Energy Efficient Assets Deliver Stronger Investment Returns, Reports CBRE
Energy-efficient commercial property assets recorded stronger investment performance compared to inefficient assets over the period from Q1 2021 to Q2 2023, according to the inaugural Sustainability Index report produced by CBRE, with annualised total returns at 1.1% compared to -0.6% for inefficient assets.
CBRE’s new Sustainability Index tracks the capital value growth, rental value growth, and total returns of assets categorised as either efficient or inefficient based on Energy Performance Certificates (EPCs). Assets with EPCs that are predominantly A or B are categorised as efficient and assets with EPCs that are predominantly C or lower are categorised as inefficient.
The research analysed correspondence between the energy efficiency of assets and their investment performance, both at an all-property level and for three main sectors of the UK commercial real estate market. It is based on more than 1,000 assets valued regularly by CBRE, with a total capital value of £17.7 billion as at Q2 2023.
At an all-property level, annualised capital value growth was -0.2% for efficient assets compared to -2.1% for inefficient assets. Annualised rental value growth was 4.2% for efficient assets and 4.4% for inefficient assets over this period.
At an all property level, efficient assets are reporting stronger investment performance compared to inefficient assets, but this story varies at the sector level. The outperformance of efficient assets is most pronounced in the office sector, present in the retail sector, and absent, for now, in the industrial sector.
The CBRE Sustainability Index will allow us to see how energy efficiency is reflected in asset valuations into the future as we continue to track quarterly valuations against EPCs into 2024 and beyond. This will give the market greater clarity on how sustainability, and specifically EPCs, affects investment performance and value in UK Commercial Real Estate.
Stronger performance for efficient assets has been most pronounced in the Office sector. Measuring from index inception in Q1 2021, annualised total returns for Efficient Offices were -1.4% compared to -4.6% for Inefficient Offices. The annualised capital value growth was -2.5% for Efficient Offices compared with -5.9% for Inefficient Offices, while annualised rental value growth was 4.2% for Efficient Offices and 2.9% for Inefficient Offices.
“The results arguably reflect the two-tier state of the office market in which there is still a large supply of older and energy inefficient secondary stock for which demand is low and CapEx costs are high. In contrast, demand for good quality, energy-efficient offices has been high, with tenants increasingly motivated to occupy energy efficient space due to corporate net zero targets,” added Carson.
Stronger performance was also recorded by efficient assets in the Retail sector. Annualised total returns for Efficient Retail assets since index inception were 2.6% compared with -0.6% for Inefficient Retail assets. However, the results are influenced by the mix of assets in the efficient and inefficient samples, as the efficient sample for the Retail sector is more weighted towards retail warehouses and the inefficient sample is more weighted towards high street shops. This contributes to a large difference in capital value growth and total returns for efficient versus inefficient assets, with efficient asset performance reflecting the stronger performance of retail warehouses over the 10 quarters covered by the index.
For the Industrial sector, efficient assets recording slightly weaker investment performance overall. Annualised total returns for Efficient Industrial assets since index inception were 3.0% compared to 3.5% for Inefficient Industrial assets. Annualised capital value growth has been 1.7% for Efficient Assets and 2.2% for Inefficient Assets in the industrial sector, while annualised rental growth was 7.5% for Efficient assets compared to 9.3% for Inefficient assets.
“Greater energy efficiency in the industrial sector might not have resulted in better performance over this period because other, stronger forces have been driving capital and rental growth. Demand has been high for industrial space while supply to date has remained constrained. Therefore, energy efficiency is not yet valued to the same degree as in offices, and pressures to upgrade existing assets that would entail capital costs have been more limited,” concluded Radcliffe.