Risk and the business case for sustainable commercial buildings

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This article outlines the business case value factors that are risk-driven and how they affect the various industry groups.

How can a sustainable commercial building affect my company's risk?

Sustainable commercial buildings – and the decision to pursue them – can both introduce or increase some risks and reduce others. This article outlines the business case value factors that are risk-driven and how they affect the various industry groups. It considers the threats to, or opportunities for, value that may arise from implementing sustainability. These include issues of compliance, as well as those issues concerned with the increased or reduced risks resulting from the adoption of sustainability initiatives.

Risk considerations in sustainable commercial buildings

Buildings are long-term assets, and hence the need to future-proof them is critical.

In the commercial building industry, there are traditionally a number of different types of risks facing industry groups. Some of these risks include:

• economic risk of overall investment quality
• financial risks, such as access to capital, unforseen events, or budget over-runs and delays
• market risks, such as damage to reputation, ability to attract and retain tenants and employees, and economic cycles
• social risks, such as occupant health and safety
• legal risks, including contractual disputes and legislative changes.

Faced with this large scope of risk, the building and construction market is generally said to be 'risk-adverse', because they seek to reduce, minimise and carefully manage their risk. An aversion to increasing risk is claimed to be slowing the acceptance and uptake of sustainability, 'because of an understandable reluctance to accept new methods without proof that they work' (RICS, 2005, p.13).

However, value in each of the above mentioned areas can be derived from reducing risks through the adoption of sustainability initiatives, extending to both compliance and beyond compliance activities. Potential also exists for systematic, early identification and attention to addressing long-term issues such as resource depletion, fluctuations in energy costs, product liabilities, and pollution and waste management.

Understanding the language of risk in the business case for sustainable commercial buildings means appraising not only what the risks of incorporating sustainability are, but also what the risks are if sustainability is not incorporated. This adds an extra layer of scrutiny to every decision made about a building.

The table below, which is based on the matrix developed by the ASBEC Building Case Sub-committee (2006), summarises those business case factors that may offer significant value benefits through better management of their associated economic, financial, market, social and legal risks as highlight above, as well as indicating the industry groups that are best positioned to take advantage of them.

Assessing risk

Good risk management is vital to companies of all sizes, and no company can underestimate the importance of sound risk management. The risks, costs and benefits, and value of a project all need to be evaluated. The concept of risk is not only about the 'downside' of a decision, but also the 'upside', as there could be both positive and negative effects. Developing a business case encourages the adoption of a risk management strategy while also providing a methodological way of developing value judgments. Risk assessment involves many steps, and there are a number of standard risk assessment tools that can be used. Many organisations have also developed their own internal risk assessment tools.

Improved indoor environment quality

• Sick building syndrome
• Future liability
• Employee expectations
• Whose business case benefits?

Indoor environment quality (IEQ), which refers to the quality of the environment inside buildings, can either increase or reduce a company's exposure to risk through its relationship to:

• sick building syndrome
• employee expectations
• future liability.

Indoor environment quality is measured on elements such as:

• indoor air quality (IAQ)
• ventilation
• thermal comfort
• natural lighting
• noise
• visual amenity.

IEQ is improved in sustainable commercial buildings through building design strategies such as:

• maintenance and cleaning standards
• high-quality ambient air, lighting and acoustic conditions
• natural ventilation
• reduced indoor pollutant loads, particularly related to VOC emissions
• individual control of the thermal environment
• being near windows with access to daylight and views
• soundproofed partitions and ceilings, to prevent noise transfer
• plants, earth banks, and screens to block external noise sources (Fullbrook, Jackson & Finaly, 2006).

Each of these factors may reduce risk through positive impacts on work attitudes and experiences that may, in turn, reduce stress, symptoms of sick building syndrome, and staff absenteeism and turnover, therefore boosting productivity.

More information about IEQ can be found in the Indoor environment, productivity and sustainable commercial buildings article.

Sick building syndrome

The term 'sick building syndrome', first employed in the 1970s, describes a spectrum of specific and non-specific complaints reported by occupants of a building. These symptoms can be associated with the occupants' presence in the building, but may also result from causes other than SBS, including illness contracted outside the building, acute sensitivity (e.g. allergies), job-related stress or dissatisfaction, and other factors (Fullbrook, Jackson & Finaly, 2006).

