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Green Buildings Lease Up Faster, But Don’t Get The Valuation Premium They Deserve

Green Buildings Lease Up Faster, But Don’t Get The Valuation Premium They Deserve

Producing more sustainable buildings will be better for the planet. But what about the bottom line of the companies that build and own them? Do “green” buildings make more money than “brown” ones?

That was the question posed by research firm Green Street Advisors in a new report, “It’s All Green To Me”.

The company analysed the portfolios of the European office REITs that it covers to find evidence of the economic impact of green buildings. It found these facilities are more profitable in some ways, but not in others. Here are the key findings. 

Green buildings have better occupancy than brown ones

Green Street found that for every 5% increment that is certified green in the total percentage of an office portfolio, the occupancy rate of a company improves by 85 basis points compared to less sustainable rivals.

“It suggests occupier demand for 'green' features beyond the sheer demand for new or refurbished buildings,” Green Street said. 

No green rental or sales premium, but a brown discount

Contrary to other academic studies, Green Street said it found no evidence from its analysis that green offices command premium rents, but vacancy rates for older, less sustainable buildings were higher and they took longer to lease up, making them less profitable.

Tenants, not owners, benefit from energy efficiency — but they could

Energy efficient buildings can reduce the cost of heating, lighting and hydrating a building by 20% to 30%, but given this only accounts for about 17% of an average building’s capital expenditure cost, that amounts to a saving of only about 3% overall, much of which goes to the tenant. Lower nonrecoverable and maintenance costs offer potential for landlords to benefit over the building's useful life, and could amount to a couple of hundred basis points of increased net rental income margin, Green Street said. But as of now, landlords do not seem to capture the economics of operational benefits. 

Green buildings cost more to build…

Given there is no real rental premium for green buildings, initially they hit returns, because they cost more to build. Green Street used the example of a new building in the portfolio of French REIT Icade. The building cost €4K per SF to build, compared to €3,500 for a non-green building. The quicker lease-up time added 7% to the profit margin, but the higher cost knocked 12% off, reducing the overall profit margin from 43% to 37%.

…But should sell at a premium

Real estate valuers put no premium on green buildings when making appraisals, Green Street said, based on conversations with those in the profession. But the company argued they should. When you take into account faster lease-up times, lower voids and the improvement to net income that is provided by lower capital expenditure costs, green buildings should be given a 50 basis point yield premium compared to brown assets, providing an annual average return of 5.6% in the buildings it looked at, compared to 5.1% for less sustainable buildings. That is before you take into account that sustainability is becoming more of a consideration for institutional investors. 

Real estate firms should be wary of a carbon tax

Given the built environment accounts for 40% of carbon emissions in Europe, Green Street expects the sector will come under increased scrutiny to reduce emissions. If a carbon tax of about £100 per tonne of emissions was implemented, UK REITs like British Land, Great Portland Estates and Landsec would have to pay out about 8% to 10% of the funds they generate in additional tax.