U.S. real estate investment trusts are under increasing pressure from stakeholders to embrace ESG values, a trend that is expected to drive more REITs to invest in green properties, which are broadly defined as energy-efficient buildings that minimize the impact on the environment and human health.
As of October 2021, only 25% of U.S. REITs have portfolios where at least 25% of properties are considered green, according to Sustainalytics BV, Morningstar's ESG-focused data company. Only 17% of U.S. REITs have portfolios where 50% or more of their properties are green.
Further, only 7% of U.S. REITs reported a strong green building investment program, while 20% reported having some kind of program. Another 27% indicated limited activities, while 46% have not disclosed any program at all.
The figures are not overwhelming, and Sustainalytics Associate Director of Insurance, Real Estate and Asset Management Research Sercan Soylu said the slow uptake has been due to additional cost and resources.
"Usually, green buildings are more expensive to acquire because of relatively higher construction costs mainly stemming from sustainable materials. Apart from that, such properties require diligent maintenance and in turn require further costs for material, labor and talent."
However, he believes a market shift is underway and real estate companies are increasing focus on green buildings every year.
"From market practice and anecdotally, I know that there is a certain improvement there. This is mainly because of further regulatory focus everywhere in the world [on] the environment, and also climate change," Soylu said.
Green certification benefits
Several ESG-related building certifications are available, but in the U.S., LEED or Leadership in Energy and Environmental Design, certification tends to be favored by investors and owners because it has a high level of market recognition, according to Nareit Senior Vice President of ESG Issues Fulya Kocak.
LEED was developed by the U.S. Green Building Council, launched in 1998 and initially targeted new buildings. It now includes existing buildings and has various rating levels.
As of October 2021, 75,784 LEED certifications had been awarded in the U.S., according to the U.S. Green Building Council. LEED Silver accounted for 31% of those certifications, followed by LEED Gold at 30.2%, LEED Certified at 28.3% and LEED Platinum at 10.4%.
REITs achieving green property certification also benefit the balance sheet in the long term, according to industry sources.
LEED-certified four- and five-star office properties on the whole command higher rents than non-LEED certified properties and have also reported lower vacancy rates, according to data from Cushman & Wakefield PLC and CoStar Group Inc.
"Green buildings definitely provide a premium in terms of the price, but also in terms of the yields," Soylu said.
Nareit's Kocak said pressure to adopt ESG practices has not, historically, been the major driver behind green building certifications. Instead, the number of annual certifications awarded has risen steadily for two decades and she has not seen any recent spike in those figures.
"We've seen jumps in other areas of disclosures because ESG is much more holistic now. It includes so many other aspects of an organization beyond green building certifications," she said.
She cited a trend toward Fitwel and WELL certification frameworks, which focus on human health and can be applied to different types of buildings, whole or partial, as well as tenant improvements. Additionally, as ESG becomes widely embraced, green building certifications and rating systems are expected to evolve and offer credits in areas pertaining to issues that have not been addressed in the past, such as climate change.
Although European REITs have been ahead globally when it comes to the share of green building certifications in their portfolios, Soylu expects U.S. REITs to begin closing the gap over the next few years.
"In the next couple of years, I'm expecting this trend may continue or even accelerate, especially in the U.S., because there is much higher room for improvement in the U.S.," Soylu said.
