ESG: Has Green Building’s Moment Arrived?

In his annual note to investors, BlackRock’s CEO Larry Fink said, “I believe we are on the edge of a fundamental reshaping of finance” because of climate change. The BlackRock chieftain pledged to adopt climate considerations when managing its client’s $7 billion in assets.

Fink isn’t alone in seemingly newfound interest in climate change. Buoyed by activist investors and violent wildfires, hurricanes and tornadoes, along with the rising temperatures, large capital providers are looking for solutions to climate change.

“It was a really interesting moment when Yahoo finance added the sustainability tab on their website where anybody can go and find out what the ESG [Environmental, Social and Governance] performance of a company is and how that compares to its competitors,” says Rachel Gutter, president of the International WELL Building Institute. “These things are really being brought into the mainstream.”

As companies begin to consider climate change, it only makes sense that they look at the buildings they inhabit and own. Real estate is responsible for around 40% of global carbon emissions, according to the World Economic Forum. Large cities are also getting into the act. For instance, New York City passed the Climate Mobilization Act, whose goal is the reduction of building carbon emissions.

“Many cities and states are progressing their own environmental regulations and energy codes,” says Erin Hatcher, vice president of sustainability for AMLI Residential. “We’re seeing a shift in focus, particularly around energy efficiency. Enhanced building envelope requirements are commonplace and sometimes even renewable energy or net-zero goals are being pushed.”

At the same time, many companies are also focusing on the wellness of occupants. For instance, MetLife recently became the first life insurance company to earn Fitwel certifications for its commitment to healthy workplaces.

“Health and wellness have been a major focus for the industry and continues to be,” says Keara Fanning, sustainability director at JLL. “We recognize that the spaces people occupy have profound effects on human health and wellbeing and we have an ability to influence this for the better.”

From afar, it may seem like big business and the CRE community have reached a tipping point with green and healthy buildings.

“The industry is doubling down on its efforts to move from doing less harm to having a positive impact,” Fanning says. “We continue to see the threat that climate change and resource scarcity have and as a result legislation and corporations are stepping up to the challenge to ensure our real estate is more efficient and sustainable.”

This sounds good. But is it really true? Are CRE tenants, large investors and cities and states coming together to make our buildings more efficient and, in the process, save the world?

If the numbers pencil out, maybe so.

THE TENANT TEST

While there is momentum behind sustainable, healthy buildings, there is still a way to go. The main reason: the numbers still make little sense in a lot of places.

“Green buildings started when there was demand for green space from tenants,” says Spencer Levy, chairman of Americas Research for CBRE. “Buildings started being green in office and secondarily in multifamily. But other asset classes are, generally speaking, laggards. That is because until you see the financial incentive to convert or to build your building green from its inception, it doesn’t make sense to do it.”

For the entire CRE sector to go green, customers need to demand change.

“Despite the fact that we are seeing a more environmentally conscious Gen Z and Millennials, we’re still not seeing the demand for that green space and its additional cost,” Levy says. “Because of that, investors are not demanding it in those sectors.”

Price sensitivity isn’t a phenomenon among younger renters, though. “You’re still in the low single digits [percentage of green apartments] in most markets, even though most new class A multifamily is being built green,” Levy says. “The reason for that is you’re not seeing older tenants in older buildings demanding conversion of their units.”

That feeling isn’t universal though, especially in the renter-by-choice segment of the apartment market. “Especially in the multifamily sector, people are starting to demand it [sustainability] as they are shopping around for an apartment,” says Megan Baker, senior director of engagement for the Green Building Initiative. “They want a place where they’re taking care of the environment, their bills go down when they’re paying for their own utilities and they have a healthy space.”

A challenge with sustainability is that it has different meanings to different residents and not everything is visible. Explaining the approach is important to help residents understand the property’s offerings. “Not everything that we provide is necessarily something that is tangible, like improved indoor air quality,” Hatcher says. “But some things, like recycling or a community garden, resident’s value and can participate in.”

