The impact of ESG on property valuation

Environment, social, and governance factors are now a key consideration in almost all major commercial real estate decisions. The industry has embraced collective responsibility to address ESG challenges, making it clear to all market players that there is a genuine desire to be a force for good.

Buildings that minimise environmental impact through all parts of their life cycle and focus on improved health and wellbeing for their occupiers may retain value over a longer term than those that do not.

A key question for investors and developers – can they expect any monetary benefit from green-rated buildings and if so, how much? Do ESG factors have any influence on property values?

Valuation standards

All recognised international valuation standards such as Red Book, Tegova or International Valuation Standards agree that valuers should consider any sustainability and ESG factors that could affect the valuation. As the valuation of commercial real estate is the function of applied yield, rent and assumed costs, there is a question of how the move towards sustainability of particular inputs affects the outcome.

There have been many research papers published recently that prove green-rated buildings do indeed offer both rental and sales value uplift compared with non-rated buildings, at least in more mature markets such as the UK.

That premium can reach 12.3% with a significant step-up in prime Central London office rents for the very highest green-rated buildings. The sales price premium is even higher with NABERS-rated buildings in Australia reaching up to 18% higher on average than an equivalent ‘brown’ building.

In addition retrofitting older buildings may also contribute to significant rental uplifts.

Our recent report Meeting the Commercial Property Retrofit Challenge analysed the rents of 130 retrofitted and refurbished offices across the UK which have moved from an EPC C-rating and below to an EPC B-rating and above, pre- and post-renovation. On average, the retrofitted and refurbished offices saw the rental gap relative to prime close by 18%. This relative uplift varied by location, level of intervention, the number of pre-and post-leases, and market-specific factors (such as supply).

Rent uplifts are expected to vary significantly between markets. For instance, Poland’s office stock is generally newer compared to that of the UK. As a result, the impact of modernisation and the implementation of ESG factors on rental values may be less pronounced in Poland, given the relative youth of its buildings and the presence of more modern technical solutions already in place.

Additionally overlooking energy efficiency and carbon footprint considerations leaves properties vulnerable to risks of higher operational charges translating into overall higher rental cost for tenant. This may lead to increased vacancy rates over time.

Yields

There is a general perception that investors are often willing to pay a premium for properties that meet ESG criteria due to their lower risk and potential for higher returns. In addition, owners of green properties often benefit from more favourable financing options.

As the valuations must always base on transactional evidence, the yield premium if any should be visible in transactions. However, there is still insufficient evidence from the small number of .  And as top ESG credentials become the norm for prime properties, there is an increasing market opinion that though it’s not possible to explicitly quantify a ‘green premium’ for a building, a ‘brown discount’ for a poorer performing property is being considered by market participants.

Costs

Whilst it may seem obvious that improving a building will lead to higher rents, it is important to also weigh it against the cost of inaction. Achieving ESG credentials in real estate often requires significant upfront investment, but the costs and benefits vary widely depending on the property type, location, and the scope of improvement. It is difficult to valuers to assess the costs of improvements needed to be caried in order to improve the rent or to retain the property attractive for tenants.

We need to strongly rely on the costs provided to us by the investor.

In markets with newer building stock, like parts of Central and Eastern Europe, ESG upgrades may be less extensive due to existing modern infrastructure. Conversely, in mature markets with older stock, such as the UK, costs can be higher due to the need for deep retrofits.

Investors should weigh upfront costs against the long-term value protection, risk mitigation, and potential for premium rents, making ESG spending a strategic, future-proof investment.

Input data – challenges for valuers

At Knight Frank, ESG is incorporated into our data collection, analysis and due diligence processes for valuations. We observe that clients have started to become more ESG-aware, and supply us with more ESG-related data on property than used to be the case. Among documents we receive for the purpose of valuations are ESG Due Dilligence analyses, ESG-related upgrade works and their costings, CREEM analyses of buildings, or EU Taxonomy compliance reviews.

As a result, valuers today exercise more caution than ever while analysing the capital expenditure (capex) require

The main challenge for valuers in the current tightening legal environment is currently an accurate assessment of provided data and no standard approach to property benchmarking.

Conclusions

Valuers are increasingly required to adopt a forward-looking perspective, no longer merely assessing the current value, but valuing the future resilience of the asset in an ESG-driven market. They need to consider all the ESG-related risks that could impact a property’s future performance, such as regulatory risks or obsolescence.