At Mayfair Capital we have long championed responsible property investment. This is illustrated by our participation in GRESB (Global Real Estate Sustainability Benchmark) and by the decision by Mayfair Capital to become a signatory of the UN Principles for Responsible Investment. As real estate accounts for 40% of global energy consumption, we view our commitment as a fiduciary duty but to date have found it difficult to demonstrate that this improves performance. We expect this to change, however, and there is an increasing volume of research emerging that seems to support this view. In particular, a recent research paper that I came across in my role as the Vice-Chair of the Society of Property Researchers (SPR), which analyses the economics of sustainable investment, caught my eye.
Entitled ‘Decomposing the Value Effects of Sustainable Real Estate Investment: International Evidence’, the paper finds that sustainable investing by REITs delivers stronger returns at both a property and a firm level. It received the 2017 Nick Tyrrell Research Prize which the SPR jointly awards with the IPF and INREV for innovative and high quality, applied real estate investment research.
At a property level the paper shows that sustainable buildings attract higher rental returns and incur lower interest expenses. This is a reflection of the preference that large corporate occupiers in the UK are showing for sustainable buildings. The first phase of the Government Property Agency (GPA) de-centralisation program, for example, led to record take-up and rebased prime rents in many regional markets last year. The GPA mandated that every new building meet the BREEAM Excellent standard and provide a healthy, productive environment.
However, to provide this level of specification in order to achieve higher rents requires higher build costs. The experience from our portfolios, where tenants tend to be smaller businesses, remains that cost and location are the primary concerns for most occupiers. Sustainability is a nice to have but most occupiers are not willing to pay more for it through their rent – at least not yet. The limited immediate financial benefit means it can be tempting to avoid the extra cost. In time though as ESG is weighted more heavily by occupiers we expect sustainable building income will become more resilient, justifying the higher expense.
The paper also identified higher operating costs in sustainable buildings due to greater deployment of tech. Considering Bloomberg’s new European headquarters at 3 Queen Victoria Street, London (the world’s most sustainable office) provides some explanation. Smart sensors, vacuum flush toilets and LED ceiling panels boost the building’s environmental credentials but mean higher maintenance and build costs relative to a standard office. Even taking that into account though, the paper found that the impact on property returns of more sustainable buildings is net positive.
In our view this phenomenon is still only applicable to a small number of prime properties sought by the largest corporate occupiers in the UK’s top markets. It is not yet a market-wide trend impacting all types of occupiers across all segments only those looking to make a statement. We have not found demand for sustainability in our assets to be a major occupational driver. Nevertheless a rising focus on sustainable buildings is an important trend that we will be monitoring closely in anticipation of its gathering momentum.
You can read the winning research study here.
Senior Analyst - Investment Strategy and Risk