Six Ways Energy Efficiency and Sustainability Measures Increase Property Value

As the attention on Environmental, Social, and Governance (ESG) has increased over the last several years in commercial real estate, more investors are using ESG factors as an asset risk management tool and demanding that they become more sustainable and adhere to environmentally responsible principles. There is certainly just cause for this. For example, adding property resilience measures help mitigate the risks of damage from climate change hazards, and may also lower future costs associated with adapting to climate change regulations. But aside from gaining better brand perception and meeting the demand of investors, implementing energy efficiency and sustainability measures can also increase commercial property values in measurable ways.

Calculating the Impact of Energy Efficiency Measures on Property Values

Implementing energy efficient measures can lead to significant cost savings in the long term. For example, retrofitting properties to be more energy efficient can reduce utility costs, and lowering operational costs increases Net Operating Income (NOI) for a higher property value.

As an example, take a property that currently brings in a gross potential income (GPI) of $1,000,000 per year. The current operating expenses (including utilities like electricity, gas, water, etc.) total $300,000, making the Net Operating Income (NOI) $700,000. Using a cap rate of 7%, the property valuation is:

NOI / Cap Rate = Property Value $700,000 / 0.07 = $10,000,000

After implementing energy efficient measures such as LED lighting, solar panels, and high-efficiency HVAC system that cost $200,000, these upgrades reduce the annual utility costs by 30%. Given that utilities are a sizable portion of operating expenses, say, $100,000, it would be a saving of $30,000 per year.

In this hypothetical case, the new NOI would be:

NOI = GPI – (Operating expenses – savings from energy efficiency) NOI = $1,000,000 – ($300,000 – $30,000) = $730,000

With this increased NOI and the same cap rate of 7%, the new property valuation would be:

$730,000 / 0.07 = $10,428,571

In this hypothetical case, investing $200,000 into energy efficiency increases property value by $428,571. This does not factor in other benefits such as potentially increased rent from tenants willing to pay for a greener space, or government incentives and rebates for making energy-efficient improvements. The actual change in value will differ significantly by property, though the principle remains.

This principle also applies to green buildings, which are designed with more durable materials that withstand harsh weather conditions better than traditional buildings, and their maintenance can be more cost-effective. This can lead to an increase in the useful life of the property and consequently, higher value.

Other Potential Impacts of ESG Measures on Property Values

There are other ways that ESG efforts may impact property value, though some of these impacts can be harder to measure initially.

1. Lower Vacancy Rates: ESG measures can attract long-term, high-quality tenants who prioritize sustainability and good governance. This reduces vacancy rates and can increase rental yields, thereby enhancing the asset valuation.
2. Higher Rent: similar to the previous point, an energy efficient or green certified building will attract high-quality tenants with personal decarbonization or net zero goals. These buildings may also be able to command higher rents than inefficient properties.
3. Risk Mitigation: as mentioned previously, ESG improvements can help mitigate various risks. Property resilience measures reduce the risk of damage from extreme weather events, and good  governance practices can lower the risk of reputational damage, lawsuits, and regulatory fines.
4. Improved Market Perception and Brand Value: having an ESG policy can also enhance the reputation of a property or the property owner, potentially leading to a premium on the market value of the property.
5. Compliance with Local Laws: energy efficient properties will be in compliance with local laws that have material fines that impact property value. For example, New York City’s Local Law 97 requires buildings over 25,000 square feet to have a 40% emissions reduction by 2030 compared to their initial benchmarks and carries an annual penalty for every excessive ton above the cap.

While ESG measures, especially energy efficiency measures that require installation of new equipment, can be costly initially, the long-term returns can far outweigh the initial costs. However, it is important to note that the effect of ESG measures on property value can be influenced by numerous factors such as the property’s location, local laws and regulations, and market conditions. When considering which energy efficiency and sustainability measures to implement, it is best to consult a sustainability expert, especially one well-versed in local laws, rebates and incentives, as well as green loans.