Key barriers to sustainability standards

To increase the sustainability standards of commercial real estate and meet corporate demand for more sustainable rental options, our global real estate study identifies three key barriers that need to be overcome:

• a lack of consensus (including definitions, certifications and data);
• the need for cultural change and organizational transformation;
• and the difficulty in bringing older buildings up to modern sustainability standards.

The lack of consensus challenge

Three-quarters of investors in our study believe that the ‘green premium’ – the higher value attached to more sustainable buildings – applies mostly to buildings that meet official sustainability certifications such as LEED and BREEAM.

A recent study by property consultancy JLL found that values for London office buildings with a BREEAM certification were on average 20.6% higher than those without accreditation, and rents were on average 11.6% higher, based on a study of office investments during the five years up to December 2021.

However, one of the challenges is that there are many different accreditation and certification schemes, and there is a lack of consensus around how to define and quantify the sustainability of real estate. In fact, our study reveals that “lack of agreed sustainable buildings standards or definitions” and “lack of global standardized regulation and policies” are the most significant barriers firms face to increasing their investment in sustainable buildings, after market conditions.

Top barriers firms face to greater investment in sustainable buildings

Of the firms that said that a lack of agreed sustainable building standards in their target markets was a barrier, the US was the most frequently-cited market where this was an issue, mentioned by over a third (37%) of these investors.

This lack of standardization can make it difficult to quantify the value of sustainable real estate, and the potential return on investment in upgrading sustainability standards. More than four in five investors (81%) believe that demonstrable evidence of a green premium would increase investment into sustainable real estate.

In the EU, there is a concerted effort underway to provide a uniform taxonomy, including standards and legal frameworks.

The business transformation challenge

Investors are aware that new attitudes, strategies and approaches to real estate investment will be needed to make progress against sustainability goals. Almost three-quarters of investors in our study (74%) say that it will require a “major cultural change” for their firm to put sustainable buildings at the heart of their investment strategy. The fact that only 29% of investors currently believe their leadership team is prioritizing sustainability shows how far firms have to go. There are signs that this cultural shift is already underway, with some firms creating “head of ESG” roles or similar. But is a fear of being accused of greenwashing or misclassifying funds under Article 8 and 9 regulation hindering action? Our study finds that two-thirds of investors say that ‘the risk of being accused of greenwashing’ is a barrier to progress in terms of their investment strategy for sustainable real estate.

To actually implement changes and make real estate more sustainable does not come down to investors alone – it relies on the wider ecosystem.

The retrofit challenge

Almost three-quarters of corporate decision-makers (73%) say that their organization favors leasing older buildings that have been retrofitted as opposed to new builds. The top reasons for this preference are that older buildings are often in better locations (54%), their organization prefers the aesthetics of an older building (52%), and older buildings have a more positive impact on their brand (47%). This contrasts with investors’ approaches: in most markets, investors say that their primary approach is to invest in new buildings (i.e. those built in the last 10 years or currently under construction) rather than older buildings. The high cost associated with upgrading real estate is likely to be a key reason for this – 68% of institutional investors say that the cost of retrofitting buildings to reach a good sustainability standard is too high.

In fact, firms claim that a significant proportion of their real estate assets simply cannot be upgraded: on average, firms say that 22% of their real estate portfolio that fails to meet basic sustainability standards would not be possible to retrofit to higher standards and 23% would not be economically viable to retrofit. Historic city centers often have a high proportion of older buildings that would need significant retrofitting to meet current and future sustainability standards. Listings in the UK, where a structure of particular architectural or historical significance has special protection, can further complicate this.

During a time of high interest rates and steep costs, few can commit to these upgrades, and investors are increasingly crowding around the top tier of premium, modern buildings. In an effort to address this issue, the European Union implemented the Renovation Wave strategy in 2020. This initiative emphasized the potential for renovating an estimated 35 million buildings and generating up to 160,000 new green jobs within the construction sector.

Increasing sustainable real estate investment

Standardized global definitions and universal standards, paired with firmer data and evidence of the green premium, would clearly help to accelerate investment into sustainable buildings. In many jurisdictions, sustainability is still hard to measure, and the lack of standardization means that comparing the sustainability standards of one asset against another – and measuring improvement over time – can be almost impossible.

What else could spur investment? As cost is a critical barrier – especially given the expense of retrofitting older buildings to meet modern standards – government incentives could play an important role. Three-quarters of investors believe that stronger external incentives, including favorable tax treatment for sustainable property, would increase investment in sustainable real estate.

Governments are generally not giving out large incentives in this area – few governments can justify putting money into commercial real estate, especially given the current economic climate.

Professor Olmo Silva, Professor of Real Estate Economics and Finance at the London School of Economics and Political Science, said:

“Green loans and sustainability-linked loans are certainly important to sustainable real estate, and many of the big players are skewing their offer towards these. One of the biggest issues for developers, especially ones that want to invest in green real estate, is defraying the cost of borrowing, so any discount that you can get in order to leverage your building is important.

“The concern with this approach is that it rests on two notions that are still very hard to quantify: one is the level of discount that you’re going to be giving to properties that are greener. There is a lack of understanding of how big this should be from the point of view of the reduced risk that these properties represent, and what makes a difference from the view of potential investors. There is a lack of research here and there isn’t a strong methodological approach to quantifying this reduction in risk. The other issue is that it rests on measuring KPIs that are prone to manipulation: when do you measure the emissions, when do you stop measuring them, and what is the KPI for the measurement?”

Our study also reveals that investors are generally encouraged to increase their real estate investment in markets where minimum energy performance standards for commercial buildings are being imposed or increased, rather than standards dampening investment appetite, pointing to an important role for government.

The impact of governments imposing or increasing minimum energy performance standards for commercial buildings.

Businesses agree that governments have a key role to play and argue that incentives are needed on the rental side too: 73% of corporates think there need to be stronger external incentives from government and regulators, including grants and favorable tax treatment, for renting sustainable property, rising to over 80% of businesses headquartered in the Middle East and Asia.

Green loans and sustainability-linked loans are certainly important to sustainable real estate, and many of the big players are skewing their offer towards these.

Fons van Dorst, Executive Managing Director UK at real estate developer EDGE, believes that the real estate industry needs to go further than simply meeting environmental and sustainability thresholds:

It is critical to think beyond basic real estate sustainability standards and consider both the environmental and social impacts of commercial real estate. It’s not just about having a sustainable building, but about having a responsible building. An inclusive building. This means a building that is aware of its surroundings: that is accessible and welcoming to a diverse range of people, and that fosters a relationship with the local community. We design buildings to be open and inviting, and to facilitate a link between the occupiers and the community; incorporating spaces that enable those who work inside and those who live nearby to meet each other.