Confronting the Brown Discount

Apr 9, 2024

What is a brown discount?

The demand for green buildings has been steadily increasing. While environmental friendliness serves as a key incentive for building and investing in such properties, investors and owners now confront a significant challenge known as “brown discounting.” This occurs when non-green real estate assets experience a reduction in rental yield and asset value.

So, what’s to stop investors from going with the cheaper, non-green buildings?

Brown discounting is a term used in real estate to describe property that is neither green nor sustainable. Properties that are less sustainable or energy efficient tend to depreciate at a much higher rate than green, or energy efficient, buildings. Brown discounting is the depreciation of rental yields and a decrease in asset value associated with less sustainable buildings.

Green buildings tend to have higher rent premium associated with them, whereas buildings not classified as green or sustainable could be subject to rent discounts of 10% or potentially higher according to a recent study by the Royal Institute of Chartered Surveyors. While brown discounted buildings may save you money in the short term, owners of brown discounted buildings could see a decrease in rent income and increased mechanical, electrical, and plumbing (MEP) lifecycle costs due to non-green, unsustainable and inefficient utilities systems.

Is brown discounting happening in the U.S.?

According to the 2022 RICS sustainability report, demand for green buildings has risen across all edges of the earth. The Americas saw an increased demand of 45%. This demand isn’t just one sided, either. 55% of responders say the demand is from tenants and 57% say the demand is also from investors looking to develop real estate. In addition, over half of the respondents in the Americas have seen a rise in interest from investors in climate risk assessments for their real estate portfolios. United States’ real estate is not immune to the brown discount and the trend suggests the risk of decreased rental yield from properties is only going to increase as the demand for green increases.

How many brown buildings are there in today’s market?

Not only is the demand for green buildings there, but the desire to evaluate, transform, and improve non-green buildings is on the rise. According to Fidelity Investments, nearly 90% of today’s commercial real estate (CRE) buildings will not allow for the transition to net zero in their current state.
Buildings that do not allow for long-term ESG improvements will become increasingly more difficult to lease or sell due to the associated brown discount along with decreased rental income potential and may become stranded assets due to loss of value. Investors that own or may potentially acquire a building should also be aware of the transition risk associated with owning a property that may have future local energy or carbon compliance requirements. CRE investors are taking note of the finically implications of the brown discount, looking beyond Global ESG Benchmark for Real Assets (GRESB) scores and beginning to prioritize sustainability and ESG factors from the start of design through completion and ongoing analysis.

What are the incentives to going green?

The incentives of increasing rental income potential and satisfying stakeholders are a plus, but policymakers are also incentivizing green building through tax credits. The Inflation Reduction Act (IRA), put into effect on January 1, 2023, is the latest in tax incentives for green building initiatives. The IRA will typically cover 30% of efficiency improvement costs with potential to cover upwards of 50% of all costs. In addition, commercial real estate properties can receive anywhere between $2.50 to $5 per square foot for efficiency improvements that meet certain criteria.

How to avoid the brown discount when acquiring a new asset:

Thoughtful pre-acquisition planning can set you up for long-term post-acquisition success. It starts with gathering ESG data about a property. Energy benchmarking and energy audits are great tools that can give you a better picture of a building’s energy efficiency. These services allow you to see where improvements can be made to make a potentially brown building green. Climate risk assessments (CRAs) are another cost-effective service that allows property owners to identify potential risks to real estate assets from climate stressors. Climate risks can lead to high insurance rates, risk of physical damage, and increased operational costs that can have negative impacts on rental income potential.

Weighing the benefits

While brown discounting may seem financially inviting in the short-term, long-term repercussions affecting investors, developers, tenants and taxes outweigh saving a few dollars at the time of purchasing a brown discounted building. The demand for green buildings is ever increasing and the advantages for all stakeholders are tremendous.

If you would like to discuss any of the points raised in this article and need help either evaluating or transitioning your portfolio, contact a member of the EBI team to connect.

Meet the authors

Nolan Previte

Chief Executive Officer

Mike Eardley

Director, Energy & Sustainability

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