Surveying the sustainable and environmental legal and market challenges for real estate

Surveying the sustainable and environmental legal and market challenges for real estate

Colleen Theron and Malcolm Dowden

6.1 Introduction

It has been estimated that the built environment in its widest sense (including construction) is responsible overall for about 40 per cent of carbon dioxide emissions, as well as 40 per cent of all energy used. Commercial property is a major contributor to this.

Despite the recent negative publicity challenging the scientific evidence underpinning climate change, the consensus seems to remain that climate change must be tackled and cutting carbon emissions is critical to achieving this. As a result (and notwithstanding the global economic downturn and the depressed property market), legislation and policy developments at global and national level has continued to crystallise solutions for reducing greenhouse gas emissions (GHG), including the built environment. In the United States, states and local governments have embraced green real estate initiatives, ahead of federal legislation. Since 2005 there has been an increase in approved green building polices from 13 to 31.

In the UK, the drive towards a low carbon economy has led to a number of policy and legislative initiatives to tackle the reduction of carbon in buildings, such as the low carbon transition plan and the consultation on zero carbon for non domestic buildings. The agenda has also been driven by directives from the European Union, which member states are bound to implement. Owners and managers of existing commercial property buildings are finding themselves bound by a raft of new environmental legislation, such as energy efficiency standards for buildings; a mandatory carbon emission reduction scheme (where the organisation produces electricity above a threshold of 6000kM per half hour); and revised building regulations.1 Legislative and market pressure is also being put on the property industry to design, construct, use and demolish buildings in a way that both mitigates and adapts to climate change. As the impact of climate change and resource pressures deepen, the effect on asset value will increase. The creation of the coalition government in the UK has not deterred from the theme of a ‘green economy’, including incentivisation for ‘green growth’ and ‘decarbonisation’ of the economy.2

This chapter examines how environmental and sustainability issues are challenging ‘business as usual’ models in the real estate sector, outlining key mandatory and voluntary requirements for ‘green buildings’.

6.2 Is sustainability green?

There is widespread and considerable interest in the topic of sustainability and sustainable construction. However, there is also a good deal of confusion over the terms used. The term ‘sustainable development’ is often confused with environmental protection, and many limit the scope of sustainability to consideration only of environment issues (Schleich et al., 20093).

The concept of ‘sustainable development’ is not always interpreted in the same way by different countries. The standard definition is the one contained in the Brundtland Report, namely

Sustainable development that meets the needs of the present without compromising the ability of future generations to meet their needs.4

‘Sustainability’ as a legal term has its origins in the ‘soft law’ of international conventions. This means that it is too vague for breach to give rise to legal sanction (Keay, 1990). In the UK the statutory guidance issued to the Environment Agency to supplement the Environment Act 1995 adopts the ‘Brundtland’ definition of sustainable development.

The concept of ‘sustainability’ is also often used interchangeably with the concept of Corporate Social Responsibility (CSR) at corporate levels, but clarity on the differences is important for the way business behaves. The European Union started to develop the concept of CSR in 2000/2001 in line with the strategy adopted in Lisbon in 2000. The so called Lisbon objective called on the EU to become the foremost economy in the world, focusing on sustainable economic growth and greater social cohesion by 2010 (Loew et al., 2004). The EU’s sustainability strategy is also tied up with the Lisbon objective. From a business perspective CSR came first and was primarily concerned with social matters. Sustainable development emerged from the environmental protection debate. The Brundtland Commission concluded that social, ecological and economic concerns must be given equal weight. CSR tends to be restricted to ecological and social challenges and economic contributions to sustainability are not considered in detail. Whilst the concepts overlap they are applied differently.

Sustainability, in the context of the business world, is used to refer to how environmental, social and economic considerations are integrated into corporate strategy and capital markets for the long term. Companies, historically, have separated financial issues from non-financial aspects of their business. This started changing with the onset of increased pressure by stakeholders and society for more transparency about governance and the impact that companies have on their surrounding environment. Ceres5 states that the ‘license to operate’ can no longer be taken for granted by business. Companies, they suggest, cannot consider sustainability challenges in isolation. A recent Pricewaterhouse Coopers survey of 140 chief executives of US-based multilateral companies found that 85 per cent of them believe that sustainable development will be even more important to their business model in five years time than it is today. This should extend to real estate investors and major developers.

