Ksenia Agapova

International environmental standards and property valuation

According to statistics from the US Green Building Council, the number of certified buildings worldwide is increasing by 35-50% annually. In Russia, in particular, over 1 million square meters of commercial projects have been certified over the past 4 years.
In this article we are talking about certified objects (according to the international systems LEED, BREEAM and DGNB), because only having a certificate makes it possible to compare different buildings according to the degree of eco-friendliness, as well as to guarantee certain clearly defined environmental benefits.
Mechanisms for the development of the green building market
Gradual "greening" of the real estate market dictates the appearance of new approaches to objects' valuation. Despite the decline in general economic activity in the construction sector, the dynamics of the eco-building market remains at a high level. For example, office buildings are a vivid example of a change in the market perception of real estate quality.
Since 2000, the number of new "green" offices has increased by 25 times compared to traditional ones. RREEF Alternative Investments predicts that this trend will increase in the future. This is explained in terms of Everett Rogers' diffusion model of innovation theory.
In the process of existence, all innovations (environmental certification refers to organizational innovations) undergo four key stages:
knowledge or awareness of innovation (for eco-certification this is a long past stage);

persuasion through appreciation of the merits of innovation (also a stage passed);

the decision to accept or not accept an innovation (a stage that comes to an end in Russia and is accepted in most developed countries);

confirmation of the correctness of the decision taken (at this stage is the market of eco-building in most developed countries - USA, Europe).

For example, in 2007, green buildings accounted for 3% of the U.S. market compared to traditional buildings and 11% of the U.S. market, now these figures reach, according to various sources, 25-30%. As green technologies are introduced, awareness of end users increases. Thinking paradigms are changing, and employees are beginning to "demand" green offices from employers. In addition, international certification systems are gradually being adapted and their implementation simplified. More and more professionals with skills in this field are appearing. According to the US Green Building Council, the number of projects registered for certification is now eight times higher than the number of buildings already certified.
Analysts predict that as the green building market grows, more and more green building technologies will become commonplace and at some point green building construction will become the norm. At the same time, the value of non-green buildings will be discounted as not meeting generally accepted standards. Despite the fact that we are still at the beginning of our journey in this direction, the increasing demand for green offices and buildings, the emergence and adaptation of international standards speak for a gradual change of the market situation towards greenery.

However, as long as there is no clear mechanism for calculating the added value of green building, investors have no financial interest in investing in green buildings. The emergence of such a mechanism could provide an additional incentive for green investment.

Environmental factors affecting property valuation

International Valuation Standards define market value as "the estimated amount for which an asset or liability would be exchanged on the date of valuation between a willing buyer and an willing seller in an arm's length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion". There are many methods to determine market value. The most common of these are the revenue approach, cost approach and comparative approach.

According to the Federal Valuation Standard, the comparative approach is a set of methods for assessing the value of an object of assessment, based on comparing the object of assessment with its analogues, for which information on prices is available.

When estimating the value of certified buildings by comparative method, the main problem is to allocate the "green" component in the added value, as there is not enough information on the market about the sample of such buildings (to date, only about 1% of quality office space has been built and certified according to environmental standards). Even fewer transactions have been recorded, which would allow to determine the value-added of certified buildings in the sale.

The income approach to real estate valuation is based on determining the value of the property based on the calculation of expected income from the use of the property. The income approach is the most progressive, as many Western experts believe that it reflects the value of the asset for business most accurately. The following methods are used in calculating the income approach:

- income capitalization;
- discounting of cash flows.

Under the direct capitalization technology, the value is determined by the ratio of net operating income before tax to the capitalization rate. The capitalization rate is determined by the appraiser based on the amount of the base rate by adjusting it for risks.

The discounted cash flow method is applied when cash flows are not evenly distributed (unstable income) and when different capitalization ratios are used. According to the method, the value of an object is determined as the sum of discounted income on the project. For this purpose it is necessary to define the cash flow model and make a forecast of expenses and investments for the selected period. The discount rate is determined taking into account the same parameters as in the capitalization method.

In case of valuation of a certified asset using the income method at the current stage of market development, it is difficult to determine the premium to the average rental rate associated with the "green" of the asset due to the lack of a large number of green offers. This undoubtedly complicates the process of economic evaluation of future cash flows. Nevertheless, the income approach takes into account such factors as asset purchase, rental rate, yield growth, risks, asset obsolescence, maintenance and operating expenses. The value of environmental standards in monetary terms is identified here by reducing operating expenses during the life cycle of the asset and also by reducing the rate of obsolescence of the asset. The reduction of operating costs goes in two directions. On the one hand, ecological buildings are more economical, which leads to lower utility costs, reduced frequency of replacement of equipment and structural elements of the building through more thorough design and maintenance.

On the other hand, operating costs can be increased by increasing the cost of technical maintenance (as a rule, such facilities require more qualified personnel in the maintenance service).

