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| From left: Professor Gary Pivo of the University of Arizona and Professor Jeffrey Fisher of Indiana University. |
Large institutional investment firms are factoring the enhanced market value of energy-efficient property into their real estate investment models, the nation’s
first study on investment returns from Responsible Property Investments (RPI) has found.
Written by prominent real estate professors Gary Pivo of the University of Arizona and Jeffrey Fisher, the director of the Benecki Center for Real Estate Studies at Indiana University, the study examined the effects of investing in energy-efficient, transit-oriented and urban regeneration office properties in the United States over the past decade.
It used property data from the National Council of Real Estate Investment Fiduciaries (NCREIF), an association that compiles real estate information from large institutional investors such as JPMorgan, Morgan Stanley, Prudential and Deutsche Bank.
Like other recent studies, Pivo and Fisher found that energy-efficient properties with the government’s Energy Star label performed better than non-labeled properties. Energy Star properties exhibited 13.5 percent higher market values and 5.9 percent higher net incomes per square foot, a result of 10 percent lower utility costs, 4.8 percent higher rents and 1 percent higher occupancy rates. They also sold at lower cap rates than non-labeled properties.
But Energy Star properties did not appreciate faster than non-labeled properties, nor did they generate better overall returns, indications that their “greater economic productivity was already priced in when they were developed or acquired,” the study said.
Across all three RPI categories, the study found that Responsible Property Investments were no less safe than traditional real estate investments.
“Since RPI can produce social and environmental benefits and fulfill fiduciary duties, it would be economically irrational and ethically unjustifiable to not engage in Responsible Property Investing,” the study concluded.
CoStar sat down with the authors to discuss the findings of the study.
CoStar Advisor: Why conduct this study?
Gary Pivo: This was motivated by a desire to respond to questions from real estate investors, especially the large-scale institutional investors like pension funds, who were asking the question, “Can I meet my fiduciary obligations while also making some contribution to social or environmental issues by investing in more sustainable properties?”
Advisor: And when did that question emerge?
GP: The big event was a couple years ago with the global adoption of the [United Nations] Principles for Responsible Investment, and the commitment to taking social and environmental issues into consideration in the investment process by leaders like CalPERS, who became signatories to the Principles. This was being done more on the equity investment side of the house, but then the real estate investment side started asking, “Is it feasible to be socially and environmentally responsible and sustainable? What does that really mean? What do the economics look like?”
That’s one benchmark, but there are certainly others. There’s the growing interest in climate change and its relationship to the building sector, and there’s also growing interest -- for example, from the U.N.’s Intergovernmental Panel on Climate Change -- that buildings are among the most cost-effective sectors when it comes to abatement. These are the kinds of things that converged to cause the industry to ask these questions in a serious way. And there really haven’t been systematic answers to those questions until this work with the NCREIF data and the other studies based on the CoStar data.
Advisor: According to your research, RPI office properties have performed as well or better than conventional properties for at least the past decade. Why has the institutional investment community not engaged in Responsible Property Investing to a greater degree?
Jeff Fisher: I don’t know that the data was available previously so they had a convincing argument. They weren’t really able to prove whether they were getting a higher value for the additional investment that they had to make in sustainability. And as Gary said, it’s fairly recent that you have this high interest. It’s been probably just the last two years or so that these were hot topics at conferences, like the NCREIF conferences and the Pension Real Estate Association conferences and others, where all of a sudden you have a lot of panels dealing with sustainability, and more discussion at meetings.
GP: Information is a market barrier, and ultimately, the institutional investors haven’t had satisfactory information. They’ve had anecdotal evidence, and some people have moved in response to that, but there really has not been widespread information like this available.
But you know, in some of these areas -- like investments in energy efficiency, or investments in central cities and redeveloping areas or in transit-oriented development -- you’ve certainly seen activity over the last 10 years. There have been early adopters who have made a lot of commitments in these areas and made a lot of money doing so. But the large-scale institutional investors have lagged in these sectors, broadly speaking. Perhaps it has to do with being more conservative, less capable of taking risk and having stricter fiduciary laws apply to them -- compared to say, for example, high net-worth individuals and other kinds of investors who are able to take more innovation and risk. It’s hard to say.
Advisor: You found that Energy Star-labeled properties have a higher market value than non-Energy Star properties, yet the investment returns for labeled/non-labeled properties were roughly the same. Why is this?
GP: Investment thinking is different than value thinking. It’s longitudinal versus cross-sectional. An investor isn’t only concerned about value and rent, they’re concerned about the change in those things relative to other properties during the period they hold the property.
We found that Energy Star properties had higher net incomes per square foot, due to lower utility expenditures and higher rents and higher occupancy rates. We also found they had higher market values per square foot, and that they had a lower cap rate. Now all of that is true, but it doesn’t necessarily mean that an investor is going to make a higher return on investment.
JF: Because they’re buying that property at a higher value.
GP: Right. We found it was already recognized by the market and priced in at the beginning of this period. We didn’t find that these properties were appreciating any faster than other properties. This lower cap rate seems to have been priced in and didn’t really change during the course of the period.
JF: But that could still mean that you’re making a higher return as a developer, depending on what the additional costs are of making it energy efficient. And what we didn’t do is look at a property that was converted to be more energy efficient over the study period. Our results would suggest that if someone took a building that wasn’t energy efficient and made it energy efficient - again, depending on the cost of doing that -- they would record a gain.
Advisor: Is it significant that the value of energy efficiency is being priced into investments?
GP: Yes. The market is differentiating these properties from other properties. But then there’s the deeper question about the extent to which the market is responding to the Energy Star label versus the actual underlying efficiency. This study looked basically only at the label as a proxy for efficiency. There’s more work to be done to take those two apart.
Advisor: Would more granular information on energy efficiency aid the market in valuing energy-efficient properties?
GP: One of the key questions is whether or not the appraisers and the underwriters -- the market, so to speak -- can get information about energy efficiency from the data that’s currently available, including utility bills and net incomes, that would allow them to reflect higher efficiency in the valuations. And we don’t really know the answer, but it may well be yes. In other words, you wouldn’t necessarily need the Energy Star label on the side of the building or the compulsory disclosure that the U.K. has required. It may or may not make a difference. But this would be in the context of the more sophisticated market, where that information is made available to the institutional investor.
JF: And we see evidence that tenants care, in addition to the appraisers. It’s showing up in higher occupancy. Again, we don’t know if it’s just the Energy Star label or if they’ve actually asked what the utility bills are because they’re worried about the pass-throughs and so forth, but clearly it makes a difference to the tenants.
Advisor: How is the recession affecting Responsible Property Investing?
JF: What you generally see during a recession is a flight to quality. One of the things we started to look at was if these properties are more liquid. We couldn’t find evidence that they sell more frequently. You may be able to sell them easier, but the investors don’t necessarily want to sell them. These are the properties that they want to hold onto because they have the higher occupancy. These are the buildings where tenants are going to want to be, all else being equal.
GP: Both types of properties -- RPI and non-RPI -- of course took a big hit in terms of value in the fourth quarter. There was no apparent difference between the two. It’s not obvious yet that RPI properties are particularly advantaged or disadvantaged in this financial crisis.
You could argue that people are looking to reduce expenses. They may be more interested in an energy efficient property. But at the same time, if those properties are more expensive, people may be looking for flat-out less expensive properties per-square-foot, if they have less access to capital. So it’s hard to know how it’s all going to wash out.