Urbanization is forecast to continue: in 2010, slightly over 50% of world’s population lived in urban areas, and by 2050, the corresponding figure is projected to be already over 66% [1
]. Currently, cities and built environments use approximately 75% of generated energy and produce 60–70% of greenhouse gas emissions [2
]. Buildings account for approximately 40% of energy use and carbon emissions [3
]. At the same time, the real estate sector comprises approximately 60% of national, corporate, and individual wealth, totaling over $
200 trillion [4
]. Moreover, yearly construction-related global spending equals $
10 trillion, corresponding approximately to 13% of GDP [5
]. Thus, enhancing sustainability in built environments matters, and property investors can choose to make a change for the better by allocating assets to sustainable properties and enhancing the sustainability of their existing properties.
Property investors can show their engagement with the rules of sustainable development for instance by committing to responsible property investing (RPI). RPI, a part of responsible investment by the UN Environment Programme Finance Initiative [6
], aims to minimize the societal and environmental impacts of investments while ensuring financial profitability [7
]. One third of all assets (also other than properties) under management in Europe, the U.S., Canada, Japan, and Australia follows sustainable investment principles [8
], which is currently a high priority item also on property investors’ agendas [9
]. Furthermore, poor environmental performance is increasingly seen as an investment risk [10
], which also encourages property investors to adopt sustainable building features. Besides acting responsibly, property investors are primarily interested in the financial performance of properties and the way in which sustainability can contribute to this, as they are in the business of securing income and capital appreciation. Accordingly, there is a growing number of studies researching the impact of sustainability enhancements on properties’ cash flows and values.
There are many reasons why property investors are interested in adopting sustainable investment principles in their investment strategies. The focus of this paper is mainly on the economic impacts of investing in enhanced sustainability. The enhanced sustainability of properties can be measured for instance by green building certificates and energy performance certificates (later referred to as green certificates). In this paper, sustainable properties are defined as properties that are certified by well-known and internationally widely-adopted green certificates used in commercial properties, such as LEED and BREEAM. As energy plays an important role in the sustainability of properties, also certificates that measure the energy efficiency of the buildings, such as ENERGY STAR and Energy Performance Certificate (EPC), were included in the current review. Some of the certificates focus on the environmental aspect of sustainability, while others consider also social and economic aspects. Certificates that measure for instance the healthiness of premises from tenants’ perspective or the sustainability of services and specific products used in the premises were excluded. Otherwise, there were no limitations regarding certificate types. In addition to asset-level studies that measure the sustainability of individual buildings, also portfolio-level examinations were included in the current review. Portfolio-level studies research the impact of sustainability on the financial performance of the portfolio. In addition to the number of green certificates in the assets of the portfolio, these portfolio-level studies use also other sustainability measures, such as environmental, social, and governance scores and different sustainability indices.
demonstrates the drivers that encourage sustainable building adoption [11
]. The focus of this paper is on property-level economic drivers, which can be presented as components that form the cash flow of income-generating investment properties [12
] and eventually the value of properties. Enhanced sustainability can increase the income and decrease the risks and operating costs of investment properties. These enhancements can lead to an increase in the value of the property, which is explained in more detail in the next section. In addition to property-level drivers, external drivers, corporate drivers, individual drivers, and project-level drivers influence sustainable building adoption [11
]. These are not covered in detail in this paper, but are presented in order to provide a wider context for the study. External drivers, such as governmental regulations, policies, and incentives, international standards, and demand and pressure from clients, as well as rising awareness and the increase in the number of tools to implement sustainability have proven to be important drivers for companies to act sustainably (e.g., [13
]). Sustainability is also a way to differentiate a company from competitors and enhance the corporate image [19
]. As people are the ones making decisions within organizations, it is also important to understand what drives individuals to implement sustainable building practices in their projects and organizations [11
The purpose of this research is to review the existing empirical research on the impact of green certificates on property cash flows and values and categorize and analyze the findings of the reviewed studies from the perspective of the most important parameters that form the cash flows and eventually the value of properties. This study focuses particularly on professional real estate investors’ perspective in income-generating commercial investment properties, specifically on discounted cash flow (DCF) valuation, which is one of the most used property and investment valuation methods [20
]. In DCF, the present value of a property is based on the sum of cash flows (rental income extracted by operating expenses and capital expenditure) and exit value, discounted to the present with a suitable discount rate [21
]. In this study, the financial performance of properties is associated with changes in cash flow parameters or the value of properties. Previously, in 2017, Zhang et al. [22
] conducted a green certificate review study, but that approached the matter from a building lifecycle perspective. Zhang et al. [22
] concluded that better understanding of increased asset value would be central in understanding the financial implications of sustainable buildings (see Zhang et al. [22
] and Figure 1
). In this paper, the increased asset value aspect is examined in more detail. Falkenbach et al. [12
] created a theoretical framework for sustainable building drivers from real estate investors’ perspective. To support their theoretical framework, the writers presented the research and industry reports published up until the date of their study. However, since 2010, the amount of research papers has increased extensively. The sustainable building driver framework was later extended by Darko et al. [11
], but with a focus on recognizing sustainable building drivers on a general level. They did not break down the impact of property-level drivers at the same level of detail as this study.
