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In this episode Ray, Marlon and Avi focus on ESG and its importance to the Canadian real estate market. ESG is an increasingly hot topic amongst investors across the globe, it stands for environmental, social and governance. ESG is a set of criteria for assessing an investment or company's sustainability in terms of environmental conservation, social impact, and corporate governance.
Welcome to Altus Insights Podcast Series. This podcast brings together some of our leading brainiacs at Altus Group to discuss, debate, and on occasion complain about the evolving state of Canada's residential and commercial real estate. Join Ray Wong, Marlon Bray, and Avi Zelver for monthly podcasts covering the latest market and construction cost trends across major markets in Canada.
Welcome to insights podcast series with Ray and Marlon hosted by me, Avi. This podcast will cover monthly market updates and construction cost impacts across major markets in Canada. ESG is a hot topic at the moment, so we'll center today's podcast on that focused on development. ESG stands for environmental, social and governance and is a set of criteria for evaluating stocks used by investors who want to keep their portfolios a socially responsible as possible. There are set of standards for a company's operations that's socially conscious investors use to screen potential investments and to identify risks and opportunities that could affect a firm's long term sustainability. Let's get started with the discussion, starting with a question for Ray. How is the demand for ESG driving the market, especially now that it's become more of a requirement for pension funds and institutions? You know, one thing is the requirement we're getting, so it's just smart business practice, if you look at the whole environmental social governance, that's the direction that I think we as industry should be heading, especially with investing responsibly and how that's impacting the environment and as well as how we treat others and diversity and make sure that everyone is heard for from that perspective. But the big thing is having more accountability in regards to keeping us in check. So it's just not a selling feature of a particular company, but is actually a belief embedded in the cultures. And I really believe that that's really going to help individual companies and how they attract great talent and retain those people as well. So I think that ESG is more of a thing that we should be doing rather than what we have to be doing. I think what we're going to see, especially with Marlon's comments later on how that's sort of impacting positively on real estate and real estate investment, especially for real estate, according to you, the Carbon Leadership forum, that building and construction sectors make up 40% of the global energy related to carbon dioxide. So we've done a really good job in really impacting the efficiencies part. What we're trying to get towards move towards is looking at the building materials and that component that is sort of embedded into the buildings and properties. So I think it's something that companies are not. Yes, it's becoming more of a requirement and expectation, but something that we should be doing. Yeah, not a labor consultant. But one quick thing is the last time we did the Valentine's edition, no one sent me any flowers. And I was extremely disappointed. And secondly, for today's thing, I actually, well, my nirvana t-shirt. Very tenuous links, but not just wearing a shirt like right. I actually stepped out from the corporate side of things a little bit. I think one of the things to highlight around ESG is that corporations and there are also country into ESG at that corporate level through, I think, very mentioned diversity of hiring. But there's also stuff like engagement in communities, innovative strategies like retail owners hosting farmers markets. When we deal with this stuff, I tend to do within a day to day, we're sort of on the tools, so to speak. So looking at construction retrofit or full renovation, the decisions to go for ESG tends to be in a larger organization at the board level and then enacting these decisions on the development side tends to move the development teams, which for some assets, I think is a little easier than others, which we'll talk about later. The other thing I think with ESG is some aspects, especially around the sustainability side, are driven by government and the driven by government mandates as well. So it's not just always the corporate decision to do it. And we have to remember in the current fiscal era, basically government responsibility when it comes to budget in is someone else's problem. After all, famously budgets balanced themselves, then we tend to see the requirements for construction, more so around the step in Vancouver and Toronto and the changes in Montreal. So there's a number of factors that contribute to the decisions to make ESG and move very. I think it's something we should be doing. We shouldn't need the government forces into doing it. Yeah, I agree. Great answers, thank you. The next question will be targeted to both of you. So whichever one of you want to respond to, please feel free. So many global companies have committed in their strategies to achieve net 0 over the next 5 to 10 years, and we're seeing more of a focus on diverse hiring. As you just mentioned Merlin and operational practices and building operations like the tip of power being used, the cleaning supplies being used. Can you tell us a bit more about net zero and how Canadian companies are positioned for the ESG commitment? And net zero basically means achieving net zero emissions if we're dealing just with net zero, so that basically means have no greenhouse gases or offset any emissions. Easiest way to offset emissions would be plant lots of trees. Obviously, that was a government policy. One point. Let's find a billion trees, and it tends to mean producing more clean energy than you consume. So it's a mix of energy efficiency and reducing the need and then adding in renewables such as geothermal and solar. All in all, it tends to be a focus not just on energy, but that better living experience. When we talk about real estate, there's also a lot of other terms I think do confuse the public a little bit like there's net zero already. That's why basically a building is built to the standards on energy efficiency, but doesn't have the renewables plugged in yet. Something like that would be similar to where the BC step codes heading and TGS. And I think those terms in the market cause a lot of confusion with the wider public. And then another example I know we spoke about before we did the podcast was office is having gender neutral bathrooms. The new projects we're seeing, it's