Valuing
Sustainability

Rating our assets
to enhance performance

We believe that sustainability will significantly impact future property values and, therefore, prospective total returns. Consequently, we place RPI at the core of our investment strategy.

Valuing sustainability
Sustainability Rating System
Informing our investment strategies
Energy Performance Certificates
Industry wide benchmarks
2007/8 Target Review
2008/9 Targets

Valuing sustainability
We are certainly not alone in taking the view that sustainability will impact future property values but the crucial question is, how will the sustainability profile of a property affect its financial performance. We have identified two key factors that will make the relationship between sustainability and total returns a reality. Firstly UK government and EU legislation, which could be far reaching but will almost certainly involve some form of taxation for poor performing (in terms of energy/carbon emissions) properties. Secondly, occupier demand, whereby tenants are increasingly addressing their own ‘green’ agenda and, given the choice, will almost certainly choose to occupy more sustainable buildings.

We have, therefore, developed and are implementing a number of strategies and tools with which to evaluate and address this key issue.

Sustainability Rating System
In order to consider the financial impact of sustainability we have developed the property industry’s first comprehensive sustainable investment evaluation tool, the Sustainability Rating System (SRS).

The aim of the SRS is to rate the sustainability of each of the properties in each sub-sector of our directly managed portfolio. The SRS is based on a suite of questions which address the issues we believe are important with regards to sustainability and total returns. The list, which is reviewed and refined as our knowledge and experiences increase, currently consists of 90 questions of which 22 are weighted more highly to reflect our view of their importance.

This enables us to establish how each asset performs against estimated market conditions, and to maximise their financial performance by identifying sustainability improvements to be achieved through management behaviour, service charge recoverable costs and capital expenditure.

An example of the output is shown in the chart below.

SRS analysis of a property sub-sector

Informing our investment strategies
Our overall strategy is to implement sustainability improvements that will add value to our assets. In order to ensure that sustainability features in all of our investment decisions, we document all improvements identified from the SRS, EPC’s, flood risk assessments and our RPM programme in our Business Plans and Property Management Strategies for individual properties. This allows both Investment Managers and PM’s to make informed decisions over the life cycle of individual assets and focus on areas that we believe will have a positive impact on value.

We believe it is inevitable that property assets which perform poorly in terms of sustainability will obsolesce more rapidly and thus depreciate in value more quickly than in the past. Most investors are not only looking to merely identify whether assets they might buy are at risk of flooding as part of a standard due diligence process, but they are using this information to evaluate whether to invest or not and, if they do, what discount they should expect. This has become increasingly important as more data is presented by the academic community on climate change and the potential effect of an increasing incidence of storms and rising sea levels. This in turn suggests that there is a risk that some occupiers will only be prepared to take space in ‘at risk’ buildings at a discount rent. This raises questions as to how the issue will impact on capital growth valuation and liabilities over time. Active asset management is a key element of our investment strategy and we believe that we can reduce running costs, maintenance and insurance premiums with this responsible approach.

Energy Performance Certificates
We aim to adopt sustainability best practice on a portfolio-wide basis. We were the first major investor to undertake asset energy ratings across our entire managed portfolio, six months in advance of the regulatory requirements and now have approved EPC’s for every one of our directly managed assets. (see chart right). We are using the recommendations from the EPC rating process to inform future investment decisions.

Industry wide benchmarks
We believe it is important that the property industry supports the development of sector wide sustainability metrics and we are committed to developing, with other bodies, benchmarks and indices that will enable an industry-wide assessment of the links between sustainability and financial performance.

We see such benchmarking as a vital component of the evaluation process to drive change in the industry. Therefore we are committed to make our position known within the industry.

Upstream Sustainability Services – The Third Dimension Analysis by investor

Hermes is positioned 3rd overall against 12 of our peers in Upstream’s 2008 ‘The Third Dimension’ analysis.
The Third Dimension score is based on the analysis of individual properties within a number of institutional funds.

At present this database comprises some 1500 individual properties. Each of the properties are evaluated against a set of 24 criteria and are determined by a set of environmental, social and economic questions. Once these criteria have been evaluated, the sustainability score is calculated.

Upstream Sustainability Services – The Third Dimension Analysis by fund

The Third dimension analysis by property investment fund shows that our five principal funds are in the higher tier of the market average, with one of our funds scoring the highest of all.