According to the results of this study, green certificates likely benefit real estate investors financially. Most research papers found a positive relationship between green certificates and the cash flows and values of properties. In particular, studies consistently found rental, sale price, and occupancy premiums in certified buildings, spread across different markets, property types, and certificate types, as well as over time. However, results related to operating expenses were somewhat contradictory. Compared to the number of studies on certification benefits, the amount of research examining whether benefits outweigh the investments needed to achieve certification is limited. Besides extending geographical coverage, studies have developed from asset-level to portfolio-level examinations, especially with a growing interest in the performance and risk of listed sustainable real estate companies. The reviewed studies still heavily relied on U.S. real estate market data, and especially on LEED and ENERGY STAR certificates. Furthermore, the reported range of sustainable building benefits is rather wide, and in most real estate markets, the availability of data is limited. The results of the studies are therefore difficult to apply to other markets and certificate types. Thus, surveyors might, in practice, not be able to take fully into account sustainability investments in property valuations [23
]. Market values that comprehensively reflect investments in sustainability would be an important motivator for real estate investors to “go green”. Accordingly, surveyors play an important role, either enabling or hindering sustainability investments.
The remainder of this paper is structured as follows: the methods and the framework according to which the review is conducted are presented in the next section. The third section describes the countries of origin, property types, certification types, and research approaches used in the reviewed studies. The fourth section presents the findings on the impact of green certificates on property values and cash flows. Lastly, the results are discussed.
This study was based on a systematic review of existing empirical academic research and conference proceedings on the financial benefits arising from adopting green certificates from the perspective of professional real estate investors. Industry reports were excluded, as only peer-reviewed research was included in this study. As this study focused on income-generating commercial investment properties, search results related to residential sector were excluded. Furthermore, other green building and energy efficiency or performance certificates were not included. The date range or geographical area of the selected studies was not limited in any way. Snowball sampling was used to collect the data for this study. The most cited studies formed the basis of the data collection. The search was performed using Google Scholar and Scopus. The following keywords were used in varying combinations:
energy performance certificate
property value: property value
cash flow parameters: sales price, rent, vacancy, occupancy, capitalization rate, risk
The references of the identified, relevant papers were examined to form a comprehensive picture of the relevant literature covering this topic. In addition to the snowball sampling, the most significant real estate research journals, such as Journal of Real Estate Finance and Economics, Journal of European Real Estate Research, Journal of Sustainable Real Estate, Journal of Real Estate Research, Journal of Real Estate Literature, and Journal of Portfolio Management, were searched via their webpages in order identify any relevant research that might have been missed by the initial snowball sampling. After filtering, 71 papers were selected to be included in the review. It is acknowledged that some relevant papers on this topic might not have been identified with the utilized methods. Figure 2
shows the process of identifying, selecting, and analyzing the studies that were included in the current review.
