable potential for a ‘brown discount’ for properties with relatively weaker sustainability performance”.

None of the research published last week provides data on brown discounts, however. Indeed, while some articles this year have provided estimates (see here and here), reports with in-depth analysis on brown discounts are much harder to come by than those covering green premiums.

That is surprising because brown discounts are potentially far more long lasting than green premiums. Net-zero carbon buildings, after all, will become increasingly common as more managers and investors embark on decarbonisation efforts. For example, the 220 signatories to the Net Zero Asset Managers initiative – launched last December by six investor groups – are required to set interim targets in line with reducing global greenhouse gas emissions by 50 percent by 2030, with 15 setting shorter-term targets for 2025. Such emissions reduction goals mean a substantial number of properties are due to become net-zero within the next decade.

In time, sustainable buildings will become the rule rather than the exception – which ultimately will dramatically lower, if not eliminate, green premiums for such assets. By contrast, brown discounts will continue to grow for properties with poor sustainability credentials, as those types of buildings continue to fall in number and stand out for the wrong reasons.

The prospect of generating more revenue from green premiums will certainly spur some managers and investors to take action on the net-zero front. But the prospect of losing money from brown discounts should be an even more powerful motivator.