Stranded offices are a siren bell for the residential sector

June 3rd, 2024

Demand from long-term, blue-chip capital will narrow further to target only the most sustainable, fully futureproofed assets, says Amro CEO Raj Kotecha.

Investor demand for the greenest real estate assets continues to grow at a rapid rate, with ESG-focused institutional investment expected to reach $33.9 trillion by 2026, according to PWC.

In a relatively short space of time, ESG has become the defining feature of the investment strategy of every single global blue-chip lender and in turn, every real estate developer seeking to attract high-quality investment capital and attractive borrowing terms.

With EU initiatives such as the Sustainable Finance Disclosure Regulation making it impossible for investors to ignore the environmental impact of real estate, the figures required to retrofit these assets to meet today’s energy efficiency requirements are now becoming clear.

During the current real estate cycle starting in 2024, we will see a clear and widening yield differential within all sectors, between best-in-class green assets and those brown assets where sustainability performance is poor. So far this is most evident in the office sector, and to some extent logistics, with the volume of stranded assets continuing to rise, but residential is not immune.

Lessons to be learned

Whilst non-green office buildings face a shortage of tenant demand, especially in a post-covid era where office occupiers need less space and have the luxury of choice, the same delta between green and brown assets is very likely to develop in the residential market. We are already routinely seeing buildings with high sustainability credentials achieving markedly higher capital values and rents, making them a far more appealing proposition for investors.

According to JLL, living has grown year on year from an 8% share of investment volumes in 2006 to 26% in 2023, whilst office has declined from 46% to 26% over the same period. Last year, living’s share matched the office sector’s for the first time, each representing €43M of capital investment, but this parity won’t continue. It’s clear that the share of living will continue to grow, and office decline, during this cycle.

With the Build to Rent (BTR), co-living and purpose-built student housing (PBSA) sectors still in their relative infancy in the UK and Europe, many developers have benefited from being able to get ahead of the curve, reducing long-term risk by embedding ESG principles into their projects from the outset. This has helped them secure planning permission, attract debt and equity investment, and meet growing demand from discerning tenants who want to live in energy-efficient properties with low bills, quality facilities and connected communities.

When considering the cost of future proofing real estate assets, the fortunes of the commercial real estate sector show us just how bad things could get if we fail to make ESG non-negotiable.

Lenders are setting a high bar

The high ESG expectations being set by lenders will have a significant impact on our sector’s success in achieving decarbonisation, by forcing real estate firms to aim higher than they otherwise might.

Since the start of this year, Amro Partners, the residential real estate firm I cofounded, has attracted a €70m green investment loan from Nuveen, part of the TIAA (Teachers Insurance and Annuity Association of America) to refinance part of our Spanish PBSA Portfolio, and a €17m green development loan from Fiera Capital’s European Real Estate Debt Platform to develop an ESG-leading PBSA project in Alicante.

In both cases, the ESG credentials of the projects involved, all which achieve or target BREEAM Outstanding, Fitwel 3* and WiredScore Platinum ratings, were a critical factor in attracting these blue-chip global lenders who are looking to build lasting relationships with ESG-focused sponsors and create resilient, inflation-linked income streams.

Those residential real estate firms who fall short will find it impossible to compete to attract the highest quality investors and secure finance at affordable rates, meaning the delta between green and non-green assets will continue to widen.

We need standardisation of ESG reporting

As the ability to demonstrate and prove ESG credentials has become more critical, it’s clear that the multiple frameworks for proving it are too complex, fragmented and overlapping. This presents challenges not only for real estate companies looking to accurately benchmark their performance, but equally for investors seeking to differentiate between opportunities.

Going forward, we urgently need standardisation of metrics, and simplification of the process. Capturing, analysing and reporting on highly granular asset level data is fundamentally important if we want to move to a green real estate world. Successful asset managers need to build significant capabilities in this area, reinventing themselves to become analytical, data-driven organisations, embracing entirely new technologies and skillsets, as we at Amro Partners are doing.

Transparency is key, since the complexity of the current frameworks and the lack of granularity provides many opportunities to sweep things under the carpet, but sunlight is said to be the best of disinfectants. By sharing, comparing and learning from each other, real estate firms can build an accurate picture of where they are now and, crucially, understand where they need to get to in order to attract the highest quality investment partners.

This article, authored by co-founder and CEO of Amro Partners, Raj Kotecha, was first published in Real Asset Impact.