The environmental, social and governance (ESG) framework is a critical topic. The green premium drives the need for investors, property owners and property appraisers to focus on ESG and incorporate these factors into their investment and assessment criteria.
Regarding the valuation industry, it simply means that the property sector can no longer focus on generating income from rent. There is an element of responsibility expected of property owners by society and legislative bodies. Developers and property owners now have to consider environmental issues, social impacts and government regulations. From an “E” perspective, owners and developers must consider, for example, water pollution or contamination.
Socially, they must consider the effect of the building on the safety and livelihood of people on or near the property. For example, do buildings create jobs for people? Surrounding poverty and unemployment can result in an “S” in the ESG score, as can development targeting the underserved rental market.
Social impact is not confined to the confines of the ESG discussion. How your property, no matter how big or small, affects the surrounding community should be considered by all landlords and property owners as a general rule of ownership.
From a governance perspective, the listed sector is well regulated. But as ESG is a growing regulatory requirement, it may require mandatory sustainability goals from the property sector in the future. This is already the case in countries such as the UK, which require an energy performance certificate (EPC) when a property is built, sold or rented.
The “G” in the ESG criteria can become more stringent if companies and the property sector fail or are too slow to comply.
South Africa is at the cusp of important decisions in the property sector. In December 2022, we will see legislation that applies property energy performance certificates in general. But this due date was extended by three years until 2025. The aim is to confirm the compliance of various properties with certain energy requirements.
The Institute of Valuers of South Africa encourages individuals to comply with the law to avoid consequences and benefit from potential incentives. There may be incentives to go green to gain support for ESG programs, for the betterment of the environment and society.
For example, good loans may be given to investors who want to develop green properties, and the incentives may not extend to properties that do not comply with ESG legislation, so investors, landlords, and property owners may miss out.
These ESG incentives can increase green building and sustainable property development as more investors want to use these good loans and comply with evolving legislation.
Green building has been around for years, even before the talk of incentivized property development, but in South Africa, the barrier remains the cost of developing and converting properties into more sustainable units with acceptable short-term returns. As a result, many developers can’t catch the green building and sustainable development hype, and now green building comes at a premium price.
The reality is that investors and owners who choose the green route to develop properties or renovate existing properties realize savings in electricity, water, heating and cooling in commercial and residential properties. The current utility model is becoming unsustainable as energy costs rise and energy sources become unreliable.
This challenge means that alternative energy sources such as solar are becoming more popular. Sustainable residential buildings and properties fetch a premium when sold because today’s market demands more sustainable occupancy.
It is interesting to learn from the World Built Environment Forum Sustainability Report 2021, where thousands of real estate and construction professionals from more than 30 countries participated, almost half of the respondents said that they believe that sustainable properties (commercial and residential) get a premium over non- green (brown). The same trend was confirmed in South Africa with quantitative data recently published on the MSCI SA Green Property Index 2022.
We also see a green premium in the rental sector – tenants want units with alternative, clean energy solutions that do not depend on the national grid, and which can ultimately save money, because they are responsible for utilities. Tenants are willing to pay more for greener options. In addition, the owner will have a healthy return on investment in the long run because the more sustainable green properties will sell above the brown properties.
For appraisers, ESG elements provide an opportunity to look at properties beyond common appraisal criteria. Today, valuers must consider environmental, social and governance aspects in the property’s market value. The effect of different properties in terms of ESG will dictate a better value than properties that do not score high in the ESG rating. This is a balancing act between the qualitative and quantitative aspects of the property as part of the evaluation exercise.
Assessors must consider the evolving ESG requirements and apply these to ensure accurate assessments in line with new legislation. They also need to know what additional effects ESG supports on property values, such as solar panels and battery storage, gas-powered geysers, sustainable lighting, and water retention and recycling units.
In addition, a property that has a positive impact on the surrounding community will also influence its value and ESG score. New legislative compliance for properties, such as energy performance certificates, should be considered in the valuation and will increase the ESG score.
The work of appraisers today requires a more objective application of the collective aspects that will be factors of potential buyers in determining the purchase price. This is a clarion call to appraisers to determine value in the hands of the market.
With all the talk and confusion about ESG, valuers need to consider the positive effects on the property market, while also considering the negative implications of non-compliance. This is a new concept that is not well defined in traditional valuation calculations. Valuers must stay abreast of all new legislative requirements that may affect the property sector, to ensure the fair value of assets in the market.