To provide a comprehensive view of the previous research that concerns the financial benefits of green certificates from the perspective of professional property investors, the review was conducted using a framework based on the parameters of DCF analysis. As explained before, DCF is one of the most widely used property valuation methods and is based on the discounted value of a property’s cash flows and exit value. In this paper, property valuation covered both investment and property valuation. Furthermore, directly considering and adjusting single valuation parameters is the most transparent method of taking (enhanced) sustainability into account in valuing properties [24
]. The Royal Institution of Chartered Surveyors [25
] also mentions that DCF might reflect sustainability issues faster than other property valuation methods and is the only way to consider value attributes that are not yet clearly evidenced in the markets, but might play an important role in the future.
The most important parameters forming the cash flow of a property are: rental income, rental growth, vacancy rate, operating and other expenses, capital expenditure, depreciation (physical deterioration and obsolescence [26
]), and discount rate reflecting the relevant risks [21
]. Inclusion or exclusion of inflation in the discount rate (in addition to yield) depends on the selection between nominal and real cash flows [27
]. The adoption of certification might theoretically have the following effects on cash flow parameters [10
]: an increase in rent levels and rental growth rates; a decrease in vacancy rates and operating expenses; and a decrease in risk (yields). Furthermore, the risk of obsolescence can be reduced by considering the growing future requirements of better environmental performance, including the ability to adapt and change [29
]. These enhancements in cash flow parameters, together with the green signaling effect of certificates [31
], should lead to better values and sales prices of properties. Each of the selected papers was analyzed and classified based on their empirical findings on the cash flow parameter impacts, methods, countries of origin (of the data), certification type, and property type.
3. Countries of Origin, Property Types, Certification Types, and Research Approaches of the Reviewed Studies
Most of the reviewed papers were published between 2012–2016, with a peak in 2014, as shown in Figure 3
. The articles were published in a variety of journals from multiple fields. In Europe, the introduction of the energy performance of buildings directive (where EPCs are important instruments to enhance the energy performance of buildings) in 2002 and the revision in 2010 [32
] likely increased the interest in the topic, the availability of data, and accordingly, the number of performed studies.
Although empirical studies on certification benefits have been geographically extended, most of the reviewed studies covered office markets in the U.S., typically relying on the CoStar database. Figure 4
shows the geographical distribution of the studies that were included in the current review study.
The reviewed studies mainly concerned green certificates (almost 60% of the published research), as Figure 5
shows. However, there was a growing number of studies examining the impact of energy performance certificates on property cash flows and values, as well as portfolio-level examinations, especially in listed real estate companies. In the portfolio-level examinations, sustainability was measured in several ways. Some of the studies used the number of green certificates as an indicator of sustainability, while some of the studies used environmental, social, and governance scores and different sustainability indices to measure the sustainability of the studied portfolios.
Besides focusing on the U.S. markets, over 60% of the published research papers concerned LEED or ENERGY STAR certificates (or a combination of these) (Figure 5
). This was mostly explained by the availability and quality of data. The CoStar database contained information on over five million properties in the U.S., Canada, and some countries in Europe [33
]. The data included information on location, building type, and other attributes, as well as rental and sales information. The drawback with the majority of the existing research relying on the same data is that it may suffer from systematically biased results.
The vast majority of the certificate research was based on statistical analysis, namely hedonic regression developed by Rosen [34
]. Rosen’s analytical framework was based on the assumption that any product or service is defined by certain characteristics, the contribution of which to the value of the product or service can be estimated, usually with the help of regression analysis. Although these certificate studies indicated a clear relationship between investments in sustainability and improved cash flows and values, it was challenging to apply the results of statistical analysis to individual properties due to the heterogeneity of assets. The results of regression analysis were strongly affected by the definition of comparable (non-certified) properties, as well as by how important property features (such as location, age, size, and building quality) were controlled. Furthermore, especially in small markets, an insufficient amount of comparable transactions limited the usability of statistical analysis. Therefore, it was also important to understand how sustainability should be taken into account in individual property valuations, which were often based on DCF. Applying the evidence found to green premiums required subjectively assessing how and to what extent the results of statistical analysis could be applied to each market, submarket, and individual property, especially when evaluating commercial properties. Despite the importance of understanding sustainability in the DCF context, empirical studies on this topic were very scarce. Vimpari and Junnila [35
] and Christersson et al. [36
] seemed to be the only practitioners that had explored in detail the value-influencing mechanism of green certificates and energy efficiency investments, respectively, in the discounted cash flow context.
