Valuing Net-Zero Assets: Capital markets ponder

from CPM November 2022

Interest Rate Repercussions: Investors await real

PEGGING THE PREMIUM

Capital Markets Ponder Net-Zero Assets

By Alison Chave, Dave Black, Hugues Delmaire, Karen Saarkoppel and Vivian Patel

With ambitious targets and tight timelines, it’s a given that the commercial real estate industry and capital markets will have to be equally committed allies in transitioning Canada’s building stock to low-carbon, climate-resilient assets that provide haven for their occupants and returns for their investors. A new discussion paper from JLL Canada examines some of the key issues, challenges and communication gaps around valuation, financing and finding the right metrics to steer new approaches. The following is an excerpt – Editor.

A LARGE SHARE of worldwide greenhouse gas (GHG) emissions stem from the construction, operation, retrofit and decommissioning of buildings, whether that be existing buildings or new construction. The World Green Building Council estimates that buildings account for 40% of global GHG emissions, but, in a recent JLL report, titled Decarbonizing Cities and Real Estate, the authors find that, within cities, the built environment accounts for a higher proportion still.

In a sample of 32 global cities, the contribution of buildings to citywide emissions averages about 60%. In major hubs such as London and Tokyo, real estate can account for more than 70% of urban emissions. Faced with this, the CRE industry itself has stepped up and, in many cases, committed to shift its operations toward a much greater degree of sustainability.

The CRE industry faces a major disruption that requires a philosophical review of how the market behaves, values its assets and reacts to these new demands and imperatives. The problems raised are complex. Even if corporate environmental, social and governance (ESG) commitments are a step in the right direction, there is a need to define a clear path to a solution.

The journey on this path can begin with how the CRE industry values the built environment. The appraisal and financing processes can provide a strong behavioral lever if practitioners learn to integrate the real impact of the zero-carbon and ESG components, and investors are prepared to

The CRE industry faces a major disruption that requires a philosophical review of how the market behaves, values its assets and reacts to these new demands and imperatives.

accept conclusions that may be ahead of market trends.

But first, fundamental questions need answers: How are appraisals evaluated and presented for green assets? Where do the funds for green loans come from? Is green capital readily available? Are conditions for green loans better than for vanilla (nongreen) loans? How might we prove a green project is loan-worthy? What types of certifications or other key performance indicators (KPIs) are needed?

The expected impact will vary across time and the type of CRE asset considered, whether buildings are new or existing, and will be especially delicate for retrofit projects.

APPRAISERS LOOK TO THE EVIDENCE Appraisers are not like a buyer or purchaser or broker, who establish the newest leasing or transaction benchmark. Rather, they seek to measure how such a typical market participant would price the asset, by interpreting evidence including completed lease deals and property sales, ongoing transactions and bidder trends, indices, supply/demand data and the economic landscape to come to their opinion of value. To that end, one of the biggest challenges is to identify and create this data to apply in practice, and to isolate the impact of particular aspects such as sustainable features to these metrics.

Be it the amount of capital chasing industrial and multi-family in recent years, the evolution of retail and the bifurcation between retailer winners and losers, or the work-from-home phenomenon in office, all these trends have enormous value implications. Attempting to isolate any sort of green premium/brown discount is clearly difficult. As practitioners, appraisers focus on considering the operational benefits (or penalties) that ESG can imply, while simultaneously seeking to justify the effect on capitalization and risk rates.

To try to informally measure that effect, JLL Canada recently surveyed senior investment and valuation professionals across the Canadian CRE industry. They identify and isolate the impacts of a building/project’s ESG, or NZC components, which result in significant outperformance versus a standard build. It is the impact of these components that must be demonstrated, with ways forward for valuation including but not limited to a pair-wise comparison of relative costs and impacts versus the standard or ¨brown¨ equivalent and potentially introducing new sources of value bundled into the ESG components.

As such, the NZC and ESG project components require data impacting valuation in two forms: quantitative and qualitative, as well as the relative cost of each component and the inter-component cost relationship — i.e., how pursuing one project component impacts the cost of another.

Components that can be assessed through quantitative data are easier to handle if enough data is available to model data trends. On the other hand, qualitativebased components present a more difficult challenge since their impact, even if real, is harder to define monetarily. In this last case, further work is needed often on a case-bycase basis to translate the qualitative components into the closest quantitative equivalent that is acceptable to the various market players.

In short: to get a grasp of the true budgetary impact of any NZC or ESG project, one needs to break it down into its various components, evaluate their respective impacts, and if these are sufficiently meaningful as to influence the asset valuation, to integrate them into a mapping to be compared to ¨brown¨ equivalents.

