Green buildings are not only good for the environment but are also more profitable than non-sustainable buildings.
That was the main argument brought forward by Prof. Dr. Piet Eichholtz on 2 October during the third lecture of the Sustainability Series on the topic of Sustainable Property, Energy Efficiency and Sustainability in the Real Estate Sector.
Eichholtz is a Professor of Real Estate Finance, and Chair of The Finance Department at Maastricht University. He also conducts research on real estate markets, focusing mostly on international investment, portfolio management and housing markets.
Why invest in green buildings?
If from the environmental perspective, green practices are highly desirable in the building sector, there is an ongoing debate over their economic benefits. The environmental argument appears to be not strong enough for institutional investors to invest in green building companies.
Investors have a fiduciary duty towards their clients to pursue the highest financial objectives, and will only take green practices into consideration if they positively impact the bottom line.
Eichholtz conducted a research to find out whether green buildings lead to higher profits than less green efficient buildings.
The research analysed the price of buildings in close vicinity to each other and compared the green buildings to the less green ones.
Variables such as size, age, building quality, amenities, and availability of public transportation were factored in to account for most price variation.
The remaining variation accounted for the “greenness” of the building. The study revealed that this factor had a positive impact on the financial viability of the investment.
Overall, green buildings mean higher rents, a more stable occupancy rate and higher selling prices. The average non-green building in the rental sample would be worth USD 5,6 million more if it were converted to green. Likewise, the average non-green building sold in 2004-2009 would have been worth USA 11.1 million more if it had been converted to green.
These figures show that green buildings represent more profitable and less risky investments thanks to the stability of occupancy and also because they are not highly influenced by price variations in energy.
Furthermore, green buildings impact a firm’s reputation. Top performers in the field are rewarded with labels like LEEDS and Energy Star.
The LEEDS label was initiated by the US Green Building Council (USGBC). It covers six different components of sustainability, including energy performance and material selection.
The Energy Star label evaluates the efficiency of buildings energy use with respect to a base building of similar size and quality.
This dynamic rating system pushes companies to see what top performers are doing and to rise to higher green standards. Only the top 35 percent of all the buildings in a cluster end up receiving the label.
Nevertheless, green buildings are expensive to build and end up costing more than the average non-green establishment. In times of crisis, the demand decreases. So why should companies continue on this path?
In San Francisco, 35 percent of office buildings are green and the number is increasing. These buildings seem to occupy optimal locations and are also very luxurious.This indicates that people are investing in green establishments and that the trend is growing.
Furthermore, there seems to be an optimal level of greenness that buildings can use as a benchmark to optimise returns. In terms of financial value, overdoing the green efficiency may negatively impact their bottom line.
Nevertheless, these examples only mirror the current state of technology and current building prices. Innovation will help advance this field in the future.
It is worth noting that green factors also influence the image of a company and the performance of its employees. In the US, the top green buildings are more common in human capital sectors such as finance or law and also industries that depend on their reputation such as oil and energy.
Governmental institutions also lead the trend in the US and Europe. For example, the Dutch government only uses buildings carrying the energy label C or better.
Impact on Real Estate Investment Trusts
If green buildings can be profitable for their owners, do they also generate better returns for funds?
Another study was conducted to check what benefits green companies can generate at the investment fund level. If the green factor is positively related to operating performance of Real Estate Investment Trusts (REITs), then it means green buildings also generate better returns for investors.
Once again, the outcome showed a positive net effect. Green companies do not generate an alpha* – they do not outperform the market – but this only proves once again that transparent information is immediately absorbed into the price, and that we are dealing with an efficient market.
In terms of beta*, or systematic risk, we expect a negative result because of less exposure to the business cycle.
As mentioned before, green buildings are less exposed to energy price fluctuations. As expected, the beta proved to be -0,173 for LEED labeled buildings and -0,011 for Energy Star buildings.
As a consequence, pension funds can choose green companies because they come with a lower risk than the overall market. That alone is reason enough to pursue this possibility.
Watch the lecture by Prof. Piet Eichholtz
Global Real Estate Sustainability Benchmark (GRESB)
The GRESB initiative was co-founded in 2009 by Eichholtz together with colleagues and practitioners to create an elaborate measure of greenness on the portfolio level.
Through a survey of 450 property companies, GRESB was able to create benchmarks for greenness in different fields. The level of response from around the world varies (11 percent from Asia, 65 percent from Europe) and can also be used as a transparency index.
The firms are spread in a four-quadrant model with management and policy on the horizontal axis and implementation and management on the vertical axis.
As Eichholtz pointed out, “it’s talk versus walk”. If most people just say they are green but don’t perform as such, they are expected to fall underneath the 45 degree line. Indeed, most were below the line, scoring higher in the management and policy field.
The Green Stars showed up in the upper right quadrant, representing firms that conceive and implement green policies. All of them receive a GRESB label.
GRESB also has an impact over time since most firms which responded to the survey saw their energy use fall by almost 7 percent. They were also given score cards to see how they did in comparison with the best business in their class.
For example, in the field of self-storage businesses in the UK, a company called Big Yellow scored the highest. Its owner uses energy efficient solutions because they lower his operating costs.
Prof. Eichholtz’ insightful lecture convincingly demonstrated that green practices are not only good for the environment but are also proved to increase financial gains.
Furthermore, they impact a firm’s image, increase employee performance and can set a good example for the industry to follow.
This dynamic benchmark creates good competition and helps set ever-growing standards of sustainability and energy efficiency in the real estate sector.
By Ana Mihail
Ana Mihail is a student in International Business Economics at Maastricht University.
* Alpha measures how a stock/portfolio is performing when compared to a benchmark (usually an index such as the S&P500).
** Beta measures the volatility or risk of a stock when compared to the market. Green companies are less exposed to market risk because of the before mentioned reasons: more stable occupancy rate and less exposure to energy price fluctuations.