Sometimes, people who aren’t interested in wellness or sustainability, can be brought along with a quality green offering. If a feature encourages more productivity in the office environment, tenants may decide to pay a premium. Gutter puts circadian lighting, which aims to minimize the effect of electric light on the human circadian rhythm, in that category.

“With circadian lighting, you actually could help your employees get a better night’s sleep when they go home and show up refreshed,” Gutter says. “I think employers have realized that they can align those amenities that the millennials they’re trying to attract are most interested in with their desire to have improved performance, improved retention, improve recruitment and all of these things.”

DRIVERS OF SUSTAINABILITY

While many tenants may still have sticker shock when they have to pay for sustainable features, the investment class, in theory, is further along.

Levy says socially conscious funds are not a major player in the real estate space. But that could soon change. “I think that you will see more socially conscious funds be another push factor within commercial real estate,” he says.

Still, Gutter says investors are increasingly looking to the ESG performance of organizations. “REITs are under a tremendous amount of pressure to prove they are shooting for that triple bottom line and that comes through ESG ratings and rankings,” she says. “The most important one for real estate is GRESB.”

GRESB, which stands for the Global Real Estate Sustainability Benchmark, is the ESG benchmark for real assets. It validates scores and benchmarks ESG performance data, providing business intelligence and engagement tools to investors and managers. “Businesses at large, especially publicly traded companies, are looking for all the different ways in which they can max out their ESG performance,” Gutter says. “They are looking to be at the top of the scoreboard when it comes to GRESB achievement.”

The healthy building movement picked up a large win in 2019 when it was incorporated into the GRSBE. “Now part of your performance according to GRESB and part of the benchmarking to your peers is based on your commitment to health and wellbeing practices,” Gutter says.

Besides feeding into GRESBE, the certifications themselves can show a building is sustainable or provides a healthy occupant experience.

“Green building and healthy building certifications are so critical because they provide validation that an organization has actually done what they said,” Gutter says.

Hatcher agrees. “Self-approving sustainability just doesn’t go as far in the investor world,” she says.

But the benefits of these certifications can extend beyond the investor class. “Green certifications make more sense than ever as consumers are more aware and conscious of these products,” Fanning. “The third-party validation is necessary as it is not enough to say, ‘designed to’ or ‘built to’ a certain standard without the assurance of the certification.”

Baker agrees. “It is really important to people just for marketability of having a third-party certification,” she says.

But in some markets, like Chicago, where a large amount of office is green certified, it’s hard to distinguish one green building from another.

“You need to do other things to attract these tenants,” Levy says. “Some of them [building owners] are adding other green features such as green building materials, green space and other environmentally conscious things that are beyond those standards.”

Still there are some energy efficient features that the certifications don’t reward. For instance, in apartments, smaller, more efficient units can offer tremendous energy benefits, according to Levy. In offices, he says open floor plans allow for greater densification and less square footage for the average person.

“Having more efficient use of space is actually greener than having a larger, more inefficient units in the building because it is a more efficient use of resources,” Levy says. “But the challenge with that is that’s not the type of thing that will get you ranked in some of the traditional LEED or Energy Star metrics.”

A DIFFICULT EQUATION

Hatcher fully admits she is a nerd when it comes to sustainability and green building products. Right now, she’s immersed herself in the new options for residential ventilation systems that help improve air quality by introducing outside air and accommodating higher grade air filters.

“Indoor air quality is something that we talk to residents about and we get a lot of interest in,” she says. “If they have allergies or other concerns or sensitives, it’s something that they can directly benefit from.”

AMLI focuses on designing this technology into new buildings. “If you were to retrofit a property, it would be very costly to do that, but possible” Hatcher says.

While incorporating green features in new construction can be done seamlessly throughout the construction, retrofits are more challenging because upgrading larger systems, such as glazing and facades, are still expensive. Not only does installing green features require a financial investment in a building that is already collecting rents, but it can also be a nuisance for current residents.

