Why real estate needs Tesla-style buildings, used 'Uber-style'

While the financial industry is still reeling from recent stock market gyrations, it is tempting to forget about long-term issues, such as extreme weather events, the rising sea levels and demographic change. It’s short-termism versus long-term thinking in its purest form. And it’s human. 

But even amidst the current turmoil, there seems to be a sea of change in investment beliefs that is becoming ever more prominent, and ever more articulate: The belief that for long-term investors, long-term trends can have real implications for capital values and income returns. Whether it is drought in western North America, flooding in Chinese cities or the rise of renewable energy, some of these “long-term” trends are starting to become real, happening every day, at many places in the world. 

While long-term trends affect all industries, they are particularly relevant for the real estate sector, where assets are long-lived and typically cannot be moved to another place. Buildings are sitting ducks, subject to changing urban form and consumer preferences. In the real estate sector, attention to information that may affect financial performance traditionally has focused on governance — deal terms, fees, and the like.

Action on buildings

But over the past 10 years, buildings have become a focal point of action on sustainability issues. In the face of climate change, buildings are a big problem, consuming over 40 percent of energy globally. In the face of water scarcity, buildings are a big problem, as significant consumers of potable water. In the face of rising healthcare costs, buildings are again a big part of the problem, often creating barriers to physical activity. 

These issues all have regulatory relevance, and in many regions, countries and jurisdictions, building-specific regulation is introduced to address the impact of buildings on energy, water and health. For investors in real estate, regulatory issues intersect with changing consumer preferences to drive innovation and positive change.

Think, for example, about the changing role of the workplace, from a place to work to a place to meet, with flexible seating arrangements and more attention to desirable common areas. And of course, there’s the “Uberization” of the real estate sector through platforms such as Airbnb. 

An electric car for real estate?

It is an interesting analogy to compare the real estate industry with the automobile industry. Fuel economy standards are common practice, increasing in both Europe and Japan by 30 percent in a bit more than a decade. In the United States and Canada, fuel economy requirements even increased by 40 percent in the last six years. Regulation is paired with increasing consumer awareness through now-ubiquitous MPG stickers.

What’s more, the industry has innovated to mass-produce hybrid and electric-powered vehicles, ranging from the now-common Prius to the highly desirable Tesla. These innovations have led not just to more efficient cars, but also to a new generation of better vehicles and business models, uprooting a century-old industry.

One needs just a little imagination to envision how a new generation of Tesla-style buildings, used “Uber-style,” similarly could uproot the real estate industry.

Ultimately, the capital market will both benefit and suffer from regulations, environmental and social changes, and societal trends. As in any business, effective action by investors requires data. Information transparency enables better investment, empowering decision makers to manage risk and find superior returns. Smarter investment will reward innovation, ultimately driving market transformation.

The ESG factor

The buzzword to measure the ability of companies to respond to long-term trends is ESG or sustainability performance, encompassing environmental, social and governance factors. In fact, companies that better understand the implications of ESG trends can be better positioned to generate higher, more stable returns in the short run, as ESG management is often a useful proxy for superior management. 

Comparable to cars, many “nutrition labels” are available for individual buildings, such as BREEAM, LEED and Green Star. But buildings are often part of larger portfolios, and many investors, such as pension funds, mutual funds, bank insurance companies, endowments, etc., never touch individual properties, preferring to invest indirectly through property companies (REITs) and funds. GRESB provides these investors with a systematic, annual assessment of portfolio ESG performance — a “nutrition label” for real estate companies and funds, comparable to Morningstar ratings for mutual funds or Consumer Reports ratings for Teslas.

The GRESB ESG label enables large investors to be smart shoppers. Today, most real estate investment decisions are made without regard to health, energy, water and so forth — not with malice, just ignorance. This means that there is a significant opportunity for investors to ask for basic information and begin to consider the most important issues. Over time, the market will respond to their interests. Their attention will drive performance. 

Ratings and returns

In 2015, 707 property companies and funds were rated by GRESB, representing $2.3 trillion in commercial real estate and some 61,000 assets. The 2015 GRESB data shows that the global real estate sector is increasingly integrating environmental, social and governance considerations into corporate policies and business strategy, and, critically, backing this up with on-the-ground implementation and improvements in performance.

In aggregate, the sector reported a colossal energy consumption of 109 Terawatt-hours in 2014, but it notably reduced its consumption by 2.87 percent since 2013. Water consumption also decreased significantly, by almost 2 percent or 6.6 million cubic meters. There is also a significant uptake in renewable energy with on-site renewable energy generation increasing to 445GWh in 2015 from 296GWh in 2014.

Analogous to the automobile industry, the commercial real estate sector has the capital power and innovative capacity to provide solutions to the problem of which it is an inextricable part. Regulation and changing consumer preferences will spur the need for these solutions.

Our collective capital, managed by pension funds, banks and other financial institutions, will be an important part of the transformation to a more efficient, more sustainable built environment. This is not for reasons of philanthropy, but for reasons that the financial industry understands best: improving returns and reducing risk, both in the short term and in the long term.