How sustainable buildings will enhance returns and mitigate risk for investors

Investors are taking note as the benefits become easier to quantify

Even a few years ago, many investors were dubious about sustainable buildings.

There were a handful of high-profile examples in the market and little hard evidence on the enhanced returns they supposedly delivered. That’s now changed significantly.

Firstly, demand for sustainable office buildings is soaring. Corporate tenants are increasingly seeking spaces that align with their own ESG goals. With energy bills high, they’re also interested in the reduced operating and energy costs that sustainable buildings deliver.

Yet supply is very much lacking. In Europe, for example, demand outstrips supply by a factor of three to one. 

And the supply pipeline is not likely to pick up any time soon. At present, the rate of retrofitting is too slow and must increase from around 1% to 3-3.5% by 2050. 

In the meantime, this supply and demand imbalance is leading to a green premium in many markets. In London, JLL research released in January 2023 shows that BREEAM certification boosted capital values by an average of 20.6% with a single step improvement in EPC ratings producing a corresponding premium of 3.7%. For rents, BREEAM certificates led to an 11.6% uplift while a higher EPC rating resulted in a 4.2% rise.

Secondly, attitudes among investors themselves have shifted as the physical risks of climate change become apparent. JLL research from 2020 found that 78% of investors now believe climate risk is a financial risk. More investors are now making their own net zero commitments – and have their own shareholders and employees looking for proof of progress - although there currently remains a gap between intent and action in implementing plans.

A changing market

Incoming regulation will also have a significant influence, even if for now, markets are moving faster than the legislators on driving change. Around the world, regulations at city, national and multinational levels will continue to tighten in the race to decarbonize.

Signs of ‘brown discounts’ may be yet to materialize in many markets, but they’re clearly on the way. Penalties for buildings that don’t make the grade will range from potential non-compliance fines, reputational damage, and pricing and liquidity issues to lower rents and higher churn among tenants.

It won’t be an easy task to get the majority of buildings to where they need to be. JLL’s Retrofitting Buildings to be Future-Fit research, found that 90% of office stock across 10 major cities in Europe and North America is over 10 years old, and even offices completed five years ago may not comply with future energy efficiency standards.

Even buildings with high ratings from certifications including EPCs, BREEAM and LEED do not necessarily have low operational energy use or lower carbon emissions. It depends on how they’re being managed on a daily basis. Landlords are now turning to voluntary energy and carbon emissions targets such as the Carbon Risk Real Estate Monitor (CRREM) to benchmark performance.

Capital expenditure will be needed to retrofit buildings and ensure their ongoing performance meets net zero carbon standards. JLL estimates the cost of retrofitting the office and shopping mall stock across 17 major countries to be close to US$3 trillion. However, this capital expenditure is typically underestimated by the market today. 

There’s one silver lining for buildings that are already more certified; they’re likely to need less investment to reach required targets.

Transitions risks mount

As the pressure to decarbonize real estate continues to intensify, transition risks will only increase.

Investors need to understand these if they’re to take appropriate action for their real estate portfolios. They should consider impacts to rental value and growth, occupancy, yield, and operational expenditure in addition to the capital outlay to measure the true transition risk of commercial real estate. 

With the right data and market insight, it is already possible to model a range of scenarios and determine how to mitigate transition risk and optimize returns.

As this decade rolls on, demand for sustainable buildings will continue to rise and climate change will increasingly impact an asset’s entire lifecycle from capital raising to buy/sell decisions, underwriting and financing. Inaction will become the biggest risk of all for investors.

JLL’s experts can help you understand how the focus on sustainability is changing real estate markets and how you can manage transition risks. Contact us for more information:

Emily Chadwick , Head of ESG & Risk, Valuation Advisory at JLL