Will Buildings That Aren’t Green Enough Be Thrown Out of the Market?

Opportunities for ESG investing are on the rise, and before us is an era in which environmental certifications have sway in the world of commercial real estate.

April 26, 2019

Offices aren’t becoming more green

Leased offices aren’t becoming more energy-efficient. The main reason for that is that making them energy-efficient has no advantages for property owners. The owner bears the expenses of energy-efficiency renovations, while the one who is blessed with utility costs saving is the tenant. It doesn’t lead to more income gained from rent, either. For owners, energy-efficiency renovations are a lot of pain, and not much gain. So far, environmental measures in real estate have prioritized cost-effectiveness, focusing on reducing heating and lighting costs. “No energy-efficient renovations unless they cut costs.” Some real estate owners actually think this way.

However, this backward-looking way of thinking about saving energy is already becoming old-fashioned. “In the near future, we’ll be in an era where rental properties that are not made environment-friendly are just asking for their values to drop,” declares Tomoyasu Okuda, the head of JLL Japan’s Energy and Sustainability Services Department, which provides environmental consulting on real estate.

U.S. environmental certification LEED takes the world by storm

Environmental certification system LEED was developed in the United States. JLL Japan is actively providing consulting on acquiring LEED certification. LEED is known all over the world as an indicator used to evaluate a building’s overall friendliness to the environment using metrics such as energy efficiency, water use, transportation, location, pollution and materials, and indoor air quality. All of the items evaluated factor into the final overall score. Certification can be obtained with a total of 40 points or higher, and buildings are given one of four rankings based on their scores. Worldwide, 58,000 buildings or projects have been certified, including over 100 in Japan. Japanese environmental certification CASBEE is also known, but its use is inherently limited to Japan. Meanwhile, LEED is the best-known all over the world, and the environmental certification has very strong appeal to overseas investors.

According to Okuda, “Research shows that, in the U.S., LEED-certified properties have higher occupancy rates and higher rents. It’s a way to increase the value of your real estate, so people are flocking to LEED certification.” As mentioned above, there haven’t been many cases of this certification being acquired in Japan, so there is no visible correlation with rent or occupancy rates. However, LEED certification is now embedded in the global real estate investment market, and having LEED certification or other environmental certifications is an important factor that can sway investment decisions. If LEED certification becomes so mainstream that it becomes a basic requirement, then rather than seeing the advantage of rising rent and occupancy rates, there is a possibility that properties that aren’t certified will be thrown out of the market. “In the past, the majority of our clients asked about what impact LEED certification would have on occupancy rates and rent. But lately, there’s been a big increase in cases where clients are considering LEED certification as a way to appeal to investors with environmentally friendly real estate,” says Okuda. This is because people are starting to see eco-friendliness as a tool to appeal to outsiders by saying that their properties have a social significance, rather than focusing on financial benefits.

More ESG investing serves as a driving force

The fact is that recognition of LEED is still low in the Japanese real estate market. Especially when tenants are looking for office space, there have been practically no cases of requests for LEED-certified properties. The only examples of companies showing preference for LEED-certified green buildings are global companies based in Europe and North America that are actively tackling environmental issues who come to set up base in Japan.

However, the tides are beginning to turn. The reason for that is something the whole world is watching—ESG investing. In 2006, the UN called on institutional investors to invest with a sense of social responsibility, and now, ESG investing is becoming a worldwide trend. As of 2016, such investments were worth 2.5 quadrillion JPY, accounting for one-quarter of the world’s investment money. Investment money is pouring into companies that focus on the environment, society, and governance—topics of social significance—and companies whose efforts regarding ESG are judged by investors as insufficient are being left in the dust. This goes for real estate, as well. “When it comes to real estate investment, eco-friendliness is already basically essential. Companies want to show how friendly to the environment their buildings are, so I think that LEED certification will become more important as time goes on,” predicts Okuda.

An era in which eco-friendliness has a major impact on the value of real estate is right around the corner.