In this episode of JLL’s Perspectives Podcast, JLL’s Head of Strategic Research, Annabel McFarlane, JLL’s Head of Sustainability, Connor McCauley and Lendlease’s Head of Leasing and Asset Management Workplace, Charlotte Stratton unpack the updated "Early Mover Advantage" research which reveals how the commercial real estate market is rapidly embracing electrification and sustainability targets. 

I have two guests with me. I have Conor McCauley, the Head of Sustainability at JLL, a sustainability and real estate expert with nearly 20 years experience. Conor has advised clients across the EMEA and APAC region and worked in London's JLL office for 2015 through to 2020. His key focus is ensuring that our clients understand the current and emerging ESG trends, regulation, and strategies that can impact their real estate operations and investments.

[00:01:08] - Terrific. Charlotte. Charlotte Stratton. Charlotte is the Head of Leasing and Asset Management Workplace at Lendlease. A real estate investment expert with nearly 30 years experience, she has led large scale pre-commitment leasing and asset repositioning across the Australian market and is known for her strategic investment expertise, negotiating skills and thought leadership on workplace innovation. Welcome Charlotte.

[00:01:38] - So I'm Annabel McFarlane. I'm the Head of Strategic Research for JLL and we have been working on some research which updates and takes the report that we did in 2023 to the next level is it was called the Early Mover Advantage and it's about assessing the demand for sustainable office assets and looking at what the supply side looks like.

So, alright, let, let's kick off with one of the first questions. In our 2023 study, we saw strong momentum in sustainability commitments. What has changed in occupier demand since then? So, Connor, why don't we start with you?

[00:03:38] - Right. Fantastic. And Charlotte, how are you seeing these evolving targets? Because what we've seen on the research side is that more companies are signing up to net zero targets, et cetera. How are you seeing it shape the way landlords and tenants and you as a landlord might work together to, you know, to solve their problems and for your assets too?

[00:04:46] - So that means a lot of measurement and

Yeah.

you know, technology,

It's technology, it's measurement, it's data that we have been collecting. It's now about understanding which bits of those, of the data set that tenants need and want to report on and will need to report on. And making sure that that's being able to be provided to them in a user-friendly way that meets all their needs.

Yeah.

So it's, it really needs to go both ways.

[00:05:48] - And the other thing that we notice in the, the research data is that it's much more likely that office occupiers are reporting they need to have renewable energy sorted out by certain dates. Is that a new thing or is that just,

[00:06:36] - Yeah. And we certainly took a quite a portfolio approach when we thought about our renewable energy, making sure that we were able to use our scale to our advantage to be able to buy that in at sort of the right price. And, you know, I'm not super technical, but I also understand that you've got to really think about the quality of the renewable energy. So how can you make sure that you can verify that as well sourced and and truly renewable. And I think if you do that in pockets, you've got that sort of potential gap of, of quality or that lack of quality assurance. And so we've taken a, a very much a portfolio view to be able to provide that in a cost efficient manner, but also with that right level of integrity behind, behind the renewable.

[00:07:35] - Sure, yeah. So this time round we went a bit deeper. We didn't just take the largest tenants over 5,000, we went down to 1,000 or 1,500.

It was 1,000,

1,000, 1,000 square metres. Yep. So a couple of takeaways from that group is one, just because they're a small tenant here doesn't mean they're not part of a larger organisation globally. And what sort of came out of the, the research was that they do, there's a large proportion of them that do have net zero carbon targets. My view would've been that if you're a smaller tenant, you don't have anything on your website, you don't have a sustainability resource or team, so therefore no commitments. But that wasn't the case. There are still a large proportion of them. And then I think the, the other thing is that they've also still got midterm or interim carbon targets as well as renewable energy targets as well. So similar consistency to some of the larger tenants.

Yeah.

Yeah.

[00:08:52] - Okay. So now let's talk about the regulation and reporting impact. And we've talked about, we've touched on it a little bit as we've gone through I think the, the regulatory environment seems to be accelerating. Perhaps Connor, you can explain what the key changes have been and where and where we're going with it.

[00:10:12] - Which is, which has got to be extremely significant for a, a landlord. And we've touched on a little bit, but I can imagine there's a huge range in offerings around landlords and, and their capability to help tenants report.