When calculating savings, it is also necessary to keep in mind the share of utility payments in total operating costs - usually no more than 20%. In this case, the annual increase in the cost of utilities in Russia is 5-9%, which should also be taken into account when compiling the financial model. It is important to note that the rise in the cost of public utilities in any case is less than the refinancing rate of the Central Bank of Russia, which directly affects the discount rate. In other words, the growth rate of resource prices is lower than the growth rate of the cost of capital in Russia, so savings on utility payments will not significantly affect the reduction of the above operating costs (taking into account the discount rate).

The calculation of the reduction of operational costs by reducing consumption of resources (water, energy and waste) is sufficiently transparent and has a developed methodology. Nevertheless, the calculation of reducing maintenance and insurance costs for ecological buildings has not yet been studied, although it is a more significant part of the "monetary" advantages of certified buildings.

Cost approach - a set of valuation methods, in which the value of an object is equal to the sum of the land plot and the cost of reproducing all improvements, less accumulated depreciation and the cost of liabilities. In calculating the cost approach, the reproduction value of green buildings will increase due to increased quality requirements for building materials and equipment (according to international statistics, by 1-10% of the total cost of capital expenditures), but the depreciation rate of such buildings will be lower as a result of more high-tech operation.

Conclusions

To sum up, the following results can be expected when evaluating certified buildings using various methods:
- no changes in value due to the small number of transactions on the market with this type of objects (comparative approach);
- an insignificant increase in the value of the asset in the discounted cash flow valuation method due to a decrease in operating costs and a decrease in the asset obsolescence ratio (the income approach). This decrease can be compensated for by an increase in the cost of technical operation of the object;
- an increase in value due to an increase in capital costs and asset quality, and a decrease in the asset obsolescence ratio (cost approach).

Other value added factors
In addition to the traditional cash-based valuation approach, the following value added factors should be considered when transacting with certified buildings:
- reduction of risk of loss;
- sustainable competitive advantages, such as an image and reputation of the company as responsible and positive;
- increased loyalty of future users of the building (tenants, guests, buyers or occupants).

Despite the fact that these factors are difficult to determine in monetary terms, they have a very strong impact on the perception of the value of the asset, as well as on its profitability. Reduced utility bills are an important factor in the perception of the asset as efficient and risk-free for the building's users and future buyers.

Savings have been accumulated over many years, which can reduce total operating costs. According to benchmarking data, there is a worldwide trend towards lower utility costs for buildings (e.g. office buildings constructed between 1990 and 2003 consumed around 400-600 kWh/m2, while buildings constructed between 2003 and 2013 already consume around 250-300 kWh/m2). However, for certified buildings the consumption reduction can reach up to 20-30 % compared to the standard one.

Reducing the risk of losses is another important factor in increasing the perceived value of an asset. Studies confirm that certified buildings increase the productivity of employees and increase sales turnover. Employee morbidity in the building is reduced by improving the quality and comfort of the indoor environment.

Marketing advantages form the bulk of the intangible component of the green asset value. Compared to traditional buildings, certified buildings are the most attractive for buyers and tenants. This forms an added value for the owner. Very often the Russian market forgets the simple truth "time is money" and does not take into account downtime factors of objects on the market. To a large extent, this perception was promoted by the period of increased rental demand in Russia, associated with a shortage of quality commercial real estate.

As the market saturation changes, tenants and buyers begin to compare and choose, based on more and more detailed quality criteria. In this regard, green buildings stand out significantly among the traditional ones, as they are rented and sold much faster.

If a buyer has a choice between two similar objects, but energy efficiency and sustainability of one of the objects will be obvious - the chances of finding a buyer are much higher. Recent research shows that energy efficiency and sustainability are the most important indicators of asset quality for future users and investors.

The problem of development of the green real estate valuation market

Of course, the financial assessment of environmental facilities is a very promising area. The main problem with this direction at the moment is the lack of data on the real benefits of green buildings, as well as the overall energy and environmental performance of traditional buildings. In fact, on the Russian market there is no idea about the resource consumption of conventional buildings based on real indicators, which could be considered by appraisers to inform the customer about the quality of the asset.

In developed markets, specialized organizations (associations and alliances, such as the International Sustainability Alliance or Green Building Foundation, for example) have long been in place to help establish clear performance criteria and accumulate data banks. In addition, the market has no clear idea of which systems and certification levels exist and how this will affect the operation of the building in the future.

In every international system (LEED, BREEAM, DGNB) there is a building quality gradation (e.g. Good, Very Good, Excellent, Outstanding in BREEAM). Depending on the gradation, the operating efficiency throughout the life cycle of the building, the efficiency of the facility and the amount of initial capital investment vary.

The logical relationship in the chain "project rating - capital investment level - financial return in operation" has not been proven to date, which reduces the motivation for many developers to "go beyond what is possible". Very often the choice of type and level of certification in the current market situation is dictated by the context of the project (choose what is easier and cheaper to implement), rather than the expected operational benefits.


Tags: #breeam #leed #greenconstruction #assessment

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