How green building certification impacts cash flow and value of commercial real estate? Findings from our Ruoholahti study
Urbanization and climate change increase the need for energy-efficient and low-emission buildings, but how LEED-certified buildings affect cash flow and market value? As sustainability is voluntary and market-based, understanding the economic impact is critical.
By 2050, more than 66% of the world’s population is estimated to live in urban areas, compared to just over 50% in 2010. As urbanization accelerates, energy efficiency and low carbon emissions of the building stock will be emphasized. Currently cities and built environment use approximately 75% of the energy generated and produce 60-70% of greenhouse gas emissions. Buildings’ share is 40% of final energy use and 30% of CO2 emissions. From an economic standpoint, buildings’ financial importance is staggering, as the real estate sector comprises approximately 60% of national, corporate, and individual wealth, totalling over EUR 168 trillion.
These global megatrends have increased the motivation of real estate investors to invest in more sustainable real estate, improve the sustainability of the existing real estate portfolio, and to commit to responsible property investing (RPI) under the UN Environment Program Finance Initiative. A weak stand on sustainability is seen as an increasing investment risk, which encourages real estate investors to adopt sustainable building practices. One way to adopt sustainable investment practices is to develop properties in accordance with the requirements of green building and energy performance certificates. But how green building certification in practice impacts cash flow and value of commercial real estate?
During the spring of 2021, we explored the ability of smart technologies to meet LEED certification requirements. In connection with the study, we examined the economic value creation logic in more detail. The data sources used in the study were based on case buildings in Ruoholahti and market data for the same Helsinki submarket. However, when interpreting the calculations, it should be kept in mind that the location of the property, the situation in the rental market and the investment risk are local factors, which means that the results are only indicative on a larger scale. In addition, it should be noted that there are many reasons why real estate investors are interested in the introduction of sustainable investment principles and certifications, for which our research basically only considers economic factors.
Looking at the economic factors, value of a building is driven by the combined effect of net operating income (NOI), capital expenditures and degree of risk associated with the investment. Net operating income is affected in rental income, vacancy, and operating expenses. Capital expenditures / tenant improvements reducing net income from the investment affect the building value significantly. All these elements can be affected with adopting sustainable design practices increasing efficiency of operational energy use and flexibility of building use.
According to studies, e.g. tenants are willing to pay up to 25% more for certified green buildings in order to contribute to sustainable employer image, employee efficiency, satisfaction, and well-being. Furthermore, considering that 75% of job seekers appreciate employer’s efforts on health and wellness, it is clear that green buildings support reaching top professionals. From a property owner’s perspective, demand for green buildings is higher affecting rental income stream security. The US Green Building Council estimates that better demand for green buildings lowers investment risk and increases asset values up to 10% while supporting corporate responsibility of the real estate owner. In addition, lower operating costs during the building life cycle increase NOI.
Utilizing the methodological framework of discounted cash flow (DCF) – widely used property valuation method for income generating properties – the study found building value is significantly affected by the green building certification. By assuming combined effect of better demand i.e. a 3-percentage point decrease in vacancy, 25% higher rent / sqm, 0,5 percentage point lower discount factor i.e. risk, 0,55€/sqm lower operational cost per month, the property value increase is 43%. Rental income growth is the biggest driver of property value increase, followed by lowered investment risk level. In order to more accurate evaluate the economic impacts, the survey sample size should have been larger. However, the study can be considered to be in line with previous studies, according to which green certification increases the NPV of building by ~ 11.8% – 14.8%. Thus, it can be said that green building certifications have a significant positive economic impact on top of which come social and environmental benefits.
Caverion Oyj / Business Development Manager
Halton Oy / Director Smart Building Segment