Still, there are reasons to make the investment. Going green can increase the property value of an old office building by up to $800,000, according to a new report released by the Urban Land Institute

“Energy efficiency continues to be the easiest and most cost-effective way to reduce a building’s utility bills and greenhouse gas emissions,” says Lauren Hodges, director of communications at Energy Star for Commercial Buildings & Industrial Plants at the US Environmental Protection Agency. “By starting with low-and no-cost measures, buildings can reinvest their savings into larger capital upgrades.”

AMLI has found there are marketing benefits to large-scale renovations with LED lighting, WaterSense plumbing fixtures and Energy Star certified appliances that incorporate sustainable features.

“These features have pretty quick impacts both from a marketing and utility savings standpoint.” Hatcher says.

Most building owners start their upgrades of existing buildings with items such as lighting, smart home devices and boilers. “LED retrofits have increased in popularity and have been shown to reduce lighting energy use in some buildings by as much as 60%,” Hodges says.

Sensors are another product that can work well in existing buildings. In fact, sensors have gotten so inexpensive that consumers can buy them online for less than $100. More advanced sensors not only have the potential to locate leaks and excessive energy use, but also let operators remain in real-time dialogue with buildings to ensure that air quality is good, among other things, according to Gutter.

“There are also sensors that detect when water is around and shut off the water supply to prevent flooding from happening,” Gutter says.

Hardly a new trend, improving lighting remains a way to reduce energy consumption “Switching out all of the lighting and having automatic controls on your lights too, so that when people move from a space the lights automatically turn off, can provide major benefits,” Baker says.

The good news is the return on costs of these upgrades has improved, according to Baker. “The technology is advancing and when that happens, prices come down,” she says. “I actually think that the ROI is a lot quicker now than it may have been five or 10 years ago.”

NAVIGATING CERTIFICATIONS

For neophyte in green building, the certification world can be confusing.

Understanding the ecosystem starts with Leadership in Energy and Environmental Design, which was developed by the U.S. Green Building Council. It includes rating systems for the design, construction, operation and maintenance of green buildings, homes and neighborhoods.

If you want a more stringent version of LEED, you could try the Living Building Challenge. The National Green Building Standard and the Green Globe are also alternatives to LEED.

The Green Building Initiative is a Denver-based non-profit that administers the Green Globe certification for commercial and multifamily buildings. “It’s really for the entire building,” says Megan Baker, senior director of engagement for the Green Building Initiative. “It’s flexible and adaptable for various building types.”

Baker says the ANSI-certified Green Globe, which uses a third-party assessor, doesn’t penalize buildings for not having a green feature, such as a cooling tower, if it’s not applicable to the project. It has a new construction program, a sustainable interiors program and an existing buildings program.

Energy Star from the U.S. Environmental Protection Agency provides information about the energy consumption of products and devices. While it has become harder to attain the certification, there are several financial benefits, including lower operating costs, higher rental rates, better financing terms, lower occupancy and higher asset values.

“EPA periodically updates this metric to reflect the most recent market data available. The latest data show an overall improvement in the energy performance of the U.S. building stock in recent years,” says Lauren Hodges, director of communications for Energy Star for Commercial Buildings & Industrial Plants.

The Passive House Institute US offers the Passive Building Standard. A passive home uses continuous insulation throughout its entire envelope, an extremely airtight building envelope, high performance windows, some form of a balanced heat- and moisture-recovery ventilation and a minimal space conditioning system.

The International WELL Building Institute offers the WELL Building Standard, which focuses only on how buildings, and everything in them, can improve our comfort, drive better choices, and generally enhance, not compromise, our health and wellness. The certification was inspired by LEED, according to IWBI President Rachel Gutter.

“It is a certification framework that historically has been applied to individual buildings and communities,” Gutter says. “In the past year we brought a new program out of pilot called portfolio that actually takes an organization-wide approach to human health.”

In the triple bottom line—people, planet and prosperity—Gutter says the well building movement puts humans first. “Whereas green building might focus on water efficiency, we’re focused on water quality,” she says.

Gutter says a majority of the projects that achieved WELL certification also pursued a dual certification under a green building framework. “To make that easier on our shared customers, we’ve created a variety of tools and other incentives.”