Building for the future: Are developers going ‘green?’

The article below is from our BRIEFINGS newsletter of 21 April 2022

Environmental, social and governance (ESG) considerations are increasingly driving corporate strategy in asset classes around the world. But when it comes to building real estate, is environmental impact – particularly carbon emissions – a critical concern for developers and investors? We sat down with Nora Creedon, an investor in private real estate within Goldman Sachs Asset Management, to discuss if buildings truly are going “green.” 

Nora, when we think of climate change, real estate might not always be the first thing that comes to mind. But just how important is it in addressing this global crisis?

Statistics tell us that real estate is actually one of the best opportunities to address climate change even though so much of the focus has been on industries like transportation. Property and construction represent about 40% of both global energy use and emissions. So, shifting toward more sustainable building and operating practices can have a tremendous impact on climate change outcomes.

What are the key issues driving the demand and urgency for “green” buildings?’

It’s really three things. The first is the global groundswell of support for more sustainability. Regulators and officials in cities around the world have also taken note of the impact property can have and we’re observing more demands on property owners. For example, you’re seeing London, Paris, Stockholm, New York, Los Angeles, Tokyo and many other cities committing to carbon reduction as quickly as possible. With those commitments come new regulations for buildings to meet various efficiency and sustainability measures. The numbers of buildings that will be facing these new regulations and will potentially be unable to meet them are staggering.

Secondly, tenants increasingly want their spaces to represent their values and they’re willing to pay the premium for “green buildings.” Many corporate users of office space have committed to carbon neutrality goals; they need their real estate to be consistent with that. We also think the shifting dynamics post-COVID have led many tenants to proactively seek out more sustainable features in their space.

And finally, capital is increasingly being reallocated to sustainable strategies. As pension funds and other institutional clients make carbon commitments with their portfolios, that increasingly is going to drive more dedicated strategies toward sustainability. That has already happened in the public markets, but we think it’s also likely to play out in the private markets in the coming years. And investors can make a case for premium valuations for sustainable assets, so you can expect more capital will therefore chase that dynamic, which creates a flywheel effect.

How important will green bonds be in the transformation of real estate? 

Real estate is an asset class that typically can carry leverage given the predictability of cash flows. From their inception in 2007, issuance in what we call “green bonds” has swelled to more than $375 billion, and that growth is really important for this space. In the U.S., real estate companies are now one of the largest corporate sectors for green bond issuance. The issuers are keenly focused on this market because there’s evidence to suggest that green bonds command a savings in financing costs (interest rates on green bonds are often lower than an ordinary bond from the same issuer.) Again, many of the same dynamics in the equity markets are in play here; more and more captive demand for sustainably oriented debt is driving better pricing for those securities.

Is greenwashing a threat? If so, what steps are being made to check misleading claims on sustainable building?

This is a really critical issue. Greenwashing is the practice of making misleading claims about ESG or sustainable products, assets and policies. We would anticipate more definition and clarity around the world of sustainability in the coming years so that greenwashing is minimized or eliminated. We are still in the early stages of understanding how to apply these ideas to real estate so the data is still nascent and so we have to assume there will be regional differences in how these principles are adopted. To that end, we are absolutely in favor of more transparency, more standardization and clearer disclosures. 

What do investors have to gain from supporting and investing in green real estate?

We believe that building green and investing in green is not just the right thing to do for the planet, it’s also a way to potentially generate better investment returns. If you look out 10 years into the future, there may be a lot of risk in owning assets that don’t meet sustainability targets. Those assets may suffer from less tenant demand, higher operating costs and increased regulations. The cost of capital for those assets is likely to be relatively higher.

We’ve spent a lot of time quantifying the ways in which we can earn a premium return for our clients in green buildings, and it really comes down to a few factors. First, the cost to build green is normalizing as technology is maturing. Second, there are specific rental premiums earned in the highest of green standard buildings. And finally, the operating costs of green buildings should, over time, be relatively lower. And as mentioned, you can make a strong case that with higher investor demand for these types of assets, you may earn a premium valuation upon sale.

The challenge for investors is finding the right opportunities to build green or convert to green, and that’s really where we’re focusing our efforts.

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