As buildings account for approximately 40% of energy usage and carbon emissions [3
], the role of built environments in fighting climate change is indisputable. Accordingly, responsible investing is currently high on property investors’ agendas and is likely to become the norm in the near future. Besides acting responsibly, investors are primarily interested in the financial performance of properties. The aim of this study was to review empirical research concerning the impact of green certificates on the cash flows and values of income-generating investment properties, focusing on the perspective of professional real estate investors. Over 70 peer-reviewed studies were identified, categorized, and analyzed using the discounted cash flow framework. The effect of green certificates on different cash flow parameters (rents, operating expenses, vacancy rates, and yields) and eventually on property values was comprehensively analyzed and discussed.
While most of the earlier studies relied on data from the U.S. real estate market, there is a growing branch of research focusing on other markets. In the beginning, studies focused on sales and rental premiums in commercial assets in established markets, such as the U.S., Europe, and Australia. Later research activities were extended in terms of property type to cover residential properties, and geographically to cover countries located in Asia and in the smaller markets in Europe. Especially the increase in sales price premium studies in energy efficient residential properties has been rapid (see for instance a meta-analysis of 66 studies by Cespedes-Lopez et al. [127
]). Analysis has also evolved from asset-level to portfolio-level, especially with a growing interest in listed real estate companies and REITs. In the portfolio-level studies, the definition of sustainability is not limited to green certificates, but is wider and typically uses different sustainability indices and sustainable scoring systems covering environmental, social, and governance aspects. Besides trying to determine whether certificates enhance the cash flow parameters of properties, scholars have investigated what portion of the premiums is associated with the improved efficiency of properties and what portion is associated with the brand value of certificates. There is also a growing interest in whether the reported certificate premiums are associated with certification itself or some desired sustainable features of properties. The effect of lease agreement structures (whether tenants are responsible for operating expenses or not) on certificate premiums has been widely discussed. The conclusion is that lease structures affect tenants’ willingness to pay for certifications and sustainable property features. However, property investors will extract the same value from the property if the difference between gross and net rents equals the difference in operating expenses, regardless of lease structure.
Based on the reviewed literature, sustainability is a significant success factor for real estate investors. Almost all the reviewed studies found that certification had positive effects on properties’ cash flows and values. The adoption of green certificates has been rapid, at least in the U.S. There are several studies examining the diffusion of green certificates and determinants of green building adoption (e.g., [39
], but they were not covered in this review. For instance, Holtermans and Kok [39
] observed that by 2014, almost 40% of the assets in the 30 largest U.S. office markets (measured by square feet) had been either LEED or ENERGY STAR certified. However, this is not the case in all property markets. There are several obstacles hindering the adoption of green certificates. First, while there is a broad consensus on the benefits of green certificates, the reported green premiums vary extensively, and compared to the number of green certificate benefit studies, the amount of research examining the cost effectiveness of the investments needed to achieve certification is limited. Second, each market actor blames others for their own lack of interest or investment in sustainability [10
]. Lorenz [10
] suggested that the vicious circle of blame must shift to a virtuous circle of positive feedback between investors, occupants, constructors, and developers, as well as certifiers, surveyors, advisors, researchers, educators, policy makers, banks, insurers, and owner associations. Third, pursuing and maintaining a certificate is costly and requires other resources, which makes the adoption of certificates possible for only a small share of properties. Fourth, certificates might not be equally valuable in all markets. For instance, in the Nordic countries, the quality of construction is high, and standards are tight even without certification. Thus, the information value of certificates might be lower than in some other markets, where the quality of construction varies more. Darko [134
] and Matisoff et al. [115
] also mentioned other possible obstacles to sustainable building adoption, such as lack of incentives, support, information, demand, regulation, and market failures.
