Do more sustainable REITs generate greater cash flow than their “non-green” brethren? A study titled “Decomposing the Value Effects of Sustainable Investment: International Evidence” provides insight into this question.
Spoiler alert… The answer is yes and the result is about a 5% increase in property level and corporate level cash flows available for distribution to shareholders.
The researchers, Avis Devine, Eva Steiner and Erkan Yönder, utilize a series of regression models to assess the influence of sustainable building certification on the following REIT performance variables:
- Rental revenue
- Rental operating expense
- Net operating income (NOI)
- Interest expense
- General and administrative expenses (G&A)
- Funds from operations (FFO)
Sustainable REITs and Funds from Operations (FFO)
Publicly traded REITs in the U.S. and U.K. with a larger share of properties certified to voluntary green building standards showed greater cash flow than publicly traded real estate investment trusts (REITs) with fewer green building certifications.
The team of researchers focus on the impact of the three dominant green building certification systems in the U.S. and U.K. markets:
- Leadership in Energy and Environmental Design (LEED)
- Energy Star
- Building Research Establishment’s Environmental Assessment Method (BREEAM)
LEED and Energy Star are dominant in the U.S. and BREEAM is dominant in the U.K.
In the U.S. the researchers found a statistically significant positive effect on cash flow for REITs that made sustainability investments. In the U.K. REITs with a greater share of sustainable properties showed more positive results to Net Operating Income (NOI).
U.K. Environmental Disclosure Requirements
The benefits of REIT sustainability on cash flow (aka “funds from operations”) in the U.S. was more pronounced than in the U.K.
Because environmental performance reporting is mandatory in the U.K. this may increase transparency in the market for CRE transactions, thereby improving the overall value of commercial real estate that trades in the U.K. market.
Therefore, the opportunity for superior performance by sustainable REITs in the U.K., relative to their less sustainable U.K. REIT peers, may seem less impressive than in the U.S.
However, U.S. REITs are not subject to mandatory environmental performance reporting.
Because the energy efficiency and sustainability enhances market transparency and drives superior cash flow for buildings in the U.S., publicly traded REITs in the U.S. without a sustainability strategy have the opportunity to improve their performance beyond their peers by seeking green building certification.
The Benefits of LEED and Energy Star in the U.S.
U.S. REITs may boost cash flows by pursuing voluntary green building certification through LEED, Energy Star or BREEAM.
Another recently published working paper titled, “On the Value of Environmental Certification in the Commercial Real Estate Market” further supports the case for U.S. commercial green building certification through LEED and Energy Star.
After examining a set of 25,690 commercial buildings in the U.S., the researchers found that the rental, occupancy and pricing levels of environmentally certified buildings remain significantly higher than for non-certified buildings. Their analysis showed a consistent rent and transaction price increment for Energy Star labeled and LEED certified office buildings.
For LEED certified office buildings, the researchers document that the marginal value of certification is higher for newly constructed buildings relative to existing buildings with a LEED certificate.
While energy efficiency performance is often the goal of increasing value in green building, surprisingly the researchers found that Water Efficiency, Materials and Resources, and Sustainable Sites have the largest effect on the effective rent level of the assets in the rental sample of U.S. LEED certified buildings.
As such, LEED and Energy Star certification offer a relatively low-cost strategy for differentiation, and potentially for enhanced performance, in U.S commercial buildings.
This article was originally published on RobFreeman.com