Investors need to factor in new building energy efficiency requirements before making decisions on buying property, says Dug Higgins.
By the time you read this article, the second step in the Building Energy Efficiency Disclosure Act 2010 (the Act) – part of the Australian Government’s Commercial Building Disclosure program – will be in place.
November 1, 2010, marked the beginning of the transition period where a large slice of the securitised property industry (including listed A-REITs and wholesale/retail unlisted property funds) have to bite the bullet on mandatory disclosure of energy ratings on the majority of the buildings in their portfolios.
Going forward, this is set to have a material impact on the operations of property trusts, particularly for those in the unlisted retail fund space.
Here, we take a look at some of the issues that investors and their advisers will need to take into account when holding exposure to this asset class or making new investments in this asset class.
‘Impending disclosure obligations means energy efficiency becomes one of the deciding factors around commercial sales and leasing’
In a nutshell, the Commercial Building Disclosure (CBD) program is the national framework designed to improve the energy efficiency of Australia’s office buildings. The program operates under the Act (which commenced in July 2010) and will become fully enforced on November 1, 2011, when all sellers and/or lessors of commercial office space of 2000 square metres or more will be required to obtain and disclose a valid Building Energy Efficiency Certificate (BEEC). A BEEC is valid for a 12-month period and must be publicly accessible on the online Building Energy Efficiency Register.
The key plank to BEECs is the National Australian Built Environment Rating System (NABERS) – a performance-based rating system for existing buildings which assesses a building based on its measured operational impacts on the environment. NABERS ratings work on a star system and are awarded on a scale from one to five. While a NABERS rating may be obtained for a range of operations (energy, water, waste and indoor environment), it is the NABERS energy rating which is being used for the purposes of the Act.
While the requirement for a BEEC will not be mandatory until 2011, the 12 months from November 1, 2010 are a transition period where sellers and lessors of office space must disclose their NABERS energy rating, rather than the full BEEC. As part of this disclosure the NABERS rating must also be included in any advertising material for the sale or lease of eligible office space.
At present, several issues are visible. Firstly, it’s not certain that all those required to report under the Act from next year will be ready to do so. At this point, indications are that only around 50 per cent of the owners of CBD office properties have had NABERS ratings assigned – so the assessors are going to be busy. But the main question from the point of view of owners – and by default, investors, given the level of investor participation in the sector – is what will be the impact of mandatory disclosure?
Implementing disclosure obligations means that energy efficiency becomes one of the deciding factors around commercial sales and leasing operations. This by default will influence the value of transactions at both levels. Up until now, where seeking ratings and disclosing them has been mostly voluntary, there was emerging evidence that energy-efficient buildings attracted a premium in the property market – which is not unexpected, given that investors expect to see a return from “greening assets”.
Recent studies show a split in the market between buildings with a higher NABERS rating versus a lower one. Indications are that buildings with an above-average NABERS rating (three to five stars) were valued at a premium compared to buildings that were rated below the NABERS average (two-and-a-half stars or below). Results have indicated that effective rents may be up to 6 per cent higher and capital values up to 18 per cent higher in energy-efficient buildings. Vacancy rates and tenant retention also improve in highly rated buildings. While the level of hard data is still somewhat limited, indications are good (if you have the right assets, that is).
So why does this have particular relevance to the unlisted retail property funds sector? When we examine the NABERS registry of rated buildings there are currently more than 500 ratings in place. Of these, more than 50 per cent relate to the assets of the major A-REITs and unlisted wholesale property funds. This is not a surprise given that broadly speaking these funds tend to have higher-quality assets in their portfolios, compared to their smaller unlisted cousins that are the domain of retail “mum and dad” investors. NABERS-rated buildings in this category number only 42, or less than 10 per cent of the current register.
Analysis of the top 200 unlisted retail funds by size shows that they currently own 181 commercial office properties nationally, nearly all of which are likely to be eligible under the Act. Based on the actual number of vehicles, including those outside the top 200, the real number will be far higher. Given the average quality of the properties in these portfolios, the longer-term viability of the unlisted retail property funds sector is facing a significant threat.
The institutional level managers who have a presence in the retail space – being Stockland, Investa and Charter Hall – make up the bulk of those with rated properties, along with cameo appearances from some other managers who are likely to be a long way down this road already.
However, it is likely that significant work remains. Going forward, it will be vital that investors carefully scrutinise the sustainability measures being proposed by smaller investment managers, and consider the implications for the future performance of portfolios.
Increasingly, as the number of highly-rated buildings in the market increases, the emphasis on a premium for high achievers is likely to change to a discount for poor outcomes.
As tenant and buyer expectations change, regarding the levels of sustainability incorporated into the spaces they occupy, those properties that cannot compete run the ever-increasing risk of becoming environmentally obsolete. The outlook for lower-quality assets is not by any means hopeless, as the returns on some retro-fitting projects are well worthwhile. However, this comes at a cost that some unlisted retail portfolios may find difficult to bear, given other extraneous circumstances facing the sector.
While the implementation of the Act and the BEEC as they currently stand has not been without controversy and has met with some strong resistance from industry regarding fine-tuning (and with good reason), the fact is that the basic concept looks here to stay. While there has been very positive feedback from global participants that the Australian NABERS system is world-class, this doesn’t necessarily mean it’s as good as it could be. We can expect further adjustments in due course and indeed some of these are already underway. In addition, the Government has indicated that mandatory disclosure under a similar system will be levied on other commercial building types around 2012.
All in all, the concept of buildings with poor energy ratings incurring a discount in the marketplace is not a new one, with Zenith and many other industry participants having expressed these thoughts for some years. Now, however, it’s crunch time. How the sales and leasing market plays out over the next 12-18 months will be very illuminating. At the very least, investors and advisers will need to consider the implications of the quality of any commercial property portfolios they are exposed to. Given that real estate is a long-term asset class (particularly in unlisted funds), considering how well they are future-proofed is vital in maximising value.
Dug Higgins is a senior investment analyst at Zenith Investment Partners – www.zenithpartners.com.au
