Hospitality investors are seeing ESG not just as a box ticking exercise but as a critical component of their investment decision making process, according to a new survey conducted by JLL and the Energy and Environment Alliance (EEA).
The results of the survey show that the engagement on the topic of ESG by hotel investors has stepped up and is no longer an after-thought.
Highlights from the survey include:
- 53 per cent said sustainability related due diligence is critical and more than a box ticking exercise.
- There is a clear link to value as the highest proportion of respondents (47 per cent) said that a more sustainable hotel will influence trading performance by achieving lower utility costs. This is not a surprise given the escalating energy costs hoteliers have witnessed.
- 55 per cent of respondents would expect to pay a premium for a hotel on the NZC50 pathway.
- Nevertheless, 63 per cent would still buy a hotel which is not on the NZC50 pathway, which is reflective of the buyer pool for hotels where the majority are private equity and high net worth.
- 60 per cent say they are currently factoring in ESG capex to comply with regulation.
- 28 per cent are planning to factor in ESG capex in the next 12-18 months.
- Yet only 35 per cent have set aside a sustainability reserve for this transition capex which means that inevitably there is likely to be a discussion during asset management meetings.
Changing regulation
The pressure isn’t just coming from consumers but from regulators as well. New rules set by the European Union such as the EU taxonomy which covers targets for both existing and new real estate and SFDR which is a product disclosure requirement for European funds as well as individual countries, mean that the situation on the ground is changing rapidly.
Speaking exclusively to Hospitality Investor, Rekha Toora senior vice president, hotel capital markets at JLL, said the results highlighted just how fast things are moving because “much of this regulation didn’t exist five years ago” hence it is not a surprise hotel owners are considering transition capex either now or in the next 18 months yet only 36% have set aside a sustainability reserve. Transition capex was not a consideration for investment decisions meaning that current buyers would be looking for a price reduction or what is known now in the industry as a brown discount as they will want to know who is going to pay for this cost to comply. This is starting to feature in commercial discussions, for example in France which has the stringent regulation Decret Tertiaire which impact’s commercial buildings in excess of 1,000sqm. In the UK, commercially let buildings need to achieve an EPC rating of C by 2027 and B by 2030 yet the majority of existing hotels in the UK are C or worse.
“The question on whether investors would pay a premium for a more sustainable hotels comes up again and again. But the real question to ask is 'will I still have a buyer for my hotel when I decide to sell it, will I still be able to get finance for it if it doesn’t have certain credentials? Will I still have a buyer?' We are starting to see institutional investors not proceed with acquisitions because they do not meet their ESG criteria," Toora said.
In the survey, respondents said they would pay a similar premium for a hotel with environmental certifications, when compared to the hotel being on the NZC pathway and also brands which have amended their brand standards to achieve NZC in operations. There is little evidence thus far of green premiums transacted especially at this time in the capital markets, but there is much more evidence of sustainability questions coming up in commercial discussions. The survey responses are more reflective of what the industry considers to be important. The response about brand standards is very interesting because whilst some major brands have made commitments, so far, there has been minimal change in brand standards which are often contradictory to investor sustainability goals particularly around how hotels are operated. However, brands are starting to become more engaged on the issue as they need to understand what their investors are looking for.
More than certification
While certification systems like BREEAM and LEED have become increasingly important in the industry. The highest proportion of respondents, 56% said they would need a minimum level of Excellent BREEAM/LEED certification. But investors invariably want to see more. This means increasing granularity around net zero trajectories through the Carbon Risk Real Estate Monitor (CRREM) tool, a framework used by real estate investors globally which maps out operational carbon emission targets annually out to 2050 by sector. Net Zero targets are not necessarily voluntary either, we have seen the number of cities setting net zero targets double since 2020 and increasingly seeing planners in the UK for example impose carbon levies for developments.
Toora, who also chairs the capital markets committee of industry body the Energy and Environment Alliance, said she is seeing transactions fall over because properties weren’t hitting these targets, mainly from institutional investors rather than other groups.
“We've seen that in the market, where the hotel had the best environmental certifications but because it didn't hit those NZC targets for at least 10 years, it only hit the net zero carbon target targets for the next four years, the buyer did not proceed with the acquisition,” she said.
Institutional investors make up a smaller but growing proportion of hotel ownership but this is the group which has embedded sustainability as a serious part of their due diligence for acquisitions and part of their asset management. However, we are also starting to see the major PE groups implement ESG strategies and conduct net zero carbon audits of their portfolios which will confirm which assets are on the NZC trajectory and which ones are stranded and so it remains to be seen what actions will follow as an outcome this exercise. At JLL’s Hotel Investment Outlook event hosted on 21 February, one third of the in-person attendees said sustainability has been a consideration in their deal discussions in the last year, this is interesting given the majority of investors were private equity groups.
Behavioural changes
It doesn’t all have to be about costly capex though, there are other, cheaper ways, that hotels can bring down their carbon footprint.
More than 65% of the respondents to the survey said that behavioural changes influence energy consumption by a larger share than financial expenditure.
"There is a lot you can do to influence how efficiently a hotel is run, and operating a hotel rather than having a leased hotel is hugely beneficial because with a leased hotel you can’t force a tenant to go on the journey with you, they need to buy into it that there is a benefit to them as well," Toora said.
Changes include things such as turning HVACs off in unused spaces, sourcing FF and E from sustainable source and encouraging the use of showers over baths. It can also be about the frequency of replacing equipment and policies around sourcing locally and waste management.
“You can get EPC rated A building which is the theoretical performance and a BREEAM outstanding certificate, but ultimately, to get the most out of it, you have to operate it in the most efficient and optimal way, which is why the training and the people element is so important,” Toora said.
In the survey, 17% have set targets to reduce emissions from a baseline, 26% have appointed ESG champions to ensure initiatives are implemented, 44% have implemented waste and water management policies, yet only 1% said the GM pay is linked to energy performance.
And hoteliers are increasingly taking their customers on the journey to reduce energy consumption. Some of the initiatives include:
- Mandatory employee awareness training for all employees globally
- Raising awareness through collateral in guest rooms
- 5-minute showers as opposed to the average 8 minutes
- Smaller breakfast buffet plates to reduce food waste
- Environmental policies displayed, vouchers/rewards for less frequent housekeeping services etc.
- Visual information in guest facing areas and digital guest directories
Social studies
On the social side, the results have been eye opening too. Respondents ranked the following criteria in order of importance to drive the valuation of a hotel:
- Payment of minimum living wage
- Employee satisfaction
- Guest satisfaction
- Proximity to transport nodes
- Low employee turnover/high retention rates
- Evidence of active measures to prevent human trafficking and slavery
- Active involvement in local community projects/charitable campaigns
The strongest link to liquidity and value is from the E in ESG but the S is also considered important. Would an investor still proceed with an acquisition if employees are not being paid the MLW and has high employee turnover rates; this is most likely expected to impact liquidity.