Integrate environmental, social and governance factors into property valuations

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The environmental, social and governance (ESG) framework is a critical topic. The green premium drives the need for investors, property owners and property valuers to focus on ESG and incorporate these factors into their investment and valuation criteria. 

Concerning the valuation industry, in simple terms, it means that the property sector can no longer focus on generating revenue from rentals. There is an element of responsibility expected of the property owner by society and legislative bodies. Property developers and owners now need to consider environmental issues, societal impact and government regulations. From the “E” perspective, owners and developers must consider, for example, pollution or water contamination. 

Socially, they must consider the effect the building has on the safety and livelihood of people on or close to the property. For example, is the building creating jobs for people? Surrounding poverty and unemployment may influence the “S” in the ESG score, as would a development targeting the under-serviced gap housing rental market. 

The societal impact is not restricted to the confines of the ESG discussion. How your property, no matter how large or small, affects the surrounding society should be considered by all landlords and property owners as a general rule of ownership.

From a governance perspective, the listed sector is fairly well-regulated. But because ESG is an evolving regulatory requirement, it might require mandatory sustainability goals from the property sector in the future. This is already happening in countries such as the United Kingdom, which require an energy performance certificate (EPC) whenever a property is built, sold or rented. 

The “G” in ESG criteria may become more rigorous if companies and the property sector fail or are too slow to comply. 

South Africa was on the cusp of a momentous ruling in the property sector. As of December 2022, we were going to see a law enact the display of energy performance certificates of properties publicly. But this due date was extended by three years to 2025. The intention was to confirm the compliance of various properties with specific energy requirements. 

The South African Institute of Valuers  encourages individuals to comply with the legislation to avoid repercussions and to take advantage of the potential incentives. There may be incentives to go green to garner support for the ESG programme, for the betterment of the environment and society. 

For example, favourable loans may be granted to investors who intend to develop green properties, and such incentives may not extend to properties that do not comply with ESG legislation, so investors, landlords, and property owners may miss out. 

These ESG incentives may increase green buildings and sustainable property development as more investors would want to use these favourable loans and comply with evolving legislation.

Green buildings have been around for many years, even before talks of incentivised property development, but in South Africa, the barrier remains the cost to develop and convert properties into more sustainable units with acceptable short-term returns. As a result, many developers were unable to catch the green building and sustainable development hype, and now green buildings come at a premium price.

The reality is that investors and owners who chose the green route to develop a property or refurbish existing properties are realising savings on electricity, water, heating and cooling in commercial and residential properties. The current utility model is becoming unsustainable as energy costs increase and energy sources become unreliable. 

This challenge means that alternative energy sources such as solar are becoming more popular. Sustainable buildings and residential properties get a premium during a sale because the current market demands more sustainable occupation. 

It was interesting to learn from the World Built Environment Forum Sustainability Report 2021, in which thousands of real estate and construction professionals from more than 30 countries participated, that nearly half the respondents said that they believe that sustainable properties (commercial and residential) achieve a premium over non-green (brown) properties. The same trend was confirmed in South Africa by the quantitative data recently published in the MSCI SA Green Property Index 2022.

We are seeing the green premium in the rental sector too — tenants want units with alternative, cleaner energy solutions that are not dependent on the national grid, and that can ultimately save money, as they’re responsible for the utilities. Tenants are willing to pay more for greener options. In addition, the owner gets a healthy return on investment in the long run because the more sustainable green property will sell above the brown property.

For valuers, ESG elements provide the opportunity to look at properties beyond the general valuation criteria. Now, a valuer must consider the environmental, social and governance aspects in their valuation of properties in the market. The various effects the property has in terms of ESG will dictate a more favourable valuation than a property that does not score high on the ESG rating. It is a balancing act between qualitative and quantitative aspects of a property as part of the valuation exercise.

Valuers must consider the evolving ESG requirements and apply these to ensure accurate valuations in line with new legislation. They should also understand what effect ESG-driven additions will have on property values, such as solar panels and battery storage, gas-powered geysers, sustainable lighting, and water retention and recycling units. 

In addition, properties that positively influence the surrounding society will also affect the value and ESG score. The new legislative compliance of properties, such as an energy performance certificate, should be considered in the valuation and would increase the ESG score. 

The work of a valuer now demands an even more objective application of collective aspects that a potential buyer would factor in their own determination of purchase price. This is an emphatic call to valuers to determine the value at the hands of the market.

With all the talk and confusion about ESG, valuers need to consider the positive effect on the property market, and they should also consider the negative implications of non-compliance. It is a new concept that is not well defined in traditional valuation calculations. Valuers must keep abreast of all new legislative requirements that may affect the property sector, to ensure a fair valuation of the assets in the market.

The views expressed are those of the author and do not reflect the official policy or position of the Mail & Guardian.