Episode 36 – Part 2: The process of moving towards ESG in valuations with Joël Scherrenberg

The following transcript is autogenerated so may contain errors.

Matt Nally: For topic two with Joel, we’re looking at the process of moving towards ESG within valuations. And I think a nice starting point might be to look at, obviously valuations cover a whole host of different asset classes. So my question there then would be it a different, Asset classes impacted quite differently, say from residential to to retail to hospitality.

They’re very differently affected.

Joël Scherrenberg: Absolutely. They’re absolutely have different angles. You have to look at different points of interest. And that’s quite logical because the way you use the different kinds of buildings energy consumptions is very relevant or not so relevant at all. Pollution risk is relevant or not, et cetera.

So if you look to all the factors of ESG, depending the kind of real estate, there are completely different cashflow risk drivers or value drivers among those categories. For example, I have an industrial building. Say for example the steel mills, I can talk hours about energy saving in the building, but who cares it’s 0.

0001 percent of all the energy consumption of the organization because 99. 99 percent of the energy consumption is in the process. So talk about energy consumption and steel mill. Don’t talk about it because those are open buildings. They don’t want to get. It closed down to make energy sufficient. In residential building energy consumption is primarily driven by the quality of the building.

So there’s a lot of interest in about energy consumption. And so you can make, among all those factors, you can look into the different kinds of asset types. And say, Hey, which are more or less relevant for this kind of real estate.

Matt Nally: So there are certain scenarios where ESG wouldn’t be considered so heavily in the valuation process, or would it still be considered as much?

It’s just that it’s waiting might not be as important.

Joël Scherrenberg: No you still see a difference in, in how ESG is relevant in valuation. When I look to the residential market, Actually they’re only looking at the E. The SMG is hardly relevant in the residential market. Yeah, sure. Within the e it’s for most in residential is energy and the rest of the E is also much less than the energy.

When I look to retail social and governance are definitely relevant and environmental is not as much about energy, but more about the other. Environmental aspects while in office buildings, energy consumption is very relevant. So yes, there are differences in the weight. That each of the factors will have among those different kinds of asset types.

Matt Nally: Yeah. And I suppose why it’s not so easy to put a and we’ll come on to this, a framework or guidance in place, because it’s going to be very different property to property and type of asset. So I suppose one of the questions I’ve got then is around the challenges of moving to ESG based valuations.

How hard is it to, one, learn about The ESG factors and how you need to apply them. And how hard is it to get the information about each of those factors to start generating an ESG based valuation?

Joël Scherrenberg: It is quite difficult to get a lot of information. Because traditionally, and that was always a joke amongst families, there were only three things relevant for the value of a property.

First was location, the second was location, and the third was location. And of course, that’s an oversimplifying of the reality. Yes. Therefore, it was always the joke. But one thing for sure, exactly everything about the location. It was completely transparent, no discussion about it. And all information about the location was publicly available.

Then of course, the size of the building is relevant. That’s quite easy because if there’s not a report, just take your your your little device. And take the measurements of the building. The technical quality, depending your personal qualities and depending the kind of assets you can do it yourself, or you might need an independent chartered surveyor for the technical due diligence.

But it’s quite well regulated everybody talks the same language about what is good, what is bad, et cetera. And there’s a lot of information available. But when we look to other things, the whole life carbon assessment or the greenhouse gas emissions, everybody knows what it stands for, but having the actual figures of a building might be quite difficult already.

Matt Nally: Yeah, very true. Okay.

Joël Scherrenberg: Let alone that, what of your references that you have got, that, how these are scoring because you don’t have any information about that at all.

Matt Nally: No, very true.

Joël Scherrenberg: And what we have said when we wrote the paper some of the failures say there’s no information, so don’t bother and don’t try to say something about it.

And we said, no, that’s not the way moving forward. We need to make ESG. Measurable, we have to put it in a framework, but also knowing that within the first period that we can identify those indicators, that we perhaps might be able to find some data about those indicators. But there will be a lot of data missing.

Matt Nally: Yes.