Sick building syndrome resulting from poor indoor environment quality has been referred to as the 'silent crisis' of indoor environment quality, as it has the potential to cause large industry losses. Building owners may incur losses if their building is seen to be causing symptoms of sick building syndrome, and they may lose current and potential tenants (see Snapshot case study: ABC Building in Toowong). Occupiers may open themselves up to possible litigation and loss from employee health claims, sick days and illness, as well as the loss of staff who may be unsatisfied with their work environment. Anecdotal evidence amongst the industry suggests that the first glimpses of a trend, particularly in the United States, for claims related to poor indoor environment quality and sick building syndrome are beginning to emerge. However, while the argument for reduced potential liability for litigation is highly logical, little documented information on the costs (either to owners, developers or occupants) exists.

With the incorporation of sustainability into commercial buildings, risks of sick building syndrome may be reduced and managed by:

• incorporating appropriate lighting and maximising access to natural sunlight
• improving monitoring and management of heating and ventilation systems
• reducing occupant exposure to chemical or biological contamination from building materials, furnishing and fittings.

Future liability

In Australia, James Hardie has been held accountable for asbestos-related claims for employees and others who fell sick, and in some cases died, often many years after exposure to the material. The final deal means that James Hardie must commit to 'up to 35 per cent of its net operating cash flow, each year, every year, pretty much effectively forever, to asbestos victims' (McCrann, 2006).

This example demonstrates the risk of future liability from material toxicity and raises the question of other future risks ¿ not only for building material manufacturers, but for building owners and occupiers ¿ that may arise from the use of materials with known human health impacts in new buildings, and from existing buildings already containing known toxics. Such examples may include adhesives, paints, sealants and wood panel products (some of which may emit problematic levels of volatile organic compounds) or brominated flame retardants (some of which have potential human health impacts and are therefore being phased out in the EU). Future liability risks may also occur from toxic leaks or soil contamination, or even asbestos, which will in return reduce the future value of the building asset.

It is also claimed that mould is becoming 'the new asbestos' and trends in the US indicate that government tenants are increasingly concerned about exposure to mould liability (Building Design+Construction, 2006). However, where there is risk, there may also be opportunity: 'Addressing the challenging issue of mould and moisture is also related to the green buildings arena. Insurers have traditionally refused to insure mould risks, but some are recognizing that this risk is insurable if appropriate risk-management measures are taken (many of which also enhance energy efficiency). By making a previously uninsurable risk insurable, insurers open a large new market for themselves while also benefiting consumers' (Mills & Lecomte, 2006, p.20).

Companies who understand the risks of future liability are taking a precautionary approach to reduce their risk of exposure to loss from litigation or employee health claims through the adoption of sustainable building philosophies in the commercial buildings they own, develop, design, construct, occupy and manage, such as low-VOC material selection or paying greater attention to construction, maintenance and operation of buildings to reduce the build-up of microbial agents, especially in HVAC systems and construction materials (Heerwagen, 2002).

Employee expectations

Sustainable commercial buildings may employ sophisticated technologies and systems that may require a higher level of maintenance than those in 'traditional' buildings. They also allow more individual control of the IEQ. Together, these factors may create a situation in which there is a delicate balance between occupant comfort and systems efficiency, which needs to be carefully managed. The risk is that occupants may feel pressure to have a positive experience in a sustainable commercial building, while at the same time experiencing changes to individual control and comfort that influence their level of satisfaction.

Poorly managed staff expectations can send negative feedback into the marketplace and de-value the business case arguments for sustainable commercial buildings: 'Adjustment and understanding on behalf of tenants is crucial for successful implementation and if this process is not handled effectively, tenants have long memories regarding instances where they experience discomfort in occupancy' (Szencorp, 2006).

Ways to manage this risk include:

• implementing quality facility management practices, with ongoing monitoring and adjustment of IEQ conditions
• training the facility manager in the use of the technologies and systems
• having the developer and designers explain to owners, occupants and facility managers about likely conditions, so that expectations are not raised unrealistically just because the building is 'sustainable'
• educating owners and occupants on how to use the building to achieve comfort conditions
• using monitoring and verification systems that also allow performance optimisation.