becoming somewhat universal, and I think it's a great step in demonstrating ESG is not just about lead lights, it's how and more importantly, who uses the building and creating comfort. It's more than just it's not just about temperature, it's the actual use of that building and how the building's been used. It's a different mindset. And just to look it from a Canadian perspective that Canada right now is the second largest producer of hydroelectricity in the world, and it accounts for 59% of the country's electricity supply. And if you look at Quebec, it generates 95% of electricity to hydroelectricity. So from that perspective, can everybody sort of has a bit of an advantage in how it's powering? It's buildings. So it's a bit of a head start from both the owner standpoint and as well as from a tenant standpoint and achieving some of those goals. So I think from a Canadian perspective and the Canadian companies and how they've embraced this, I think we're at a good point and good inflection point. And right now, I think the focus is to implement these initiatives, but as well as having benchmarks, accountabilities and being transparent. So we can actually see the differences with how companies operate. And as Marilyn mentioned earlier, with respect to hiring practices and just hearing the different people within the organization and not just the senior people and having that interaction both internally as well as externally and how we deal with our clients and community. That's great, thank you. So this question will be targeted more toward marlin, but ray, feel free to add anything. So is it difficult to make performers work with these kind of standards? How can you balance your performer and what sort of cost premiums are we seeing? It's a little more of a complex question because it does vary from asset type. I mean, the most recognizable ESG sustainability initiatives I think we've mentioned TGS in Toronto, in b.c., Montreal with the modifications recently. Before that, there was the lead standard, which were very recognizable for a long, long time. I think Canada's got the second most leader LEED certified buildings in the world and passive house has been in BC we started to see our East fit well well standards like the keep going on. Again, I still believe that contrary to some public confusion on it, some of these are optional. Some of them are mandatory, so some of them have to be in the Pro forma. Some of them are a corporate decision to do, and the cost premiums really vary based on the baseline. It's very critical to define that baseline, and the baseline varies from each project and each asset time, i.e. what is the minimum expectation that was always in the market or what was always produced before? Because you can't just say something is necessarily a premium is at 5 percent, is at 10% Devil's in the detail. I'll talk some specific numbers in a moment. I think it's also important to remember this is a worldwide challenge that isn't made in front or this isn't punishment from the council in Vancouver. This this is a good thing that we should all be on board with, and it's not a left or right issue either. It's a people kind challenge. It's easy to say we want it. It's much harder to balance the pro forma, especially in the residential hydro's market. It's very difficult to balance without some degree of incentives, and it's getting a little more difficult and TGS is a great example. We have tier two, 3 and four. They have the same DC rebate. So basically the city of Toronto has come out and said, we only want you to get tier two. In fact, we only want you to get to one. If you get two tier two, we'll throw in a couple of pennies. If you go over that, yeah, it's on you. That basically sends the wrong message. So stuff like density bonus in some sort of incentive to green up the building makes a hell of a lot of sense to me. You start to look at an office. Offices have been high ESG and leading the way for a while, and that's it's been all recent. History has been in that direction, especially at the tier side of things, and it's driven by the tenant, the larger tenants, institutional investors that they kind of willing to pay for it to a degree and residential doesn't have the tenants for in it. So rent increases more difficult to establish. And there's a lack of momentum. I think on the residential side, I think it's starting to build home, but it's education and you start looking at the last few years now. It's stuff like passive house 80gb standards. I don't think there is any private building over tier 2 at the moment yet. And generally, the changes in step two, version 4 that are coming in there are around a 5 to 15 square foot premium on a residential project, be that condo or rental and going to net 0 is going to be about $40 per square foot, could be 35, could be $60 per square foot and office building class 8 going LEED gold or platinum. It was going to go for that anyway. So the premium in essence is zero. No matter what I do as a cost analysis, you were going to do it anyway. So is that a premium? I'd argue, you know, or it's nominal. So how do you get to the targets? How do you balance the pro forma recent trends, especially? We've seen these geothermal is very, very popular. That's both energy efficient can help in the profile as the number of companies that can provide solutions upgraded the envelopes the most expensive one, but don't just accept the first upgraded envelope. This is where you need an energy model and make them earn their fee. Look out and try and get it down. CLT I know where he was a big fan of CLT. I'm a huge fan of CLT. Looks absolutely amazing. Local trade, sustainable bit of a premium cost. There is an advantage in time. I think as the market share increases, it's going to become more and more popular, more cost effective. Also, with former can still increasing at the current price, it might actually just naturally become cheaper and then the stuff removes gas supplied equipment. Carbon had to be like you mentioned hydrogen Capex nice and cheap. Not as much fun in Ontario. Thank you very much. Windmills and I think the bigger issues actually on the revenue side, which were raking drop in a second, is the office had an offset in revenue, residential design and office deals with a large tenant that's driven by similar goals. When you go to high rise residential, even in low light residential, you know, basically dealing with a million different purchasers or tenants, they like it well. The ones with the tinfoil hat without the tinfoil hats are interested in saving the planet. The challenge is, do they want to pay for it? Well, in theory they say Yes. But then when the rubber hits the road, they're going to say, I don't think so because we're already unaffordable. So if now we had 10% to 15% on a