Julie Hirigoyen on the business case for investing in sustainable buildings

Our design community can make all the technical advances it wants, but if investors don’t value sustainability, we won’t see the radical change we need.

Major institutions in the UK were slow to appreciate the relevance of sustainability to real estate assets, despite many of them applying socially responsible investment principles to their equity portfolios.

Ten years ago, pension funds and life insurance companies were not particularly engaged in the environment. As a result, early movers like Hermes and Prudential Property Investment Managers enjoyed a significant profile for their pioneering approaches to responsible property investment, involving the integration of environmental and social practices into mainstream property processes.

But now, sensitised by the most severe recession in memory, institutions are more reluctant than ever to expose themselves to risks they cannot quantify or predict. They need tools that enable them to understand the sustainability risks of their real estate investments, and to future-proof their assets to ensure they retain value in a low carbon economy. Understanding this helps all parts of the supply chain deliver a more sustainable and, crucially, valuable building.

When investors consider new properties for their portfolios, initial risk assessments look at issues that might increase the insurance liability or tax burden of the building in five or 10 years, such as the flood risk for the building and its surrounding infrastructure. Assuming the building passes these tests, the next steps would form part of an extended due diligence process, and look in more detail at the building fabric and services.

Investors who believe the market will favour sustainable buildings claim the cost of improvements now will be outweighed by the cost of retaining poor performers

Julie Hirigoyen

Those investors concerned about the obsolescence of poorly performing buildings in a low carbon economy are prepared to go one step further. They commission a detailed energy assessment of the building to understand its carbon abatement potential, and to plot the capital expenditure required to bring it within a specified performance threshold. Their reason for undertaking such a survey preacquisition is, of course, to reflect forecast capital expenditure in price negotiations.

In the management of their portfolios, institutions wish to understand the risk profile of their different funds. Our sustainability risk mapping work with investors suggests many of the risks which might become acute in the next decade are not necessarily being captured by typical fund management practices. For instance, in 2008, more than 40% of the 1500 properties analysed were found to be at risk of contagion flooding; only 10% had smart or zoned lighting systems; only 5% had any water conservation devices installed; and 15% had no natural ventilation whatsoever.

Institutions that profile such risks on a regular basis are using the results to feed into asset allocation decisions and transactions strategy, and are integrating the lessons into future asset management plans and fund management principles. They are also looking to engage more proactively with their tenants through occupational strategies and green leases.

In a credit- and a resource-constrained economy, it might be sensible to assume that investors will, in coming years, give more attention to refurbishment rather than new development. Indeed, we are being asked to apply complex cost-benefit analysis tools to evaluate the net present value of sustainability improvements that might be made to Class A buildings in investor portfolios. Investors who believe a two-tier market will rapidly emerge in favour of those buildings that demonstrate a strong sustainability performance claim that the cost of improvements today will be outweighed by the cost of retaining underperforming assets in the future.

Such trends are a strong indication that institutions equate responsible property investment with financial returns. Whether through reducing void rates, minimising running costs, or improving capital values, the perception of a rapidly growing number of institutions is that sustainable practices will ultimately improve the long-term value of their funds. And that’s good news for everyone who believes sustainable building should be the norm, not the exception.