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ESG Trends: Green Premiums and Brown Discounts

Sustainability is a well-established imperative in the commercial real estate industry. Today’s workers (and future generations) are growing more environmentally conscious, with 75% of Gen Zers reporting that sustainability is more important than brand when making purchasing decisions. 301 asset managers representing over $59 trillion in AUM have signed onto the Net Zero Asset Managers Initiative. And there are now over 2,500 organizations with an approved Science-Based Target. 

With stiff competition for tenants across key asset classes like office, industrial, and multi-family, it should come as little surprise that building owners are turning to ESG as a key differentiator in a crowded market. This has, in turn, given rise to a new concept, the "green premium," which refers to the price premium that investors and tenants are often willing to pay for greener, more sustainable buildings. On the flip side is the “brown discount,” experienced by older buildings that have not been updated to meet modern environmental standards and which may become less valuable over time. 

In this article, we’ll explore the green premium and brown discount phenomena, why they matter, and the factors that contribute to a building being considered "green." We will also share best practices and steps that real estate investors can take today to be well-positioned for the future.

Understanding The Green Premium and Brown Discount 

Though the twin concepts of green premiums and brown discounts reflect the broader market shift towards sustainability that has taken hold in the last 3-5 years, they’ve in fact been around for a while. CoStar first reported in 2008 that “green” buildings (initially defined as having LEED and/or ENERGY STAR certifications) command higher rents, occupancy rates, and sale prices than non-green buildings.

The term “green premium” thus arose to refer to this fact: that tenants and investors are often willing to pay anywhere from 3-20% more for modern, energy- and water-efficient buildings with LEED- or BREEAM-certified design and sustainable infrastructure like rooftop solar.

On the other end of the spectrum lies the “brown discount,” which threatens older buildings that have not been updated to meet modern environmental standards. The idea of a “brown discount” posits that these buildings are less desirable and will thus sharply decrease in value over time. These buildings often have higher operating costs and are more energy-intensive than newer, greener buildings, which might deter environmentally-conscious tenants and investors. They may also have other negative attributes, like lower levels of natural light, more dated design features, and less sustainable materials in use.

Per the thesis of the brown discount, all of these factors combine to make “browner” buildings more difficult to lease and sell, meaning their value may decline (and that they can be rented or purchased at a discount) – to the point where they eventually may even become stranded assets.

What Makes a Building "Green"?

Multiple factors contribute to a building being considered "green." These include:

  • Energy efficiency: Green buildings are generally designed to be energy-efficient than their “browner” counterparts. Efficient design is typically achieved through LED lighting and efficient HVAC systems and equipment, in addition to insulation and other building materials that help to reduce energy consumption and waste. Technology like Aquicore can help ensure that buildings maintain excellent energy and carbon performance on an ongoing basis.

  • Water efficiency: Green buildings are also frequently designed to be water-efficient, through the use of low-flow plumbing fixtures, rainwater harvesting systems, and other technologies that help reduce water waste.

  • Building certifications: A great way to signal a building is green is if it has certifications, like LEED, BREEAM, ENERGY STAR, or WELL, which variously recognize sustainable design, strong energy performance, indoor air quality, and other features that promote occupant health and happiness, like natural light levels. 
  • Sustainable materials: Related to the above, green buildings are often constructed using sustainable materials with lower embodied carbon, such as recycled components, sustainably sourced wood, and low-emitting building materials that contribute to healthier indoor environments. This helps to reduce the environmental impact of the building's construction and operation.
  • Indoor air quality: Green buildings are typically designed to have better indoor air quality than non-green buildings. This can be achieved through the use of modern ventilation systems, low-emitting building materials (as mentioned above), and high levels of natural light.
  • Sustainable transit access: Finally, green buildings are often located in areas that are well-served by public transportation, like urban cores, helping to reduce Scope 3 emissions related to occupant transit. They may also offer amenities like bike storage and EV charging stations to further defray transportation-related emissions. 

Best Practices for Real Estate Investors

Though there is growing industry awareness of the brown discount, we have yet to reach a major tipping point – one in which older, less performant assets are devalued en masse and the high capital costs of upgrades and retrofits are outweighed by the imminent threat of asset stranding (making costly upgrades newly attractive to the investors who hold the purse strings). 

However, that may soon change: in one chilling example, a recent study by the NY Comptroller’s office found that 70% of buildings will be out of compliance with NYC Local Law 97 by 2030 unless they undergo major retrofits. With fines for noncompliance on the horizon – and more and more states and municipalities evaluating building performance standards with similarly punitive enforcement mechanisms – it seems clear that the real estate industry is hurtling toward a possible watershed moment. 

Real estate investors can take a number of steps to position themselves for success in this changing market. Here are some best practices to consider:

  • Conduct sustainability assessments: Before investing in a new asset, conduct a sustainability assessment to determine the asset’s current energy and carbon performance and identify opportunities for improvement. Reviewing building benchmarking data publicly available through ENERGY STAR can be a good starting point.
  • Prioritize “greener” acquisitions: You may want to focus on acquiring properties that are designed to be energy-efficient and sustainable, which already meet performance levels dictated by local compliance markets (or have a clear roadmap to get there). As discussed, these properties are likely to command a premium in the market and may be more attractive to tenants and future buyers over time. However, that also means they may be less opportunistic.
  • Implement technology: Before evaluating capital upgrades and retrofits, make sure you’ve fully maximized the operational performance of your assets and are leaving nothing on the table. Implementing technology like Aquicore will help ensure all of your buildings are running well, with no missed opportunities to save energy and emissions and avoid waste.
  • Evaluate retrofits: If you own older buildings that do not meet modern environmental standards, retrofits may be unavoidable. You may consider upgrading to LED lighting, upgrading insulation, installing energy-efficient windows, installing solar panels or other renewable energy systems, and upgrading or replacing major building systems and equipment. Technology (like Aquicore) can provide a boost here by helping you forecast and ultimately measure and verify the impact of retrofits and other sustainability projects across your portfolio.
  • Stay abreast of regulations and trends: This perhaps goes without saying, but ESG is a constantly-evolving field. It is imperative to monitor market trends to stay up-to-date on the latest developments, which may include new regulations and building codes; fluctuating rental and sales prices; the availability of rebates, incentives, and green bonds for sustainability projects; and the ongoing impact of transition risks (like the rise of remote/hybrid work) on various asset classes.
  • Consider the long term: Finally, though short-term returns for investors are paramount, savvy real estate owners are also actively weighing the long-term implications of all of the above dynamics. Climate risks, the growing regulatory burden in the U.S. and abroad, and changing consumer preferences will inevitably impact real estate within the next 5 years and beyond. Strategic investments made today (that may be tougher to sell to stakeholders in the immediate term) may prove to pay off in the long run. 

Final Thoughts

The green premium and brown discount are important concepts that reflect a broader shift in the real estate industry. Investors who are well-positioned to take advantage of this shift may be able to achieve higher rents and sale prices and a competitive advantage over those who do not. By focusing on building sustainability, leveraging technology, making strategic upgrades, monitoring key market and regulatory trends, and considering the long-term implications of all of the above market dynamics, real estate investors can future-proof their operations and ensure success in the years to come.