When seen in this light, the nature of the project is meaningless as it is a simple aggregation of specific project components. However, its nature will play a significant role when looking at ways to finance it. zz

were asked how much of a cap rate premium would they be willing to pay on a net-zero carbon asset.

The survey results showed that over half the respondents were willing to pay a 22 to 25 basis points (bps) compression factor, meaning that if a traditional, non-net-zero carbon building was estimated at a 5% capitalization factor, the expected cap rate for a net-zero carbon equivalent building would be 4.75%.

This was true for the retail and office sectors; it dropped slightly when looking at the industrial and residential sectors. From a value perspective, this translates into roughly a 5% pricing premium.

The feedback gained from this survey illustrates both the market understanding that there is an underlying value to net-zero carbon assets — an element of which can be attributed to reduced obsolescence risk — and that there is a willingness to price it. However, the uncertainty surrounding the associated valuations is hindering quick adoption. It is a chicken-and-egg problem: there are few net-zero carbon (NZC) buildings so there is no market evidence of them transacting.

While the Canada Green Building Council (CAGBC) Zero Carbon Building standards exist in Canada, a general global lack of clear NZC certifications or measurement approaches also means that the market may define NZC in different ways. Therefore, there is uncertainty over how appraisers will treat such buildings.

STANDARDIZED DATA NEEDED Other important problems that make assessment difficult include: assessing the sustainable credentials of incremental improvements towards a green building in granularity; the myriad sustainability measurements that exist; and a historic lack of transparency of these KPIs in transactions. There is a need for standardized and benchmarked data, for agreement on how to use that data, and for the necessary education and convincing of market players to accept both the data and its use.

A first-principles approach could JLL Canada’s discussion paper, Capital

Markets Foundations and the Net-Zero

Carbon Transition, can be found at www.jll.ca/ en/views/capital-markets-foundations-net-zerocarbon-transition.

EXCEEDING EXPECTATIONS SINCE 1992

Premier Elevator Celebrates 30 Years in Business

What began three decades ago in a small offi ce east of Toronto has grown into a multi-service enterprise serving customers throughout Canada and the US. Since 1992, Premier Elevator has risen above the competition and distinguished itself as a leader in the design, manufacturing, and installation of high-quality elevator interiors.

“The goal, originally, was to bring exceptional service and value to the market—and without a doubt, that’s what we did and continue to do,” said Dino Mele, Executive Manager and Founder. “Our knowledgeable team is fully committed to our single greatest priority: achieving 100% customer satisfaction.”

Like all businesses, Premier Elevator has faced numerous obstacles on the road to success, including economic downturns, Building Code changes, evolving technology and even a global pandemic. But no force among them has been great enough to stand in the way of the company’s progress or ability to adapt under pressure.

As Mele put it, “Keeping ahead of trends, having a strong, reliable team, and sticking to our core values has allowed us to get to where we are today…celebrating 30 successful years in business.”

QUALITY & AESTHETICS Premier’s amazing track record for achieving customer satisfaction has a lot to do with how it designs and builds interiors with a focus on longevity—both aesthetically, and in terms of quality.

“To do this, we rely on extensive project documentation including 3D renderings, graphics, illustrations, fabrication approvals and material content inventories that go beyond what any of our competitors provide,” Mele said. “Our engineers and licensed mechanics have worked with hundreds of satisfi ed clients over the years, bringing quality fabrications, timely installations, and designs to fi t all customer needs and expectations.”

In fact, step into any number of high-rise offi ce towers or hotels in downtown Toronto and chances are you’ll be surrounded by the craftsmanship of a Premier Elevator interior. Some notable projects include: 81 Bay Street, BMW Toronto, 1 York, 16 York, 18 York, 160 Front Street, 44 King Street W, Ritz Carlton, Four Seasons Yorkville, MaRs, M-City and Sugar Wharf, to name a few.

But each building holds a special signifi cance for Mele. “Every custom interior we’ve designed since 1992 is one we are proud of,” he said. “It’s been a pleasure to deliver the best products and services we can to our customers—customers, that in some cases, have been with us since the beginning.”

EYE ON THE FUTURE As the world enters a new post-pandemic era, Premier Elevator is looking forward to more growth and continuing to uphold its reputation as a leading, reliable service provider.

“Buildings are changing dramatically; they’re getting taller, smarter, and more resilient to meet Canada’s net zero targets in 2050,” Mele said. “Our custom elevator interiors and how we approach design already refl ect these changes, whether it’s through our materials, our processes or the way we operate with sustainability as a priority.”

Congratulations PREMIER ELEVATOR. Here’s to the next 30 YEARS!

For more information on Premier Elevator, visit: www.premierelevator.com.

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