Speaking Finance Is Not Enough – Sustainability Must Be Part of the Bigger Picture

How are financial metrics, such as IRR (Internal Rate of Return), ROI (Return on Investment), and Yield on Cost, being considered in the context of sustainability within the real asset market? We have no intention of delving into the detailed definitions here (our clients are far better placed to do this). However, we would argue that these three metrics are being used almost interchangeably when related to sustainability.?

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Sustainability professionals have put on their finance suit and mastered finance lingo, but it’s time to challenge over-reliance on financial metrics, and advocate for integrating sustainability into a bigger-picture view of value.?

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Not Every Measure Can Be Measured in Returns and Yields

There are clear cases where calculation of the Yield on Cost is possible, most obviously where the intervention either generates accretive revenue (think solar panels and renewables) or reduces operating costs (such as MEP upgrades which lower energy consumption and costs). Avoidance costs, or the implied cost of doing nothing, also play a role. But not every measure can be measured in returns or yields. ?

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Take the analogy of a new lobby; part of the value-add plan for a major office refurbishment perhaps. Often, resources and ultimately money, is spent on working out exactly what would be the best new design for this lobby. Many samples are supplied and tried and tested and then once installed, it can even be dismantled and refitted so that it is “just right”. The cost for this new lobby is built into the refurbishment capital plan – but at no point does anyone request a yield on cost or IRR specifically and separately for the lobby. Instead, it forms part of the long list of features and amenities provided at the building.?

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Instead of isolating sustainability features separately, including items as smart- metering, high energy efficiency, occupier amenities and proximity to transport could be baked into the asset scorecard. In many markets, these are already considered as standard, business as usual (BAU) requirements and part of the complexity that makes up a ‘good’ building. Depending on the geography and sector, the BAU list will look different and be comprised of the Must Haves (Regulation + House Views) combined with Optional Extras (Add On elements, including certification targets).??

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Put more simply, BAU in more sophisticated markets is the cost of doing business there.?

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A Building’s Value is Not Solely Defined by Its Sustainability Credentials

It’s important to remember that a building is not an island (in most cases, at least) but an integral part of the community in which it sits or which it serves. A net positive energy asset in the forest is all good and well, unless the occupiers hate it and can’t get to it. A building must work within its context and serve its occupiers effectively.?

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As we (hopefully) enter a new investment cycle, relying on the historical ‘green premium’ runs the risk of driving a disjointed and mispriced view of sustainability features by treating sustainability as a separate, rather than integrated with other valuable features. One could argue that the correlation between ‘good asset features’ and ‘green features’ are almost 1 to 1, in which case any premium associated with green labels should rather be given to ‘good buildings’.

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Put simply, a truly valuable building naturally incorporates sustainability as part of its overall quality; good budlings are also sustainable and efficient buildings, and sustainable features should be part of the broader criteria for what makes a building valuable.?

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The Cost of Ignoring Sustainability in Investment Cycles

From our recent experience, we are seeing reputational risk featuring highly in Materiality Assessments as the risks of not anticipating market expectations and technological shifts put more focus on the question of timing – in itself, perhaps the most critical factor of all. This fear is also driving increased levels of “green hushing” –underreporting green initiatives to avoid scrutiny.?

Conversely, the brown discount is alive and well and much of it can now be defined. At EVORA we have seen firsthand the cost of not underwriting efficiency measures adequately in the last investment cycle, leaving assets in sustainability-sensitive markets stranded – not in carbon but in financial terms – where the cost of bringing them up to scratch is now more than the remaining equity portion.??

For typical core funds, 2030 is only one hold cycle away and 2050 is no longer in the invisible distance. As cities introduce stricter regulations and tools to manage climate risks, properties that fail to comply will likely face penalties or devaluation.?

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The Shifting Role of Sustainability Professionals in the Investment Landscape

So are sustainability professionals obsolete? No. But underneath their polished panel performances, many sustainability professionals are deeply frustrated. Often seen as the nay-sayers, or the budget busters, and much of their career is now taken up with arbitrating between lawyers’ opinions of SFDR and CSRD for real estate, rather than improving the built environment in order to protect the planet and everything that lives on it. We have learned to speak finance so that the investment community will take us seriously, to talk about yield on cost rather than whole life carbon and impact, but most would love to get back to having a tangible impact on the built environment.?

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In the current state of sustainability in real estate – where efforts are dominated by compliance and financial justification – we need a shift that allow sustainability professionals focus on their core mission.?

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Now that value is directly linked to sustainability outcomes, perhaps the time has come to rebrand these roles as Head of Value Preservation and let them get on with what they are passionate about and trained for. It’s time for the rest to become rather ordinary and procedural, based on metrics we already have, used intelligently in the next round of underwriting, and built into existing investment decision-making processes.??