Research flags rising ESG risk for real estate

In April 2022 the latest Intergovernmental Panel on Climate Change (IPCC) report stated that 61% of global building emissions could be cut by 2050 if renewable energy policies, sustainable development strategies and water efficiency were introduced.

This means investors will need to direct considerable capital towards real-estate projects to ensure they meet environmental, social and governance (ESG) standards.

A UN Environment Programme report found that, even in the wake of the COVID-19 pandemic, global investment in buildings' energy efficiency rose by more than 11% to around $184bn in 2020.

Meanwhile, an October 2021 Deepki survey of 100 institutional commercial real-estate investors and professionals revealed that 73% expect buyers to avoid properties with poor ESG performance. The same amount said they are looking to sell commercial real-estate assets with poor ESG credentials.

Research from Knight Frank covering prime real estate in London, Sydney and Melbourne found an 8–18% sales price premium for buildings rated by the Building Research Establishment Environmental Assessment Method (BREEAM) or National Australian Built Environment Rating System (NABERS), compared with equivalents without green certification.

Looking at the damage done to property values, a survey of 250 European pension funds carried out by Deepki found that between February 2021 and February 2022, 40% of respondents said they had seen depreciation of 21–30% because of brown discounts on commercial property assets which demonstrate poor ESG compliance and deferred maintenance risk that may require additional capital outlay for improvements. A further 21% have seen assets devalued by 11–20%, while 18% have seen depreciation of as much as 31–40%.

The research indicates that the impact of brown discounting is set to increase significantly over the next three years. Further damage is anticipated by 62% of European pension funds; 37% expect it will devalue assets by a further 31–40%, while 24% expect a 21–30% reduction.

The first is of 'gathering reliable information on energy efficiency measures' an obstacle reflected in responses to Deepki's February survey. More than half – 53% – of property investors said they struggle to collect quality data; 44% said they have concerns that data collection may breach legislation such as the GDPR; two-fifths revealed that asset managers supply inconsistent data; and 36% said the data they receive is incomplete.

If companies and their investors are to understand their real-estate portfolios asset by asset as part of a net-zero strategy, then obtaining specialist ESG data must be a paramount objective. This data can be used to identify gaps between where a portfolio is and where it needs to be to meet sustainability standards. Only then can an ESG strategy be put in place, against which performance targets can be set and measured.

A second barrier to achieving sustainable real estate lies in a dearth of qualified professionals able to help with the green transition. In 2021 the Institute for Public Policy Research wrote to the Treasury warning of a major skills shortage in the construction sector, arguing that gaps must be plugged if there is to be any chance of the UK reaching its net-zero targets. Commercial real-estate professionals must move quickly if they are to stand any chance of securing the resources needed to retrofit buildings and improve their ESG credentials.

The shifting regulatory landscape presents yet more challenges for real-estate investors and commercial property professionals. The EU has implemented a raft of legislation designed to accelerate capital towards proven green projects including the Commission Delegated Regulation in January this year which establishes 'the technical screening criteria for determining the conditions under which an economic activity qualifies as contributing substantially to climate change mitigation or adaptation, and for determining whether that economic activity causes no significant harm to any of the other environmental objectives'.

We can expect more legislation like this to come.

There are also international standards with which the industry must comply, but these are not necessarily consistent. There must be certainty and stability from policy-makers if the real estate sector is to make progress to net zero.

Investors and property owners that move quickly to understand their exposure and then take necessary action to mitigate the risks – capitalising on the opportunities presented by green premiums – will be best placed to implement an effective real-estate ESG strategy.