In the real estate sector, environmentally sustainable buildings are also referred to as ‘green buildings’. Although, ‘green buildings’ have been used as a synonym for sustainability, this has often led to sustainability being understood from an environmental perspective, neglecting the social and economic perspectives. Despite the lack of a universally agreed definition of ‘sustainable buildings’, as the market evolves and as new metrics and regulation are developed and implemented, consensus may emerge. The practice of ‘green building’ is seen as the practice of creating structures and using processes that are environmentally responsible and resource efficient throughout a building’s life cycle from siting to design, construction, operation, maintenance, renovation and deconstruction. There is an assumption that sustainable property will perform beyond the baseline of compliance and that it will offer considerable benefits over and above conventional or merely compliant property.

6.3 What are the drivers?

A major driver for sustainability in the real estate sector has been the growth in environmental legislation to regulate the impact a property has on the environment through its whole life cycle. The overall increase in legislation at both international, EU and domestic level does not show signs of any abatement, which will continue to drive change. It is believed that the environmental and social aspects of sustainability will also impact on property performance.

However, there are relatively few studies that have been undertaken about the business case to promote sustainable development in the real estate sector. In 2010 the RICS Foundation, in conjunction with Kingston University, London issued a report entitled “Is sustainability reflected in commercial property process: an analysis of the evidence base’.6 The report assessed the evidence that exists on whether sustainability is reflected in commercial property prices. It found that although the last ten years has shown an increase in reports on the business case for sustainable property, very few large-scale empirical studies have been undertaken. The greatest number of reports are US based. The conclusions in the report emphasise the need for a clear definition of sustainable buildings and what sustainability features really matter to tenants and building occupiers. The provision of meaningful benchmarks will be able to support valuers in the preparation of valuations. To complement this report, the RICS believes that further research is needed in relation to the financial performance of sustainable buildings.

A joint study undertaken by the University of Regensburg and Helsinki University of Technology (Schleich Report) identifying the drivers of sustainability in real estate practice, confirms the limited availability of research in this area. Whilst some mention is made of the corporate drivers, the study focused on three main property-led drivers, namely increased rental level, decreased property costs and decreased risks.

6.3.1 Increased rental level

Those studies that have analysed the comparative data of energy costs of green buildings to other conventional buildings show reductions of energy use and savings between 6 and 30 per cent.

The Schleich Report highlights that surveys conducted by Jones Lang LaSalle7 (2008) amongst corporate occupants globally, and a survey undertaken by Cushman and Wakefield (2009) show signs of a willingness to pay for rental premiums for sustainable space, the range of the size of the premium varying from 2–12 per cent.

It is believed that a tenant’s willingness to pay premiums for sustainable real estate is a result of increased occupant productivity, potential image benefits and lower running costs.

However, the evidence of a willingness to pay premium rents is far from conclusive. Perceived benefits such as lower operating costs depend on occupier behaviour and where that is achieved in whole or in part by the imposition of ‘green lease’ obligations, it may be that increased obligations or more rigorous restrictions on use would in fact blunt any argument that the landlord should receive an enhanced rent.8

6.3.2 Lower operating costs

Lower operating costs are considered to be an issue promoting sustainable buildings. Empirical evidence indicates that operating costs of certified buildings are lower compared to non-certified buildings. A study in 2008 by Miller et al. indicated lower operating costs on a sample of 243 certified and 2,000 non-certified buildings.

6.3.3 Decreased risks

The decreased risk associated with sustainable buildings arises from the perception of lower vacancy rates; however, this is not conclusive.

6.3.4 Reputation

There is a corporate driver for improving reputation, by publishing CSR reports and Carbon Disclosure reports. The drive towards mandatory reporting across the globe will no doubt see an increase in more information being available about property companies. Also, as more companies embrace ‘sustainability’ in the way they develop their strategies and reporting, this should lead to more transparent information. Theoretically, such positioning by corporations should translate through market mechanisms into increased demand for sustainable property. Although the principles of sustainability may be embedded in the policies of some property owners and occupiers, translating them into property decisions has been difficult.

6.3.5 External factors

Another external driver is the issue of how much weight asset managers of institutional investors are giving to sustainability and climate-related issues. A study by Jones Lang LaSalle in 2008 sought to make the claim that investing in accredited or sustainable stock either does or may yield higher returns and other benefits.

6.4 Are real estate investors interested in energy efficiency?

A 2010 report ‘Energy Efficiency in Real Estate Portfolios’9 published by Ceres, and Mercer,10 outlines the business case for investing in energy efficiency on the basis that it enhances value in real estate portfolios.

The report aims to provide direct and indirect real estate investors with the background information, academic and industry research, case studies, key steps and best practices for integrating energy efficiency across their portfolios.

The report also states that fiduciaries responsible for these portfolios may assume unnecessary risk and overlook substantial opportunities to enhance returns if they fail to factor energy efficiency into their real estate investment decisions. A further Ceres report on Asset managers’ practices (Ceres, 2010) highlights specific best practices that asset managers are purporting to use to incorporate climate risks into their due diligence, corporate governance and portfolio valuation. However, the report states that there are very few asset managers actually doing this.