Joël Scherrenberg: If we don’t start collecting now,

Matt Nally: we’ll never

Joël Scherrenberg: get to the point where we have measurable and referable data. So

Matt Nally: a continual improvement,

Joël Scherrenberg: yeah.

Matt Nally: Yeah.

Joël Scherrenberg: So we said we have to start somewhere and we did start now. And now the main issue about ESG is gathering sharing data because some data are available, but people are very reluctant in sharing it.

Which make it very hard to compare one building to another. And what you have seen in some studies, is that what determines a value. And you can, from every building, you can determine what are the value drivers. And you can say, okay 40 percent was location, 40 percent was the size of the building, and 10 percent was the technical quality.

The remaining 10%, and then don’t take me about a percent here because there’s just ational. The last 10% is determined by a hundred or 200 different aspects. And only when you have a huge amount of data, of a lot of transactions, of a lot of buildings with all the underlying specific. You can make a regression analysis and say, okay, this point determines the failure by that much percentage.

And yes, in the Netherlands the Tilburg University has done it several times already in the past 20 years or so, where they regularly measured all the data of the residential market because from the residential market, About 70, 80 percent of all transactions are registered in a system with a lot of details.

So you have a transaction date and transaction price and about 60 aspects of those buildings. And if you didn’t have a hundred thousand transactions a year, you can make great statistical analysis. And they have determined that the energy label where it was 10, 15 years ago only determined. a price difference of one or two percent between the worst and the best label.

This has now already has made a change of ten percent plus or minus between the best or the worst energy rating. So you see change in society and now there’s becoming more and more evidence about how energy ratings influence the pricing of residential houses.

Matt Nally: Definitely. One question I’ve got on that tying into something you said in, in part one obviously we, if you’re doing evaluation you’re giving the market value of today.

So for example, let’s say it was. A long time ago, and it affected the energy rating, for example, affected the property’s value by a percentage, two percentage. So we’re still having to give the valuation today. So in terms of allowing for the ESG aspects, is there an element of saying this is what it’s worth today, but we also have to say, potentially it’ll be go up or down in value in 10, 20 years, but.

By this amount, because of these factors, or are we only giving a price based on,

Joël Scherrenberg: No, you are never allowed to give a value tomorrow. You can say what it’s worth today or what it has been worth in the past.

Matt Nally: Yeah. You

Joël Scherrenberg: can never say what it will be worth tomorrow because you don’t know what the market will be tomorrow.

No, but what you can do is determine risks and what failures should do more. Because that’s something they did too little. Is say, okay, I have a value or have a property. It is failure today at a million euros, but be aware that if the owner doesn’t take the proper measures to change this or this, because of the change in legislation in 2025 or 2030, there will be a negative impact on the value at that time.

I cannot determine how much I cannot determine exactly when it will happen, but it will have an effect in the future. Okay. And then you give a risk analysis and that’s something a failure should do.

Matt Nally: Yeah. I can say that. That’s the bit I was trying to understand is, yeah. How do you both price for today’s market and understand the ESG impacts of the future.

So that’s, yeah, that’s.

Joël Scherrenberg: And what’s already, for example, in the Netherlands the financial institute now say, if you value a building we have to make a full ESG analysis. And in the Netherlands, we call it the DUPA 2. 0, the sustainability paragraph is the translation. So in English, it will be the super instead of the DUPA and there you have to assess a building on a certain amount of aspects, and if your building is not.

Having the proper score, you’ll also have to make an assessment and say, what would it cost today to change the building, to bring it to the level as required to make it more tangible. A building has a label C. What would it cost to bring it up to label A and what would the value be today? The building would have had the qualities required in the future.

Matt Nally: Yes.

Joël Scherrenberg: Yeah. So you’re still not saying what it will be worth tomorrow, but you’re saying, and that’s a special assumption. What if the building would have had this qualities? What would have been the value then? And which investments have to be done to reach that level? And that’s already a standard question for the financial institutes to the failures today.

In commercial real estate.

Matt Nally: Awesome. Okay. So I suppose the, one of my next questions is potentially moving on from that is, what are the buildings of the future going to look like in terms of obviously allowing for the types of things that would make a building in a, for example, And then all the other factors we, I know there’s obviously lots of changes around, smart buildings being built or buildings upgraded to have all the sensors in to measure all these different things whilst we’re discussing surveyors learning more about ESG.

