The environmental, social and governance (ESG) framework is a critical issue. The green premium drives the need for property investors, property owners and valuers to focus on ESG and incorporate these factors into their investment and valuation criteria.
As for the valuation industry, in simple terms, it means that the real estate sector can no longer focus on generating income from rentals. There is an element of responsibility that society and legislative bodies expect from the property owner. Property developers and owners must now consider environmental issues, social impact, and government regulations. From the “E” perspective, owners and developers must consider, for example, pollution or water contamination.
Socially, they must consider the effect the building has on the safety and livelihood of people on or near the property. For example, is the building creating jobs for people? Surrounding poverty and unemployment can influence the “S” in the ESG score, as can a development that targets the underserved rental market.
The social impact is not limited to the limits of the ESG discussion. The way in which your property, no matter how big or small, affects the surrounding society should be considered by all property owners and owners as a general rule of property.
From a governance perspective, the listed sector is fairly well regulated. But because ESG is an evolving regulatory requirement, it could require mandatory real estate sustainability targets in the future. This is already happening in countries like the UK, which require an Energy Performance Certificate (EPC) every time a property is built, sold or rented.
The “G” in the ESG criteria may become more stringent if companies and the real estate sector fail or take too long to comply.
South Africa was on the cusp of a momentous ruling in the property sector. Starting in December 2022, we were going to see a law enacting the public display of energy performance certificates for properties. But this expiration date was extended by three years to 2025. The intent was to confirm the compliance of various properties with specific energy requirements.
The South African Institute of Valuers encourages people to comply with the legislation to avoid repercussions and take advantage of potential incentives. There may be incentives to go green to gain support for the ESG program, for the betterment of the environment and society.
For example, favorable loans may be given to investors intending to develop green properties, and such incentives may not extend to properties that are not ESG compliant, so investors, owners and property owners may lose .
These ESG incentives can increase green buildings and sustainable real estate development, as more investors will want to use these favorable loans and comply with evolving legislation.
Green buildings have been around for many years, even before there was 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 returns in the short term. As a result, many developers failed to grasp the hype for green building and sustainable development, and now green buildings command a premium price.
The reality is that investors and homeowners who have chosen the green route to develop a property or renovate existing properties are realizing savings on electricity, water, heating and cooling in commercial and residential properties. The current utility model is becoming unsustainable as energy costs rise and power sources become unreliable.
This challenge means that alternative energy sources like solar are becoming more popular. Sustainable buildings and residential properties command a premium during a sale because today’s market demands more sustainable occupancy.
It was interesting to learn from the World Forum on the Built Environment’s 2021 Sustainability Report, which involved thousands of real estate and construction professionals from over 30 countries, that nearly half of those surveyed said they believe sustainable (commercial) properties and residential) command a premium over non-green (brown) properties. The same trend was confirmed in South Africa by recently released quantitative data on the MSCI SA Green Property Index 2022.
We are also seeing the green premium in the rental sector: renters want units with alternative and cleaner energy solutions that are not dependent on the national grid and can ultimately save money as they are responsible for utilities. Renters are willing to pay more for greener options. Also, the owner gets a good return on investment in the long run because the more sustainable green property will sell above the brown property.
For valuers, ESG items provide an opportunity to look at properties beyond general valuation criteria. Now, an appraiser must consider environmental, social and governance aspects in their valuation of properties on the market. The various effects that the property has in terms of ESG will dictate a more favorable valuation than a property that does not score highly on the ESG rating. It is a balancing act between the qualitative and quantitative aspects of a property as part of the valuation exercise.
Valuers must consider and apply evolving ESG requirements to ensure accurate valuations in line with new legislation. They also need to understand what effect ESG-driven additions will have on property values, such as solar panels and battery storage, gas-fired geysers, sustainable lighting, and water retention and recycling units.
Additionally, properties that positively influence the surrounding society will also affect the value and ESG score. New legislative compliance of the properties, such as an energy performance certificate, should be factored into the valuation and would increase the ESG score.
The job of an appraiser now demands an even more objective application of the collective aspects that a potential buyer would take into account in their own determination of the purchase price. This is an emphatic call for appraisers to determine the value in the hands of the market.
With all the debate and confusion about ESG, valuers need to consider the positive effect on the real estate market, and they also need to consider the negative implications of default. It is a new concept that is not well defined in traditional valuation calculations. Appraisers must be aware of all new legislative requirements that may affect the real estate sector, to ensure a fair valuation of assets in the market.
