Prioritize sustainability to future-proof APAC investment

INTERNATIONAL REPORT – Despite growing evidence supporting the business benefits of sustainability in risk mitigation and opportunity creation, investors in the APAC region tend to undervalue its importance during hotel transactions. This raises questions about the primary factors influencing capital allocation towards sustainable real estate, the potential impact on property valuation, and the strategy that various stakeholders—including general partners, limited partners, lenders, and hotel operators—can adopt to build more resilient and sustainable hospitality investments.

Climate-related risks and opportunities are already posing to be a key downside risk to the hotel real estate sector and are projected to become more pronounced based on current climate forecasts. From a physical climate risk perspective, the increasing frequency of extreme weather events is directly affecting profitability and asset values through business interruptions, higher repair costs and spike in insurance premiums. Some markets are on their way to becoming uninsurable.

Moreover, governments across the globe are implementing building performance standards and carbon pricing mechanisms to discourage high-emission practices. Some leading cases are seen in policies enacted in New York, Germany, and Singapore.

The transition to a green economy presents opportunities for the real estate and hospitality sector. Owners and operators are focusing on energy, water, and waste savings, and green energy procurement. Resort markets have benefited from investments in renewable energy generation (rooftop solar panels), energy efficiency measures (MEP recommissioning), and water-saving technologies, often achieving attractive payback periods of three to five years.

Businesses that recognize and act upon climate-related opportunities and risks have demonstrated greater resilience. Shangri-La in Chiang Mai was protected from recent floods due to installed floodgates, while other properties suffered considerable damage. Climate resilience measures at an asset level will impact hotel values going forward.

Numerous Maldivian resorts have weathered spikes in utilities expenses and insurance premiums in recent years, thanks to substantial energy savings from solar installations. An analysis of luxury Maldivian resorts revealed that properties with solar panels contributing 20%-50% of their total energy had utilities expenses Per Available Room (PAR) ranging from $25,000 to $40,000, compared to $60,000 and $69,000 for resorts primarily or entirely reliant on diesel. Such climate-related risks and opportunities are expected to intensify as carbon emissions rise, and current policies and practices persist.

However, there appears to be a divergence in how investors assess the timing and impact of climate risks and opportunities, which in turn results in the understated impact of sustainability on hotel transactions.

Investors generally operate on shorter investment cycles compared to the longer-term impact of climate change. Institutional investors have a typical three- to six-year investment horizon, and although high net worth owners tend to focus on generational ownership, their investment decisions tend to be similarly short term. Climate risks may take 15 to 20 years to materialize as recurring phenomena in specific locations. Transitional risks, such as policy changes and modern technologies, may materialize sooner but are less predictable, complicating effective pricing and accounting for climate-related risks and opportunities.

The competitive nature of transactions inhibits potential buyers from effectively considering climate-related risks as a significant tail risk. Many hospitality investors conduct sustainability due diligence for compliance and post-acquisition asset management rather than as a factor of commercial negotiation.

Consequently, lenders and valuers struggle to properly underwrite risks beyond qualitative assessments as "fair market values" are inherently guided by historical performance and market transaction evidence. This creates a valuation deadlock where valuers are unable to reflect the full range and impact of sustainability risks in regulated valuations. The fragmented and progressive nature of APAC jurisdictions, and the predominantly private ownership structure, limit transparency and regulatory pressure.

European institutions, regulated entities, and private equity firms are integrating sustainability considerations into their investment decisions, increasing scrutiny of APAC fund managers regarding their net-zero plans and climate resilience strategies.

Geographical disparities in sustainability impact on transactions are evident, with Europe and Australia showing clearer evidence across various sectors due to their more regulated and institutionalized markets. European institutions, regulated entities, and private equity firms are integrating sustainability considerations into their investment decisions, increasing scrutiny of APAC fund managers regarding their net-zero plans and climate resilience strategies. Comprehensive investment parameters now often include sustainability factors such as CRREM pathways, electrification, tenant/Scope 3 emissions data, EU Taxonomy, and climate-related physical risks.

Investment criteria are evolving to incorporate climate resilience when defining a core investment. For instance, various fund managers in Asia and Europe now require office buildings to have flood-resistant basements housing critical MEP systems to be considered core assets. Norges, Norway's sovereign wealth fund, will divest from high emission industries entirely to align with net-zero targets. CRREM analysis is becoming more commonly required for European funds, with stranded assets raising red flags.

These trends demonstrate the growing influence of climate-related factors on investor decision-making and transactions. This impact is manifesting in extended due diligence periods and the depth of the buyer pool. APAC property owners must be prepared with comprehensive data and information to address ESG due diligence inquiries and appeal to a wider range of potential buyers. A Singapore-based firm requested tenant data for a Sydney office building investment, impacting the due diligence timeline. Increased disclosure such as the IFRS will magnify this trend.

As climate change continues to impact cash flow volatility and stakeholder requirements, owners and investors should revise their asset management and investment strategies, considering:

Medium-term climate and sustainability outlook: Evaluate potential climate scenarios affecting future buyers' asset performance assessments, considering the 5-to-20-year horizon.
Quantify impact through science-based scenario analysis: Utilize science-based tools and standards such as CRREM, GHG Protocol, climate risk analysis. Assess specific risks and opportunities at country, state, and property levels. Go further by examining how shifting seasonality and extreme weather events might affect demand patterns to quantify business impact and future capex reserve allocation.
Intangible benefits of social and natural capital: Recognize their role in enhancing resilience and performance, especially in experience- and nature-driven hospitality sector.

Integrating sustainability into hospitality investments involves understanding future risks and opportunities to build resilience. By incorporating future climate scenarios into governance structures, owners can promote forward-thinking decision-making and address potential risks. This assists assets with liquidity and value preservation if the owner decides to exit. Being prepared for the future climate reality offers investors and owners a competitive advantage.

Contributed by YouRee Park, vice president, JLL Hotels & Hospitality, Bangkok

The views and opinions expressed in this content do not necessarily reflect the opinions of Hotel Investment Today by Northstar or Northstar Travel Group and its affiliated companies.

Prioritize sustainability to future-proof APAC investment

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