The issues raised in these reports highlight that climate risks and opportunities are rising on the investment agenda as environmental, social and economic implications of climate change begin to crystallize.

6.5 Legal standards for sustainability

The life cycle of a commercial property is affected by both legal and voluntary standards for sustainability. Pressure is mounting for all parties involved in real estate to do more to achieve sustainability throughout the lifecycle of a building, from design to demolition.

6.6 Building design

6.6.1 Legal standards

The Building Regulations 2000, as amended (BR2000) set out a minimum sustainability standard relating to, for example, energy and water efficiency. The local authority may refuse to issue a completion certificate if the new buildings fail to meet the BR2000 standards.

The impact of the Flood and Water Management Act 2010 will also require developments to be designed to prevent surface water run-off.

The main voluntary tool for assessing the sustainability of new commercial buildings is the Building Research Establishment Environmental Assessment Method (BREEAM). BREEAM awards new commercial buildings a ‘rating’ measuring their level of sustainability over and above the minimum requirements of the BR2000. It does not, however, address existing buildings.

The Green Rating11 is a new alternative to BREEAM. It is an assessment of the energy efficiency of a building that looks at both the building materials and the waste generated by the building. It is an international standard intended to allow companies with an international property portfolio to accurately measure the efficiency of their sites.

Other sustainability assessment tools are LEED (Leadership in Energy and Environmental Design) developed in the United States and Canada; and Green Star and NABERS (National Australian Built Environmental Rating System) developed in Australia.

6.7 The planning system

6.7.1 Local authorities

The UK planning system increasingly requires the promotion of sustainable development in planning applications.

The Planning Act 2004 requires local planning authorities to exercise their planning powers with the objective of contributing to the achievement of sustainable development, taking into account government Planning Policy Statements (PPS) (such as PPS 1 and 22) promoting on-site renewable or lowcarbon energy generation when drafting development plans. In their capacity as ‘reporting authorities’ under the Climate Change Act 2008, local planning authorities also have a crucial role to play in climate change mitigation, adaptation and in facilitating transition to a low-carbon economy.

The result is that developers are increasingly required to ‘front load’ their planning applications with details at the outline planning stage of sustainability considerations. Developers also have to include sustainability standards for new developments as a planning obligation under Section 106 Agreements.

For local planning authorities, though, demonstrating compliance with increasingly broad and complex statutory duties at a time of significant public sector retrenchment is a major challenge. The UK’s coalition government has announced a radical shift towards a localized planning system, abolishing regional planning bodies and policies and allowing local planning authorities to produce local plans within a single broad national framework. This move towards ‘local democracy’, including enhanced rights for local residents to challenge planning decisions, may exacerbate the difficulties faced by unpopular developments, such as waste and energy from waste projects.12

6.7.2 Environmental impact assessment

Under the Town and Country Planning (EIA) (England and Wales) Regulations 1999, planning applications for major developments are required to be accompanied by an environmental statement detailing the likely impacts on the environment, and measures to be taken to mitigate those impacts.

6.8 Construction of new buildings

6.8.1 JCT contracts

The standard form of contract13 used by the construction industry (drafted by the Joint Contracts Tribunal) has recently been amended to include sustainability clauses. The sustainability clauses and guidance do not impose a rigid set of targets upon parties, but instead create a framework in which a contract can include sustainability criteria.

6.8.2 Waste management

Waste is of increasing environmental and economic significance as the increasing regulatory pressure and rising cost of landfill taxes is making waste management a significant cost issue for many organizations.

The Site Waste Management Regulations 2008 require developers of projects worth over £300,000 to prepare a Site Waste Management Plan (SWMP). The SWMP will record details of the construction project, estimate the types and quantities of waste that will be produced and confirm the actual waste types generated and how they have been managed.

Buildings also have to be constructed by using the correct materials. Both these requirements will place additional burdens on the principal contractors to ensure that any subcontracts include the necessary provisions to ensure that sustainability and environmental issues are covered.

6.8.3 Land remediation

The RICS highlights that many sustainable building rating systems take into account land use. Valuers should take land use into account where buildings are constructed on brownfield land and watercourse setbacks. Where land has been constructed on previously developed land, issues of potential contamination must be considered as this may bear a risk of outlay in terms of cost and/or insurance against potential problems in the future.

It is not only valuers who should consider the potential risk of contamination. Developers intending to build property will need to carry out an environmental assessment of the site, and remove all environmental and health risks before construction can begin.