[00:12:02] - Yeah. And of course the whole point is to reduce emissions. So let's get on to how the market forms for the better rated assets and what, in a minute, we'll, we'll we'll also tackle the move to electrification. But let's start first off by looking at the highly rated neighbours assets, which is the five and a half star plus assets. That's what we've decided as is, is the key benchmark, try and get over for this, for this measurement. And certainly if you look at the research numbers, what we've seen over time is that vacancy for the better assets, the five and a half star assets and above, has over the last two years, the difference between those assets in the wider market has widened. So you end up with, for example, the five and a half star assets across our CBD markets with 5% less vacancy than the wider market. Now that's material in a, in a situation where CBD markets are challenged with high vacancy across the board, the rental story is a bit little bit more complex, the premium is not quite there. And we'll under, we'll, we'll we'll unpack that a little bit as we go forward, but the yield premium is, has been very consistent for some time until more recently. So let's, let's unpack some of those, those factors.

[00:13:50] And I mean Charlotte, maybe you could have a view on why we think that is.

I should point out that the four and a half and five star do outperform the wider market.

So I think that would play into the

Some of the results we're seeing as well. I mean, so when we finalise this research, I think that the rental premium would be the most interesting one. The yield premium is fairly clear.

Mm.

Once you've spent the CapEx, you've done the conversion, the upgrading the assets, there's a yield premium in terms of 40 basis points has been consist the last couple of years, which is understandable from a landlord's point of view. Once the the money's been spent, you de-risk the asset.

A real driver, isn't it?

And you know, that downtime and not having that vacancy sit there sort of translate to a rental premium 'cause you're achieving 5% more naturally 'cause you've 5% fuller. So I think there is a, you know, maybe a little bit of tenants aren't paying more for it, but they're shortlisting that asset a lot faster or it's being, it's attractive to a wider pool of tenants and therefore it's not sitting vacant as long as maybe some of the other offerings in the market.

It's a good point. It's an element of regulation, but it's actually from an occupier, a government occupier lens.

[00:16:42] - Okay. So we're seeing some, a measure of, you know, outperformance for these highly sustainable assets. Is it - is sustainability alone enough to secure leasing success or are there other factors? I think we all know the answer to this one.

Yeah.

Nice try Connor. Yeah. Tim O'Connor will be looking to recruit you into his leasing team if that was the case. Yes. Yeah, no, I think there's so many things that go into the mix, but what we're finding, like some of our research is sustainability is once again one of those top performing factors. I think maybe there were a few years where it was a bit more business as usual, just kind of taking it as red and now it's a lot broader the conversation. I'd say also the conversation around social sustainability is really increasing as well in that space that tenants really want to know, you know, what you're doing with some social good as well. But I - you know, there are a lot of factors that go into what makes a building successful and at the moment we're really seeing that, you know, the pull of the precinct, we're really seeing that core great located, well amenitised precincts are doing really well.

Yeah, it's risen up the ranks.

And I think like the last point I make on that is, is around what I'm doing, like sustainability literacy. I think a lot of companies now have had their goals. They've had their targets for a long time. And hopefully the likes of me and and the rest of my cohort in the sustainability sector have helped educate, you know, the people within their organisations and then, you know, whether that's also tenant reps and leasing agents and others in, in the real estate sector. So the types of questions they're asking of landlords and others has improved and that's helped to put it higher up on the agenda.

[00:20:22] - Yeah. So last time there, there weren't many all-electric assets out there, but this time we decided to go out to the research database. So all of the landlords and REITs that we have on our research list and ask them a question. And that question was: can you tell us which of your buildings are all-electric? and that definition we used was a link to the Green Building Council of Australia. So for us, all-electric building is one that is, is fossil fuel free, so it's taken out any gas use for heating, hot water, if there is a diesel generator still in there for backup purposes, we kept that in, but that's the definition we used and the process we went through is to send out a survey to all landlords and we got some great responses.

[00:21:29] - Yeah. I think to dive into that a bit more, we've had, there's sort of three different types. There's the new developments that have come, come out of the ground and are now all electric. And there's some few examples of those in both Sydney and Melbourne. We also found some other older assets that, we weren't aware of that I guess we didn't pick up last time that are all electric and have been since they were built. And then there's some repositioned assets as well. Most of those are coming, have come out of Melbourne, but there are some in Sydney.

[00:22:00] - Yeah, I think we've touched on a few of them. One of them is the tenant demand. I think tenants and through those leasing negotiations are driving that. And I think, yeah, the technology piece is there now as well. Before, if you were designing a building to be all-electric, there was a lot of confusion. not as much interest in doing it, but now with the use of heat pumps and others, that's up.

