Decarbonisation in the built environment is becoming more important to property valuations in a higher interest rate, higher inflation setting as investors put more emphasis on sustainability, according to Amy Pham, Portfolio Manager for the Pengana High Conviction Property Securities Fund.
Sustainability is becoming more closely linked to attracting quality tenants on longer leases, Ms Pham said. “Buildings have a large carbon footprint and anything to lower energy costs is going to increase yield.
“A more energy efficient building will reduce outgoings for the tenant and is more likely to attract more tenants and have higher occupancy levels.
“In the past three years, we are starting to see tenants’ preference for more sustainable buildings with high NABERS ratings of five stars and above – particularly from government tenants and large corporate tenants who may have substantial decarbonisation policies.
“This puts more pressure on older buildings and increases their risk of being latent.”
Ms Pham said AREITs were showing resilience but the transition to a higher interest rate regime was still playing out. “Earnings have been much more resilient than anticipated with most REITs maintaining their earnings guidance.
“As cost of capital has risen sharply from an average of 2.5% a year ago to now 5.5% the ability to deploy capital accretively is key to growing earnings and offsetting higher costs.
“For many years where the sector had benefited from cap rate compressions, many investors opted for a cheap passive exposure.
“Now we are entering a more challenging environment where the divergence in performance of different sub-sectors is greater than it has ever been – consider the difference between logistics vs office. Within sub-sectors such as office there has been a flight to quality.
“The ability to pick the best of breed managers and invest outside the benchmark is important in generating sound risk adjusted returns. Alternatives such as data centres, child care and health assets are also moving to the mainstream.”
Ms Pham has incorporated ESG into her valuations for several years. “ESG is used to manage risk, and forms part of our model for property valuation. We currently assign 30% of an AREITs value to ESG factors.”