Here are the hurdles to assessing ESG in valuations

INTERNATIONAL REPORT — Hotel valuers play a key role in moving toward a net zero carbon (NZC) future for the hotel industry, but there is still a great deal of work to be done in educating them, according to the latest JLL study, “Navigating the sustainability maze.”

JLL last commissioned a report three years ago, and the new report, commissioned by JLL’s EMEA researchers, says progress has been made in several areas, but challenges remain.

The report said there is growing momentum around regulatory frameworks, especially ones that align with the Paris Agreement. Data collection is key for reflecting ESG factors in valuations, and while the hotel sector is getting better at collecting data, the complexity of hotel operations makes getting easy access to that data a challenge. 

“Nine out of 10 hospitality businesses employ fewer than 10 people,” said Ufi Ibrahim, CEO of London-based Energy & Environment Alliance. “While larger companies are starting to think about ESG, the real question is how do we effectively engage the [small and mid-sized enterprises] in this transition.”

Here are the key findings from the study:

Guest behavior remains key in determining the payback period of investments using net zero carbon (NZC) measures. While consumers may claim they are willing to spend more on stays at ESG-aligned hotels, there is a long way to go between stating intentions and actual spending behavior. According to a Booking.com survey, 28% of respondents said that the time spent traveling is too precious to put sustainability at the top of decision-making lists. 

In addition, translating ESG investment into improved top-line performance assumes that guests will see those measures and trust hotel owners’ claims.  

High energy prices may have derailed profit margins. So, the focus should be on improving energy efficiency over the long term. Energy audits, lighting upgrades, HVAC system optimization, water conservation, the use of renewable energy and guest engagement are all key to ensuring a hotel building is as efficient and sustainable as possible. According to a recent analysis from HotStats, total utility costs per available room in the UK rose 83% between 2019 and 2023, from $6 to $11 per room (the U.S. has reported a 27% increase during that same period).

Those efficiencies due to investments will likely be reflected in the valuer’s cash flow projections for the hotel asset. Communication on the exact investment undertaken and anticipated savings will be key for the valuer to reflect decreased utility costs. That cost decline will likely be reflected in an improved profit margin, translating into a higher asset value.

Changes in design and improvement work are contributing to the ESG target and potential reductions in operations costs. The report said continued improvements in the way hotels are built or renovated make them more environmentally and economically viable.

“Eighty percent of the existing hotels in 2050 have already been built. How we transition those hotels towards net zero emissions is the fundamental challenge we face as an industry,” Ibrahim said. 

Renovation work on hotels typically focuses on thermal insulation upgrades, a fully integrated building management system and solutions that limit property disruptions while providing improved performance.

The appetite for green financing options is strengthening. According to JLL’s 2024 Hotel Investment Outlook, over the last decade, $4.4 billion of global impact bonds have been issued, with 70% of them issued in the last three years. The hotel industry was slow to participate initially. Still, adoption has accelerated, and the report expects further growth in this segment in the coming years, with Europe likely leading the way. Lenders are also expected to step up initiatives that include sustainability linked loans, which typically make performance improvement on several metrics a prerequisite for the best debt terms.

ESG is still not properly reflected in transactions. Despite the increased focus on sustainability-linked loans, there is still scarce evidence of ESG considerations impacting hotel transaction prices. The lack of overall transactions is one reason, combined with inconsistency and a lack of visibility, for how the market assesses ESG risk. 

“We have seen few examples of green premiums for hotel transactions because it is difficult to isolate these factors,” said Rekha Toora, senior vice president for EMEA Hotel & Hospitality Capital Markets for JLL. “However, price chips as a result of failing to meet sustainability standards are becoming more common.”

The report said increased communication, better data collection, and standardization will be the keys to avoiding mispricing assets in the medium to long term. 

“If we have enough time, we can price in ESG risks earlier and we can correct prices incrementally. Otherwise, it’s going to be a major shock to the global financial markets,” Ibrahim said. 

There is a need to improve understanding of the impact of investing in NZC measures on hotel cash flows and values. The report said the difference between a comprehensive reflection of sustainability-investment changes and a more conservative approach marks the distinction between risk analysis and regulated valuations.   

Right now, a potential value increase within a regulated valuation is highly dependent on the return on investment of the specific measure taken, with savings in energy costs the most likely to be reflected in cash flow projections. The report said it believes that sustainability-focused CAPEX schemes that lead to a value uplift in regulated valuations are possible for many hotels, based on payback periods of net zero-based investments and a market-standard hold period of 10 years.

The report concluded that hotel valuers play a key part in the move towards a NZC future for the hotel sector. However, regulated valuations still lack sufficient evidence to reflect a change in yield profile solely due to ESG credentials. While continued education of the valuers is crucial, they are also reliant on continued efforts by the whole sector regarding data transparency, standardization, and collaboration to enable an appropriate reflection of the risks and opportunities of NZC for the hotel sector.