The cost of these initiatives will need to be factored into the business case.

Whose business case benefits?

Occupiers are commonly listed as the key beneficiaries of improved environment quality. However, owners are also likely to reduce their risk of loss by achieving high occupant satisfaction levels if improved IEQ contributes to their ability to attract and retain tenants. All industry groups can reduce their risk of litigation due to health-related claims from sick building symptoms and future liability.

Reputational capital

Organisations that behave ethically, and that are governed in a responsible manner, can build their reputational capital. Reputational capital is often referred to as the incremental profits or long-term strategic assets that accrue to an organisation when they have good reputations. It is a valuable intangible asset and contributes to an organisation's competitive advantage and business continuity. However, reputation is fragile, and serious reputational damage can threaten business survival. In a 2005 biennial survey on the risk management and financial strategies of public and private sector organisations, UK insurer AON found that loss of reputation was seen as the greatest risk to organisations (see the figure below).

At the basic level, reputation is protected by compliance with legal requirements. Beyond that, businesses are increasingly being called upon to account for their ethical behaviour, with a demand for greater transparency of their operations and their associated financial, social and environmental impacts. Sustainability, which requires more stringent evaluation and reporting of performance, is considered an important tool for managing reputational risk, through its role in both avoidance of penalties through compliance, and avoidance of visibility and criticism for what may be perceived as anti-social practices. Reputation is also increasingly having a positive benefit on corporate valuations. The adoption and demonstration of sustainable practices around commercial buildings can therefore be useful in helping companies to manage their reputational risk.

Whose business case benefits?

All industry groups have the potential to benefit from reduced risks to – and enhancement of – their reputation and protection of their reputational capital.

Reduced insurance

• Climate change risks
• Whose business case benefits?

The potential for reducing risk and, in turn, for lowering insurance premiums is one of the anticipated benefits of sustainable commercial buildings. This is particularly related to risks associated with climate change, although other risk management benefits have also been identified, ranging from improved indoor air quality to enhanced disaster resilience. Insurers who are leaders in the field are beginning to revise their business strategies and products to capture these benefits, and this should flow through to owners and developers of sustainable buildings in the form of lower premiums. Additionally, building codes are now starting to address new building requirements that take into account changes in climate and more severe weather events.

Climate change risks

Risk is now inextricably linked to climate change and organisational ability to adapt to the uncertainties of a changing natural environment. The fourth Assessment report of climate change (IPCC, 2007) indicates that the Australian climate will be affected more severely than previously thought, due to human-induced climate change. Increases in the number of unusual and more severe weather events are predicted to occur in Australia, including droughts, bushfires, cyclones and floods (Coleman et al., 2004, p.22-29).

Insurance generally does not cover for damage caused by natural disasters or 'acts of god'. Should the building industry fail to act to mitigate the impacts of climate change on commercial buildings, it will only compound the risk of increasing insurance premiums and uninsurable claims.

Some insurance companies are beginning to reflect the cost of climate change induced risk in their premiums, particularly in tropical areas exposed to the likelihood of extreme weather events.

Conversely, climate change also offers opportunities: 'But while climate change poses potential threats, it also creates vast new business opportunities. Just as the industry historically asserted its leadership to minimize risks from building fires and earthquakes, insurers have a huge opportunity today to develop creative loss-prevention solutions and products that will reduce climate-related losses for consumers, governments and insurers, as well as the emissions causing global warming' (Mills & Lecomte, 2006, p.1).

Insurance Group Australia (IAG) is one insurer working to understand the risks that climate change poses for the built environment and to reflect those risks in their insurance products (see snapshot case study on IAG finds business opportunity in climate change below). While such knowledge is in its infancy, it is likely that owners and developers who build sustainable buildings may be able in the future to benefit from lower premiums. Alternatively, they may be able to avoid higher premiums by avoiding construction in high-risk areas.

Other insurers are also reflecting the value of sustainable buildings in their products (see the snapshot case study on Fireman's Fund below).

