Coming soon: Sustainability ratings for real estate investments

Coming soon: Sustainability ratings for real estate investments

Comparing sustainability practices in the real estate industry isn't easy. Some companies monitor and disclose how they manage natural resources. A great many of them don't. The lack of comprehensive data acts as a blindfold for investors, covering up their exposure to environmental and social risks. In the next month or so — the precise date hasn't been fixed yet — the blindfold will fall to the floor.

What you'll see when this happens is an index series (picture lots of numerical tables) measuring real estate portfolios based on the share of assets that are certified as green properties. FTSE Group, a market research firm, is developing the index series in a partnership with the real estate industry association NAREIT and the nonprofit U.S. Green Building Council. The series will be subdivided into real estate industry segments, such as apartments, offices and shopping centers. It's due to go live by March 31, according to USGBC's vice president of research, Chris Pyke.

The green-property index will feature the same set of real estate investment trusts, or REITs, that comprise an existing benchmark for U.S. real estate. Each of these 172 companies will receive a score based on the proportional value of their holdings that have achieved LEED certification or Energy Star labeling. Pyke says institutional investors will be able to purchase these individual scores as guidance for their own asset allocation. Retail investors will have open access to composite data for the various segments of the index but not the individual scores.

The level of transparency accompanying the green-property index marks a significant step forward for an industry that's traditionally relied upon voluntary disclosures for comparative sustainability data. About 16 percent of companies listed in the FTSE NAREIT index participated in the 2012 Global Real Estate Sustainability Benchmark, an annual survey of publicly listed REITs and private funds, while the green-property index will capture all of FTSE NAREIT members.

Will the green-property index green the market?

Recent academic research has shown that green properties have positive effects on operating performance, and they help protect stocks against business cycle volatility. Pyke says the green-property index should encourage companies to act on this information. "It'll create another reason for them to examine their own properties and consider using LEED or Energy Star to provide more information about the achievements and performance of these assets," he said.

We contacted the top 10 companies in the FTSE NAREIT index, based on 2012 year-end market capitalization, to find out if the addition of a green-property index will lead them to invest more heavily in the relevant green-building certificates. None of these companies actually responded with a definitive yes. In fact, some said no — and with good reason. These negative responses point out how market pressures won't affect all building owners and managers equally.

Simon Property Group, the biggest FTSE NAREIT member with shares worth $48.5 billion at year's end, said LEED and Energy Star aren't available to shopping centers, ruling Simon out of the green-property index. This de facto exclusion would affect two dozen companies representing 21 percent of the overall value in the index.

Another leader in the FTSE NAREIT index, Public Storage, does relatively little new construction or retrofits and therefore has a different approach to LEED and Energy Star than, say, apartment building owners. "You've got to consider the type of space one has," said Clemente Teng, Public Storage's vice president of investor services.

Based on voluntary participation in the Global Real Estate Sustainability Benchmark, apartment and office building portfolios appear to be well-represented among companies that report on sustainability practices. Large health care and industrial facilities owners also feature prominently in this group. Noticeably absent are the market leaders in lodging and resorts, self storage and timber.

It won't be easy to pinpoint the direct effect of the green-property index immediately after its publication or even in the months ahead. The FTSE NAREIT index is coming off a strong overall performance in 2012, a year when this group outperformed several investment benchmarks, including the Standard & Poor's 500 index. This marked the fourth consecutive year that FTSE NAREIT beat the S&P 500. Can the green-property index be credited if the winning streak carries on, or blamed if it comes to an end? Probably not.

But Pyke is looking further into the future. "We know that REITs own thousands, actually tens of thousands, of properties. The majority of these have not been certified or labeled, and consequently we do not know how they address energy, water, waste, health and other green-building goals," he said.

When you remove a blindfold and open your eyes in a light-filled room, vision is normally out of focus. So it will be for investors once the green-property index goes live. Then as the market takes on more data from newly certified green buildings, it will become easier to observe sustainability practices in real estate. And it'll be harder for companies that waste natural resources to hide in plain sight.

Photo courtesy of the U.S. Green Building Council