Article | Intelligent Investment

Understanding sustainability ratings and its impact on the property lifecycle

With Australia’s movement towards net zero, there’s a need to analyse the relationship between sustainability ratings, office valuations and occupier satisfaction.

October 10, 2023

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The race towards net zero is building momentum across Australia’s business landscape. This is according to research from a 2022 Monash University study which found that approximately half of the country's biggest listed companies have plans to reach net zero greenhouse gas emissions. This is no minor commitment considering these 187 companies listed on the ASX200 are responsible for producing 32% of Australia’s operational emissions.  

With this mounting sentiment towards sustainability, a natural flow-on effect of proactive businesses seeking out the best performing green buildings to occupy is expected. CBRE’s latest Australian NABERhood Watch report 2023 was compiled to shed more light on this evolving market trend.  

Based on CBRE’s analysis reflecting the latest rents, yields, and occupancy premiums associated with offices which have higher NABERs ratings, it was found that energy efficient buildings experienced more enduring premiums. Other key findings included: 

  • Over three quarters of Australian office stock is NABERS rated 
  • 54% of office buildings are now 5 Star and above rated. This statistic stood at 35% in 2019, showing that landlords are continuing to invest in improvements across their portfolio 
  • Age is no barrier: 43% of buildings that were constructed pre-2000 have been upgraded to at least a 5 Star rating 
  • Energy costs make up 10-15% of the operating cost of an office building.  In today’s high energy cost environment, the business case is easier to justify 
  • Office towers with 5.5 Star and 6 Star ratings enjoy a 7% occupancy advantage to their 4 Star peers 
  • Rents are 2%-4% higher for each notch of higher NABERS rating, comparing buildings within each city CBD location 
  • There is a slight correlation between cap rates and NABERS ratings. There is a slight premium for 6 Star rated buildings and a slight discount for 4.0 Star rated buildings, while valuations are also impacted by location and cashflow strength. Of course, other building features may also be contributing to the higher building occupancy 

Aside from NABERS ratings, today’s occupiers and landlords are also invested in Green Star ratings – across both new building certifications or operational performance of existing assets. The latest CBRE research on Green Star found that: 

  • 68% of 6 Star and 5 Star buildings have an occupancy rate of over 90%. This new finding should be a significant drawcard for landlords and occupiers 
  • On average, the building occupancy rate improved by 2% for each notch of ratings from 4 Star vs 5 Star vs 6 Star. This could provide landlords with an incentive to pursue on-going upgrades including energy efficiency features. Of course, other building features may also be contributing to the higher building occupancy 
  • Over the past seven years, 82% of new supply that has or is coming to the market has been rated 6 Star and 18% has been 5 Star 

To further explore the relationship between higher sustainability ratings and both office valuations and occupier satisfaction, we spoke to CBRE Office Leasing Director Rachel Vincent, Director of ESG Consulting for the Pacific, Natasha Mulcahy, and Andrew Lett, the National Director, Office Valuation & Advisory Services, Australia.  

Sustainability ratings and its impact on valuations  

While a definite correlation between higher NABERS ratings and office valuations needs more comprehensive data and research in order to be conclusive, there are some strong anecdotal indicators in the market to date.  

In a recent CBRE Global Learning and Development series, the question of quantifying green premium and brown discount was posed to a panel of expert speakers from specific global regions.  

“Full transparency certainly makes valuing a lot easier, but the proliferation of factors which valuers consider when appraising property means it can be challenging to pinpoint a green premium or a brown discount,” explained CBRE’s Andrew Lett.  

Lett emphasised that like any amenity in real estate, green features are essentially the product of investment.  

“As the market evolves, investment continues to be required to achieve Prime status, in this case based on green features. Without that investment, the asset depreciates to become more average, and eventually more obsolete.  

“We’ve seen a strong alignment between NABERS rating and values. In the key gateway cities of Sydney and Melbourne, Prime assets are the higher rated buildings, mainly due to their more recent construction or in the case of older generation buildings, investment to make them more green.  

“Although there are current unknowns, what we do know is data and research is increasing our understanding of how sustainability impacts value.”   

As for where sustainability will influence values the most in the coming years, Lett says it all depends on the location since markets around the world are at different stages of their sustainability journey. 

“I expect that in markets where sustainability reaches maturity, there will be no green premium as being green will be required to be considered Prime. Assets which are considered to have a high ESG specification will depreciate more slowly. Evidence of capex injections focused on ESG could protect or even extend value. 

“Also, regulation is one of the main drivers for change and I expect this to continue. The role financial institutions play will be highly influential. ESG requirements will likely play an increasingly growing role in lenders' risk processes, to manage future compliance, reputation and sustainability risks.” 

