Elizabeth Fletcher, Associate at Knight Frank Newcastle, shares some thoughts on the sustainability push in commercial real estate.
I am a commercial property manager and up until fairly recently, if I talked about sustainability in client meetings, eyes would glaze over. Saying the letters E, S and G was akin to waxing lyrical on pensions or quantum physics.
For those of you who don’t know – ESG stands for Environmental, Social and Governance. It is a set of standards for a company that socially-conscious investors use to screen potential investments.
Environmental criteria consider how a company performs as a guardian of nature. Social criteria look at how you manage relationships with employees, suppliers, clients and the communities you operate in. And governance deals with a company’s leadership, executive pay, audits, internal controls and shareholders.
Sustainability used to be a ‘nice-to-have’. Or do. But today, ESG (sustainability) is a business imperative. It averts future risks. It prepares businesses to manage the changing regulatory landscape. And it adds value to real estate assets, projects and firms.
It is not just offices that are at the forefront of the UK’s ESG agenda. Industrial buildings are too. Many will soon feature things like on-site renewables, green walls and wooden bike sheds doubling as insect hotels.
All ESG elements have financial costs and benefits – be it direct or indirect. But it’s important to understand whether they sit with the asset or the wider business. And also consider them in the context of the fundamental drivers of value.
Key Facts:
-40% CO2 comes from properties.
-ESG is increasingly front and centre of property investment decisions.
-Real estate industry is under pressure to challenge climate change.
-UK to be carbon neutral by 2050. UK gov propose raising minimum EPC rating to B by 2030.
-85% of non-domestic buildings will need upgrading (to B) – costing £5bn.
-By 2022 listed companies and large asset owners must disclose climate-related risks.
-From 1 April 2023, landlords must not continue to let any buildings which have an EPC rating of less than E unless the landlord registers an exemption. Crucially, this impacts buildings where a lease is already in place.
-Key challenge is future proofing buildings – green lighting & energy, EV charging, sustainable travel.
The ESG catalysts in commercial property:
-Investor drivers: increasing regulation & corporate reporting; cost of bringing assets up to rising standards; money behind funds is driving change from top.
-Landlord drivers: sustainable buildings have competitive edge; increasing regulation; occupier retention and satisfaction.
-Occupier drivers: they want buildings that reflect their own ESG values; next-generation employees desire more sustainable workplaces.
What is the cost of ignoring the ESG agenda?
There are physical risks, like increased operating costs, wear and tear damage, possible adaptations needed in the future and insurance implications.
There are also transition risks – regulation risks – such as tougher building standards and emissions regulations (we are likely to see a rise to minimum EPC rating of B by 2030). So this isn’t something you can ignore.
There may even be risks of whole markets becoming less desirable if climate change makes it more costly to maintain infrastructure and supply resources – utility bills and property taxes, for example, may rise.
And finally, a damaged reputation. A company’s brand – and potentially the viability of the business – may be at risk of backlash if climate change and the wider ESG agenda hasn’t been taken seriously. And this may impact investment value and liquidity if the company as a tenant cannot pay rent or is poorly perceived.
Will pressure mount?
In the world of real estate, we can certainly expect pressure from tenants and investors to avoid less sustainable buildings. We can also expect to see investors reject tenants who are deemed unacceptable to their stakeholders.