There is also evidence that sustainable commercial buildings may contribute to business continuity in the event of natural disaster, therefore reducing the risks to insurers, owners and operators. While some facilities were disrupted for weeks or months after Hurricanes Marilyn (1995), Bertha (1996), Georges (1998) and Lenny (1999), Harmony Resort on the Island of St. John, located in the US Virgin Islands, which was constructed using sustainability principles, was able to continue to provide communications, lights, hot water and refrigeration because of their solar power and hot water systems (Deering & Thornton, 1999, p.8-9; Mills & Lecomte, 2006).

Whose business case benefits?

Owners and occupiers are the key industry groups to benefit from the reduced insurance risks resulting from owning and occupying sustainable commercial buildings. These benefits may be in the form of reduced insurance premiums, loss-prevention after unusual weather events, and reduced health-related claims from their tenants or employees.

Risk of new materials and methods

• New materials and methods
• New maintenance and operating systems
• Whose business case benefits?

The design, construction and operation of sustainable commercial buildings often involve innovations that push the boundaries of technologies and systems. All innovation has inherent risk and, in the case of commercial buildings, the risks may be spread across the whole building life cycle, from the specification of materials, through to implementing them in construction and maintaining them until they become mainstream. The market is also shifting quickly, and with it comes changes in standards and the need to invest in being up-to-date on the latest materials and construction techniques. Typical areas requiring risk management strategies may include:

• new materials and methods
• new maintenance and operating systems.

New materials and methods

Part of the design philosophy behind the sustainable building movement is the push to use new and innovative construction technologies and materials to improve efficiency and effectiveness. However, the innovation has attendant risk if long-term performance data does not exist. Product liability actions against manufacturers may be limited to specific time frames, with the result that owners and occupants, who may not be able to obtain compensation for failed materials or assemblies, may look to others, such as the designer and builder, for cost recovery. Contractors may also seek to minimise their exposure to risk by applying heavy cost penalties to new construction methods and materials, for 'fear of the unfamiliar' and the potential for increased complexity in the 'buildability' of new sustainable design concepts (Bordass, 2000).

New materials – or new applications of existing materials – may require testing to ensure that they will perform to their intended purpose, and this may impact on project costs and schedules. The sharing of knowledge is an important sustainability consideration, as using the experiences and learning from other projects may provide information (for example, see Materials selection in green buildings and the CH2 experience).

New maintenance and operating systems

Compared to 'traditional' buildings, which are more an assembly of technologies, sustainable buildings are highly sophisticated technological systems. This inherent complexity of sustainable commercial buildings means that they require increased commissioning and that new and unforeseen management and maintenance issues may arise. These will no doubt get more predictable as the industry gets better at delivering and understanding these new systems (for more information about the commissioning of sustainable buildings, see Commissioning of sustainable commercial buildings).

On the other side of the argument, however, measuring and operating systems can also deliver measurable performance improvements.

Whose business case benefits?

All industry groups need to understand the risks associated with new materials, technologies and methods, and to have risk management strategies in place in order to reduce any potential increased risks from product failure or unexpected performance results.

Future-proofing

Sustainability implies an investment beyond that required by compliance. However, there are few – if any – companies that would take the risk of developing, owning, or renting a building that merely complied with legislated requirements. The debates around climate change and cost internalisation of energy, water and emissions, mean that legislation is changing rapidly. Furthermore, environmental benchmarking of the built environment is on the rise in Australia and, with the new Section J BCA energy efficiency guidelines coming into effect, extends beyond voluntary tools such as Green Star, NABERS and ABGR. These guidelines will affect all asset classes, including older commercial assets. New sustainability inclusions in the PCA quality matrix will also impact on not only new, but existing, buildings. The introduction into the market of new buildings with higher sustainability performance standards threatens the future value of older stock, which will need to be upgraded to satisfy fast-evolving market expectations. In Australia, all state governments and the Commonwealth Government have minimum ABGR requirements for leased or owned office accommodation, and most have Green Star requirements as well.

As a consequence, to begin a building project – either a new building or a refurbishment – or to rent a building that does not meet or exceed today's sustainability benchmarks, risks it being functionally obsolete from the day it opens, and economically disadvantaged for its entire life span. Similarly, developing and owning buildings that will not be able to cope with the growing demand for sustainable commercial assets opens owners to greater risk of losses on their investment.

