Demand for green buildings to revive commercial real estate

This article first appeard in Business Day on 7 June 2021

R100bn green buildings demand could revive SA’s stagnant commercial real estate market

By Nigel Beck

As South African corporates strategically align themselves to the green economy by committing to carbon neutral and net zero emissions, so the demand will sharply increase for green certified buildings to rent or own.

Green buildings play a pivotal role in spurring clean energy and securing a transition to low-carbon economies for an increasing number of companies and governments.

This shift could be a new source of growth for the commercial real estate market in South Africa, which needs to transform in order to attract green-minded tenants or risk becoming vacant - and ultimately a stranded asset.

Real Estate Investment Trusts (REITs) the world over are still struggling from declining demand for office space, as a result of the lockdowns, even as the world inches closer to returning to work. The hybrid model of working from home and an office is likely to be the new normal for some time to come.

The question remains how the transformation of existing buildings could be funded, given that it is a costly process at a time when REITs face falling rentals and higher vacancies.

There are similar financing and sustainability challenges for real estate developers. 

They must keep pace with tenants 'green demands’ for energy and water efficiency, with respect to both existing and new leases. Developers will increasingly need to build green buildings in order to differentiate their offering, while attracting investors who are progressively keen on directing their money into green initiatives.

Enter the Climate Bond Initiative (CBI), an international organisation working solely to mobilise the largest capital market of all, the $100 trillion bond market, for climate change and green solutions. They promote investment in projects and assets necessary for a rapid transition to a low carbon and climate resilient economy.

Currently, in South Africa’s commercial property sector, R4.7bn ($330m) worth of buildings meet the CBI criteria, but it is estimated that R100bn ($7bn) of new or refurbished buildings could potentially qualify as green buildings as per the Green Buildings Principles. The Principles are based on conserving resources and minimising the environmental and health impacts of buildings while ensuring they are energy efficient.

The South African opportunity is part of the global green buildings sector which represents a $24.7 trillion investment opportunity by 2030 across all emerging market cities (with a population of more than half a million people).

As the demand for sustainability rises, there is a growing niche market for green finance as issuers, building buyers and renters become increasingly ESG (Environmental, Social and Corporate Governance) focused.

We expect to see several climate and green bonds and loans issued by large corporates and REITs in South Africa in the coming years, which will radically transform the commercial property stock.

The reasons are compelling for all parties.

According to the IFC (International Finance Corporation) - a sister organisation of the World Bank and member of the World Bank Group - there is a strong business case for growing the green buildings market.

Their research indicates that green buildings, or buildings that use energy and water more efficiently, are a higher-value, lower-risk asset than standard structures.

The IFC notes that while building green could range from 0.5 percent to 12 percent in additional costs, green buildings can decrease operational costs by up to 37 percent, achieve higher sale premiums of up to 31 percent and faster sale times. They also have up to 23 percent higher occupancy rates, and have superior rental income of up to 8 percent.

Issuing Green Bonds effectively links sustainable development and green buildings with capital markets. Savvy investors understand the financial benefits of green buildings from lower long-term operating and maintenance costs to potentially higher returns on investment.

The bonds give investors bespoke opportunities to participate in supporting greater environmental sustainability and climate change mitigation and enables them to easily evaluate the environmental impact of their investment.

In response to the evolving sustainability concerns, landlords and property management companies can make good use of effective tenant engagement to disseminate sustainability-related information and attain continuous improvement of the occupancy’s environmental, social and governance performance.

Conducive tenant engagement brings abundant advantages. Tangible ones include reduction in water and energy consumption, and hence utility cost savings, whereas intangible ones refer to enhancement in environmental awareness, fostering landlord-tenant communication, improving overall environment of occupancy, and promoting health and well-being of occupants.

As a large and liquid green and climate bond market develops, it will help drive down the cost of capital for climate projects in developed and particularly in emerging markets.

South Africa faces a transformative time in the overhauling and greening of a substantial amount of its building stock for which capital is becoming increasingly available.

The RMB Sustainable Finance & ESG advisory team is working closely with a rapidly growing number of real estate clients on sustainable products such is the acute interest.

Beck is Head of Sustainable Finance and ESG Advisory at RMB

Contact:

Nigel Beck l Rand Merchant Bank l nigel.beck@rmb.co.za

Kate Kelly l Rand Merchant Bank l kate.kelly@rmb.co.za l +27 79 637 4663