rent or a purchase price, is that really an affordable solution? So the has got a balance that means which is a similar theme I think will go from affordability previously. That means that the revenue has got to increase or the incentives have got to increase. Inclusionary zoning is about to add 50 to 100 square foot to the price of a condo in Toronto. So how much more can the market bear? And marlin, to your point, especially on the office market, that when LEED certification originally came out, that there was a thought with tenants willing to pay higher rents and initially. I think tennis really embraced the whole green concept because it's not just it's certain savings and more of a healthy work environment, but it was a way to really attract and retain talent. But now it also got to the point that similar to your comments on the residential that some the tennis expected that weren't willing to sort of pay that premium. And this was 10 to 15 years ago. So we're at that same point now where the especially the new bill, especially with Vancouver and Toronto and the last couple of years, despite the overall office availability rates moving upwards, we haven't seen any sort of major lease cancellations on the new build is actually attracting more interest. And you're actually seeing reflective of some of the net effective rents actually increase in some of the newer office buildings because it has these type of amenities and as well as, you know, better shelter system, better space layout, less columns and so forth, they're attracting companies that want to make sure that office space is you have social distancing of some flexibility to create some sort of collaboration areas. You're seeing that they are looking to pay a little bit more and it's reflective of new space, but be interesting with existing space and whether or not it needs to be retrofitted and what the costs have to be or the capital improvements that need to put in the space to get at a certain standard and how those buildings are going to compete going forward, especially with close to, you know, close to 25 million square feet. That's going to be built over the next 5 to seven years. Mm-hmm Really, really good points, and I was actually going to ask about whether it commands higher rent and if there's a demand, but I think you guys already answered that, that it really depends on the asset class. And there is a demand, but people are only willing to pay to an extent at that point. With Marlins coming earlier, it really depends on location. It depends on the type of building and depending on the type of use and you look at office and offices in news right now, just because the higher availability rates and what we've gone through the last couple of years. But if you look at the premiums now being paid for industrial warehouse buildings that have more people operating in, especially with some of the more sophisticated stacking and rocking with warehouse distribution that you know, there's a lot more light that is being punched into those boxes and a lot more focus on air quality and other amenities in office buildings and in the industrial. Now we're seeing now, especially some rents in the suburbs, actually at the same rent. Net rent as office, if not higher. So for industrial and based on the market, that willingness to pay for that, that premium ones because of shortage of space, but to it also really depends on the need by the companies. And we're starting to see that switch. So industrial is actually looking a lot nicer and again is reflective of the need of the tenant. So definitely with industrial there, there is a need to people are more willing to pay higher rents for that type of space. Yeah, I think in general, is it something people want to do. And we've seen the market take care of that naturally on itself. I think the thing we've got to watch is too much government intervention in trying to force a narrative or force something that's not happening naturally or trying to speed it up faster than the market can bear on the revenue side. I think we're naturally going to head towards the net zero with or without the government just because it's good social practice. And I think, especially in a country like Canada, we're very, very open to these sort of ideas. So I think it's making sure that the market's not punished or forced into doing something. It lets it happen naturally. And I think in the end, we'll get to the same target everybody wants to get to. But the market's going to get a pace that's reasonable where the end users are not going to be punished unduly and revenues will stay more in a little more balanced with marginal increases over time, driven by other factors. Yeah really great point and great insights, as always, thank you, guys. And before we close this off, any final remarks or anything keeping you up at night, any last things that you would like to include. Sorry, Marlin. No, I was going to say around ESG, I suppose I already make my final comment. Obviously, right now, this is recorded in advance of the stuff happening in the world that probably keep us up at night by the time this comes out. Hopefully there's a peaceful resolution to what's happening in Ukraine, but obviously our heart goes out in that direction. So I'd say that definitely keeps us all up at night right now. Absolutely I was just thinking the same way. I wasn't sure when this would be released, but hopefully by the time it's released, things are things are looking much better. Well, thank you both so much again, as always, for your incredibly valuable insights and for your great discussion. I'm again grateful that I always get to learn from you, and I'm happy that now the audience gets to learn from you as well. And thank you to anyone that's tuned in. Thank you for listening in and for taking the time. If you'd like to contribute to the discussion, please feel free to comment below. Or if there are other topics that you'd like us to cover, please feel free to write those down as well, or you can email us directly. Thank you all very much and hope you have a wonderful rest of the week. Thanks, everyone. Thank you. Thank you for listening into our episode on ESG. Make sure to tune in to our next podcast, which will be centered around purpose built rental, where we'll discuss cap rates, get into the growing pipeline and demand in major markets. Look at performance for purpose built rentals versus condos and more. I want to take this opportunity to announce some exciting news, starting with the upcoming release of the GTA multifamily rental data and analytics coverage for data solutions, which is scheduled for March 30 first. Following the initial launch of calgary, please find the link above the podcast recorded. Thanks so much for listening in and hope you have a great week ahead.