There are some limitations in the reviewed research. Certified properties seem to be larger, taller (indicating a central location), constructed later, and of better quality than non-certified properties. For instance, Robinson and McAllister [74
] observed that nearly 35% of properties with transaction prices over $
60 million were certified, while the corresponding figure was only 2% for properties sold for under $
26 million. As better buildings are more likely to be certified, the results of the reviewed studies were clearly biased. For instance, Olaussen et al. [135
] studied apartment pricing before and after the introduction of energy performance certificates in Norway. They found that apartments that seemed to have a sales price premium associated with a better energy rating sold with a premium also before launching the energy certificate system in the market. Furthermore, other reviewed EPC studies found no relation between increased energy efficiency and sales prices [45
]. Furthermore, the results of green premiums have varied widely according to model specifications and data. In real estate, finding comparable properties is difficult, as properties are heterogeneous. When employing statistical analysis, it matters how building attributes, quality, and location are controlled. Robinson and Sanderford [136
] questioned the idea that sustainable buildings contain similar attributes to non-certified buildings. However, they found little evidence that building attributes are a good predictor for whether the property is certified or not. They concluded that their finding supported the view that green certificates generate premiums and the methods used by other researchers to determine the existence of green premiums are appropriate.
This study also has some limitations. First, it is possible that some relevant key words were inadvertently omitted in the initial search of relevant studies, and there was a risk that some of the relevant studies were therefore unintentionally excluded from this review. This risk was mitigated by using snowball sampling (i.e., the references of identified relevant studies worked as an important source of finding further studies) in addition to Scopus and Google Scholar searches. Second, the results of this review are applicable to income-generating commercial investment properties that are professionally managed, but there are limitations in the generalizability of the results. The results of the reviewed studies were clearly biased towards high-value properties, which are more likely to be certified than the rest of the building stock (certified properties are not a random sample of the entire building stock). Furthermore, the reviewed studies concerned specific property types, certificates, and markets, which limited the applicability of the results of the reviewed studies and this review, as well. As the majority of existing research focuses on the U.S. markets (and especially on LEED and ENERGY STAR certifications), different legislative requirements, varying quality of construction, and different market characteristics reduce the explanatory power of these studies for other markets and certificates. Furthermore, the range of premiums found was rather wide, making application of the findings for valuation purposes difficult.
There is a need to understand how surveyors consider the empirical findings of green premiums in practice, as investors are primarily interested in how their investments in sustainability are considered in the market values of properties. This is the key to motivating mainstream property investors to enhance the sustainability of their properties. There is evidence that surveyors are not fully reflecting sustainability investments in property valuations [23
]. Accordingly, the obstacles to their work need to be understood and eased. Currently used valuation methods, and especially the definition of market value, exclude some key aspects of sustainability [10
]: only direct monetary benefits affect the market value of a property. For instance, the intangible benefits of green certificates or carbon emission reductions, which might be important motivators for property investors, are usually ignored in valuations as their impacts are difficult to measure.
As sustainability becomes mainstream, it is not just a question of how much more valuable sustainable buildings are compared to regular buildings. Regular buildings are those that suffer from faster obsolescence and tightening regulations [24
], which further increases the polarization between sustainable and non-sustainable assets. This means that sustainable properties will be even more valuable than currently. Thus, poor environmental performance should also be considered in various analyses and decision-making processes regarding properties. This is an important point for politicians as well. Wider consideration of sustainability issues for all properties, also by law, would increase the transparency of property markets. Furthermore, in many markets, there is a need for more detailed data and more systematic regulation for the gathering of sustainability information during the whole lifecycle of properties [137
There are several avenues for future research. As most of the studies concerned the U.S. commercial market, further expanding the empirical evidence to other markets and certification types is necessary. As the majority of green premium research has been conducted in the early adoption years of green certificates, there is a need for continuous research to understand the growing (and perhaps changing) market dynamics. Future research could also attempt to further explain the premiums: Which parts of sales price premiums are explained by the capitalization of increased efficiency and other benefits, such as the brand value of the certificates? Furthermore, certification in existing buildings and green retrofits requires more attention. There is also a need to continue the work of Chegut et al. [120
], who used a large dataset to study whether the benefits of green certification exceed the investments and costs needed to achieve the certification.