There's definitely investor appetite for that to really think about, you know, they want to invest in assets and have funds that have those attributes. So I think that then helps the case to do it. It's definitely seemingly getting a little bit easier. I mean, as you say, with lights of heat pumps and stuff. But I think there's still a lot of complexity around how does it work in each individual building and how does it work from a spatial point of view. How do you, how do you take out the equipment, how do you put in the new equipment? And also when do you do that in a, in a way that makes sense. So, very conscious of-

That was my question, how do you decide, say most landlords are saying, well, electrification, we've got to do it at some point. How do you decide when?

So you're not going to replace it.

So you know, when are you going to replace it anyway. And if you only did it a year ago, then throwing that out doesn't really seem that sustainable for other reasons. So finding the right time in the lifecycle assessment of the equipment, it's also around, you know, who are your tenants, whether they're key lease renewals, and also who are your target tenants. If you, if you know that you're going to be wanting to attract tenants and coinciding that with a repositioning of the asset or some vacancy, then it becomes a sort of a much simpler justification. And then I think, you know, usually it's a portfolio of assets that, you know, a fund is looking at at one time. So it's then prioritising that in terms of which ones go first. And that's around that return, the timing of key tenant decision making and the timing of equipment as well

Oh yeah, I mean that's definitely a factor. We're always really conscious to make sure that if we're using capital, we're using it efficiently, we're getting a return on it as fast as possible. So when we are assessing that potentially in a fund between two assets, which one goes first, you sort of want to do the one that's going to give you a higher return sooner, and some markets will just really demand it, faster than other repositioned assets.

Mm.

You know, we've got a current shortage of highly sustainable and electrified assets. Will this drive retrofits, can it accelerate that activity or stimulate new builds or both?

[00:25:50] - Yeah, I agree. I think if you're just waiting for new developments to solve all of it, you'll still have a real gap between the supply of assets with net zero carbon and those tenants that have those goals. So I think you still would have a mismatch of supply and demand in that equation. So retrofitting becomes obviously a big part of the overall conversation.

[00:26:38] - It'd be good to have a crystal ball to know the exact right moment. That is the right time. I mean, I think like all these things, it will become more marked into market practice and then it, it's just normalised and then potentially moving then to a brown discount rather than any premium. Given how quickly we've gone from having one or two all electric assets in a market to having 12, maybe it's faster than we think, but I'm not sure of what timeframe I'd put on that.

Yes,

That's when we start getting into that sort of stranded area for assets as well.

Yes. The rising cost of maintaining the gas networks.

Yeah,

Absolutely. Key takeaways and advice to finish up now. For landlords, electrification is becoming essential. And we're aligning upgrades with equipment lifecycle and marketing. Any further thoughts from a landlord's perspective?

[00:09:40] - Yeah, I agree completely. I think it's having a plan, making sure it's communicated really clearly to the tenants. And an example of that is with the government requirements that are in play now, when they're looking for space there, there aren't enough five and a half star rated buildings for them to move into. So if you have a plan either for electrification or to improve the performance of that asset from say a four or four and a half to a five and a half, be really clear on what that plan is. And then when that gets submitted to the government or the Department of Finance, they can put that in there for a reasoning and, and really show what that pathway's going to be for them to achieve their sustainability targets.

Yeah.

To align with their, their targets. So what would be the top message for tenants and what should they be prioritising when they in their building selection processes?

That, you know, new

Building a new

Building, sorry.

Yeah. A new building, that's sending a market signal out and we're seeing some large corporates in Sydney and Melbourne consider staying in older assets that want to be repositioned so that there isn't that additional upfront embodied carbon. So I think there'll be an option for companies to make that decision as well as what their fit out will bring to it as well. So if they're working with the landlord, making sure it is as sustainable a fit out as possible and looking at low carbon materials.

I think it's about choosing a partnership that can really work with you on your whole of life of, you know, your whole of life story around sustainability. And I think trying to choose those landlords that will partner with you and can bring, you know, some of their learnings. I don't think anyone comes with all the solutions. I don't think anyone's got kind of everything just neatly wrapped up, but I think it's about that right attitude of, partnership and really working out where things change, how you can move together to both still get your needs aligned and met.

[00:32:33] - Thanks Annabel.

Thank you, thank you.