Rachel Vincent, whose experience extends across valuations, project leasing and development in the Australian office sector has a first-hand perspective of the connection between sustainability ratings and rental yields.  

"The biggest parallel you can draw from a building that has a high sustainability rating is that rentals are higher,” she says.  

“Particularly in North Sydney, we have what we are calling a flight to quality. That flight to quality has allowed a 2% to 4% premium in our rental. Combined with rent reviews, then you have a cumulative effect of the rent increasing. 

“And what is also interesting is that we're in a very tight employment market and we have a lot of tenants and staff who are super conscious of the environmental impact that they are personally making. So, when it comes to recruiting, if your building and your place of work is aligned to the values of the people that want to come to work, that could be the difference between recruiting a preferred employee or getting someone that might be your second or third choice. That’s especially the case when you're in a war for talent like now. 

Vincent believes that she’s seen enough evidence in her current landscape to establish a relationship between NABERS ratings and rental yields. 

“I think the data is there,” she says. 

“At this point in time, Sydney office markets are struggling to get occupancy levels to pre-COVID levels. Are we ever going back to that? Now we enjoy hybrid working, flexibility in my mind is here to stay. I think that whole collaboration piece of people coming back together is definitely why people want to come back to the best office space.  

“People are really assessing their footprint and asking: ‘If we're going to go to the best space and people are working from home, do we need the same size?’ 

“I've never seen more workplace strategy and postcode analysis done in my life until now in 2023; it certainly increases the time a tenant takes to consider their moves. The right sizing takes time as we are at a turning point in how we use the office. And for the first time we are seeing sustainability requirements being included in formal briefs to the market.”  

This significant observation inspires a more detailed question of whether there are differences in leasing performance between the highest-rated NABERS buildings and their lower brown building counterparts. 

“Most people are looking for energy efficient buildings with a minimum 5 Star NABERS rating,” says Vincent.  

“Some tenants enquire about the amount of material that had been transported and how far it had been transported to develop the property. They want to know where all the material was sourced from and they’re really big on the carbon footprint that’s being created. All of these terms are starting to come into play because most companies are trying to meet their net zero targets.” 

From Vincent’s experience in the market, it’s not just the environmental aspect that today’s tenants and landlords are targeting in buildings. It’s also the ‘S and G’ in ESG alongside the detail of specific requisites.   

“We're starting to see a greater awareness and companies ensuring there is more consumer protection, digital security, better working conditions, human rights and diversity to name a few. We are seeing Indigenous procurement as well. For example, some building owners have placed designs and works from particular Aboriginal artists through some of their buildings.”  

Sustainability ratings and its impact on occupier satisfaction 

As the Director of ESG Consulting for the Pacific region, Natasha Mulcahy has her finger on the pulse when it comes to understanding occupier satisfaction and what the current trends are. In the midst of a challenging economic climate, is the subject of sustainability in buildings still a talking point? 

“Absolutely, there's a huge amount of interest and inquiry coming through from all sectors. 

“If we talk about investors initially, we're seeing asset owners under pressure from their investors and from tenants. They're getting inquiries, pressure or direct contractual requirements being placed on them. 

“And with the increasing cost of finance, we’re also seeing asset owners being driven by the ability to access cheaper financing if they have ESG performance targets and criteria. The growth in sustainability-linked loans is having a big impact right now.  

“There’s an increasing number of lenders now that are rewarding organisations for good performance or committing to improvement targets for ESG criteria.”  

Nonetheless, Mulcahy emphasises that a more holistic perspective must be taken when analysing the link between NABERS ratings and rental yields.  

“Anecdotally, we see that the occupants in those types of buildings seem to be stickier and satisfaction is higher.  

“I would say for tenant satisfaction, if you're in a high Green Star rated building, then you are going to be using less energy than if you were in a poor performing building. And for many organisations facing the rising cost of energy, that’s certainly a factor.”  

Mulcahy believes that a building tool like the new Green Star performance assessment has a more direct impact on a building’s occupants.   

“It is more all-encompassing rather than just looking at the building in isolation. It really focuses on operational performance, and it also brings in some of those community and amenity aspects as well.”  

What Mulcahy can confirm are the types of occupiers that are presently seeking sustainability and ESG credentials in buildings.   

“Those that have set their own targets would be the ones who are prioritising it. 

“You're starting with the larger organisations - larger national or multinational organisations - that have their own ESG strategy and targets. 

“They're the ones that are saying to their landlord: ‘We've set a minimum and we will only be in Green Star rated offices’ or ‘We've set a requirement of what our minimum NABERS rating will be’.”