Eco-friendly real estate: Financing the cities of the future

It often takes a shock to provoke substantive change. When the oil price touched $100 a barrel in January, the news could not be ignored: the days of cheap energy were over, even for the Americans. Even Jeroen van der Veer, the chief executive of Royal Dutch Shell, is advising consumers to ditch petrol-guzzling cars. High energy costs have turned out to be perhaps the most influential factor in convincing world leaders and chief executives that sustainable living is not something solely for the committed few but also for the masses.

The great and the good in real estate – developers, investors, tenants and landlords alike – have largely have come to terms with the inevitable greening of the built environment. Buildings are inextricably linked with the climate change crisis. An estimated 40% of carbon emissions worldwide come from buildings, a fact that has focused regulatory, legislative and real estate industry efforts on changing the nature of where we live, work, shop and play.

The cities of the future will look similar to today’s but beneath the surface new buildings are radically different. And it is the technology used in constructing sustainable buildings that will distinguish them from yesterday’s outmoded designs.

Green roofs and solar panels are only part of the story. If a structure is to be truly sustainable, architects and developers need to look at how it functions as a whole. Waste-water management, efficient heating and cooling systems, recycling regimes, energy consumption, cleaning practices, and more, are all part of what it takes to make buildings greener.

Among the upper echelons of developers and investors, the green revolution is coming on fast.

"It’s happening so quickly that soon it will be impossible to be a class-A building without being a green building," says Tatiana Eck, vice-president at AIG Global Real Estate in New York.

The clamour around sustainability and the promotion of environment-friendly property has already spread to the financing side of the business. In the UK, the first green leases appeared this year (see Signing up for sustainability, Liquid Real Estate, March 2008). These contracts, which include clauses aimed at managing energy efficiency, for example, are being embraced by such institutions as Hammerson and Prupim, the real estate investment arm of Prudential. And one of the first green leases has been signed by Moto, a motorway services company, which is seen by some as an unlikely innovator in green leasing.

Green leases are just the beginning. Investment managers seeking to attract new capital from pension funds and local authority schemes are going to need to show their green credentials.

"We get questionnaires in from local authorities when we’re pitching for business and one of the bigger sections is actually around sustainability: what’s your policy? What do you do? And if that’s not completed to their satisfaction, you don’t even get to the interview stage," says Paul Cornes, investment manager Prupim’s London-based head of sustainability. "It doesn’t matter what your investment record is or whether you’re best investment house around, you don’t get through the door. Our fund managers are realizing that this is not something outside the business, it’s something inside the business."

For real estate investment managers, sustainability goes beyond changing the office light bulbs and putting a few recycling bins by the photocopier. With real estate being so closely linked to carbon emissions, being sustainable and investing in sustainable projects is swiftly becoming the rule rather than the exception.

Prupim has drafted a sustainability development framework, a stringent roadmap that its development team will use when embarking on new builds and refurbishments. The framework takes the development through a number of actions and questions, asking what can be done on each development in terms of including sustainable elements and whether they are cost-effective.

"We’ve got to make sure that we are upholding our fiduciary duties to our policyholders," says Cornes. "It’s all very well us saying we’ll pay an extra 20% than we could spend to make this building more sustainable, but we are responsible for policyholders’ money. There is a balance here and we will spend more than on a non-sustainable property because actually that will be beneficial to policyholders. When we go to sell the building it will be, theoretically, worth more because of the changing climate with legislation. It’s about future-proofing our properties."

Moving forward, the pressure to reduce property-related emissions will come down on landlords and developers through stringent legislation. In the UK, for example, the introduction of Energy Performance Certificates (EPCs), which rate a building’s energy efficiency on a descending scale of A to G, will force those that have not addressed sustainability to put it on their agendas or risk being sidelined. Already tenants, concerned primarily with ever-increasing energy costs, are enquiring about buildings’ energy efficiency.

"Tenants are starting to specify a level of performance that they didn’t a year ago" Chris Hiatt, Jones Lang LaSalle

Beyond maintaining and creating value and enabling developers and landlords to remain competitive, greener buildings could bring advantages when it comes to funding. There is already an expectation that a green premium will benefit borrowers, which could encourage fence-sitters to take on board sustainable development practices.

"To the extent that something has very good green credentials and that remains an important part of the decision-making process for tenants in large buildings, then those buildings are going to be more attractive and, if not more financeable, financeable on better terms, because people will take a more aggressive view on the prospects for re-letting," says Peter Clarke, executive officer of British Land.