In contrast, a sustainable commercial building that exceeds minimum legislated requirements can 'future-proof' against risk by acting as a safeguard against future energy and water price increases and downturns in the real estate market, the impact of which, according to Davis Langdon Australia (2007), 'should not be underestimated'. Future-proofing of assets and investments so that they anticipate market trends and minimise the need for future large-scale refurbishments and upgrades is a risk reduction strategy that may help to stabilise asset value.

Emerging evidence is starting to prove that sustainable commercial buildings can increase the value of a property through reduced requirements for future capital investment in upgrades and maintenance. The failure of valuation processes to keep up with sustainability expectations in society and in the industry is a subject addressed in the Valuation of sustainable commercial buildings article.

Whose business case benefits?

Developers and owners are the key industry groups to benefit from going beyond compliance to future-proof their assets. Developers want to ensure that the buildings they develop will be attractive to tenants and perspective purchasers, while owners want to ensure that their buildings remain attractive to tenants, in order to protect the value of their assets.

Regulatory requirements

Andrew Quade, from GPT Group, highlights that governments at all levels are now more focused on sustainability. It is increasingly difficult in a growing number of regions to get design approval through the development process without meeting sustainability requirements and/or addressing sustainability in the application. Similarly, securing government contracts to develop a property or region, or securing government tenants, increasingly requires a demonstration of sustainability performance on behalf of tenderers and their buildings. Although not simply qualified in quantitative terms, approval processes may become more onerous, and failure to understand and meet sustainability obligations may lock companies out of opportunities for government projects and land releases.

Whose business case benefits?

Developers and owners are the key industry groups to benefit from complying with regulatory requirements related to sustainable buildings.

Performance disclosure and building ratings

There is a strong trend in the corporate world towards more transparent governance and reporting, increasingly evidenced by mandatory reporting requirements, including those in contractual agreements (such as green leases) that oblige parties to achieve certain sustainability performance levels. This opens up new areas of risk.

Property is at risk, not only from the physical impact of climate change, but also from new building industry regulations covering energy efficiency and mandatory disclosure of energy efficiency ratings, as well as from the growing demand for greener buildings (The Climate Institute, 2006, p.21).

There are risks for building owners and in some cases for tenants, who fail to deliver specific green building contractual outcomes. While the obligations of owners and tenants may be clear under such agreements, those of the building developers, designers and managers may be less so. Facility managers, for example, are a key to ensuring that the outcomes are achieved as they are responsible for the day to day operation of the building. Committed performance also brings with it potential for disputes between developers and their consultants if contracted performance levels are not met.

Additionally, owners and developers will likely consider the potential risk to value and marketability of their building assets if mandatory disclosure of a building's sustainability rating exposes poor performance, and look to legal remedies.

Examples of financial incentives or penalties as a mechanism for clients to shift some risk onto the project team already exist in Australia. According to Caimin McCabe, Director at the engineering firm Cundall, to win the bid for a new sustainable commercial building project in South Australia, the bid teams had to agree to a penalty clause which would come into effect if the brief's minimum environmental performance requirements were not achieved. These requirements included a 5 star Green Star Office Design and Office As-built rating, 5 star ABGR rating, as well as obtaining specific credits under the Green Star programs to achieve the ratings. A percentage of the budget was placed at risk if the building failed to meet with the brief. During the design process this performance was mutually agreed to be increased to a 6-Star Green Star Office Design and Office As Built rating.

Performance disclosure and building ratings also extend the 'make good' concept of the building and construction industry by ensuring that design intent is delivered through as actual building performance.

Whose business case benefits?

Owners and developers are most likely to benefit from sustainable commercial buildings and their ability to meet market expectations for performance disclosure. However, all industry groups have a role to play, and consequently carry risk, in ensuring that sustainable commercial buildings achieve contracted building ratings.

For the industry as a whole to improve its knowledge in the successful application of sustainable design there is also a need to find ways for the lessons learnt in projects to be disseminated without fear of litigation, so that we continually improve and not repeat the same less effective outcomes over and over again.

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