In valuations, are we also including perhaps, I don’t know, architects and developers and so on in that process. So they can also factor in changes to buildings over time.

Joël Scherrenberg: Yeah. How the buildings will change. There will be a difference in development also among the different assets, get curries partially driven by legislation, partially driven by market and within an asset category also in the kind of users, what we already see, for example, in the office market.

The primary office for the larger organizations are ahead of the market. Where the smaller offices are leaning a little bit more back in, in their investments. The difference in speed will remain. So yes, the entire portfolio of the entire market will change, but the speed will be different within an asset category and between asset categories.

Matt Nally: Of course. Yeah, that makes complete sense.

Joël Scherrenberg: And what’s the general trend will be Lower the energy consumption, partially driven by environmental concerns, but also driven by financial concerns and uncertainty. All the everything was happening in Russia and Ukraine is affecting how people are thinking about how certain is my energy delivery at my building, and they want to be less dependent on the Of the grid technical developments will help changing the buildings.

Another one will be also the whole life carbon assessment, because when we really are going to price carbon, people will become more open to take steps to lower their carbon deposit.

Matt Nally: Yeah, absolutely.

Joël Scherrenberg: Then also, it’s also the same combination of. environmental responsibility and financial consequences.

Matt Nally: Yeah. Yeah, absolutely. I suppose my final question around, around this is, are you seeing certain asset classes that are implementing this faster? Cause they’re more affected by it. Is it residential with energy, for example, or are there?

Joël Scherrenberg: Yeah. Where you see the most changes are happening are when related to the building are the offices because, and that’s driven by investors and financial institutes.

And residential market driven by energy crisis. For example, in the retail market, you see a lot of changes in especially where people have a grocery store in all the equipment, which is in the building, so not, it’s not much about the building itself, but. Making doors before the cooling, et cetera.

That’s changing what’s inside of the building, not the building itself. Industrial, they’re mostly looking at their process because the building is hardly relevant in their cost structure.

Matt Nally: Yeah, no, that makes complete sense. And the uses and the makeup are very different between.

Joël Scherrenberg: Yeah.

Matt Nally: Yeah.

Joël Scherrenberg: So therefore residential is energy driven, commercial wheels the office market.

It’s partially driven by energy consumption, but mostly driven by investors.

Matt Nally: Yeah. Makes complete sense. Yeah. Okay. Oh, that’s, I think it’s been really interesting. I think my final question on this as a topic, if you’re, if you are a surveyor that’s doing valuation work and you’re starting to look at how you can improve your ESG factors within the valuations you’re producing, where’s the best place to start learning about it?

Is there CPD courses you can go on or like ways to get your valuations straight?

Joël Scherrenberg: First of all, follow the newspapers, be aware of what’s happening in society, be aware of what’s happening in legislation. And then of course you will need to improve your skills and it will be divided into developing technical skills, because if you are not aware of what, for example, a heating pump is, You won’t recognize it when you see one.

So you will need to, yeah, because you don’t, you know what the old installations look like, you also need to know how the new ones look. And then of course you have to make sure that you are understanding what’s happening in market. And therefore you need Interaction with colleagues, read market reports and follow, of course, CPD.

Because they will help you to improve your skills, to improve your knowledge and depending in what kind of part of the market you’re acting in, you might dive into the deep in specific parts. And more in a glance in other parts, but that will be different depending the kind of work, the kind of market, the location you are, et cetera.

Matt Nally: Yeah, completely. Oh, that makes complete sense. Thank you very much for coming on today and sharing your insights across the two topics. If anyone wants to get in touch or learn more about your paper, what’s the best thing to.

Joël Scherrenberg: Feel free to share my email address and they can contact me by email.

That’s the best way to have confidence was a great to have this contribution today.

Matt Nally: Awesome. But yeah, anyone looking for the email address, we’ll have it on the, at the episode detail. Check those out and then you can get in touch, but yeah, thanks again for coming on. It’s been really interesting.

Joël Scherrenberg: Okay. Thank you very much and see you next time.