Protecting value through ESG

With ESG compliance now at the heart of the journey to core, sustainability has become the non-negotiable differentiator between prime and sub-prime buildings. Doug Morrison explores the metrics that matter.

After years of benefiting from loose monetary policy and cap rate compression, the real estate industry is getting to grips with generating returns amid uncertainty around values in a high-interest-rate market. If anything, this new challenge is reinforcing the importance of the ESG agenda.

Industry leaders canvassed by PwC and the Urban Land Institute for the 2023 global edition of Emerging Trends in Real Estate warned that the prevailing market uncertainty is creating “a widening divide” between “fit for purpose” prime assets and energy-inefficient buildings in secondary locations requiring significant capital expenditure.

In effect, ESG compliance is at the heart of a redefinition of prime real estate. “It’s one of the key factors that acts as a differentiator now, particularly as market conditions get tougher,” says Robbie Epsom, CBRE Investment Management’s EMEA head of sustainability. “But it is not just about differentiating between prime and sub-prime, it is definitely seen as something that protects value in a downturn.”

The recent spike in energy prices has also led to greater urgency in the decarbonization of real estate, says Anna Olink, business development director, real estate, EMEA at environmental benchmarking firm GRESB. “Tenants are hesitant to allow rent increases on non-decarbonized buildings, as they are already burdened by high utility expenses,” she says. 

It is evident that investors and occupiers have been driving ESG compliance for some time, but emerging regulation is now increasing the risk of obsolescence of non-decarbonized buildings. In Europe, for instance, the EU Taxonomy provides clarity around what defines a sustainable asset, while greater transparency is now a prerequisite because of the Sustainable Finance Disclosure Regulation. 

Alongside such regulatory parameters, both Olink and Epsom stress the importance of data quality when measuring sustainability performance. As Olink says, “core environmental data is critical” – energy use, greenhouse gas (GHG) emissions, embodied carbon – in other words, “metrics that point to one’s ability” to reach net zero and decarbonization targets. Epsom adds: “Data analysis is complex. But it does matter. Once you have good quality data about assets’ sustainability performance, it can be analyzed and combined with financial data to present opportunities to benefit both the owner and occupiers.”

Epsom suggests that the challenge is not simply around the cost and return on ESG-related capital expenditure but finding the “optimal time” to act. “Do you wait for breaks in leases? Do you wait for the technology to mature a bit more? Those are key questions which you can answer when you start to take it asset by asset, which makes it hard work in the long run, but it means that we make the right decisions for each asset.”

Jumping over hurdles

ESG-compliance may be a simple objective, but it is anything but straightforward for global investment managers to put into practice. CBRE IM, for instance, is assessing the potential for solar PV for logistics assets – totaling as much as almost 90 million square feet of lettable area – across EMEA. Small wonder, Epsom says, there has been a rise in specialist in-house ESG teams among the major managers in the past year or so, rather than relying on advice from external consultants.

Aside from the regulatory pressure, ESG capex is determined by many variables, including location and whether an asset is multi-let or single-let – and, importantly, whether it sits in a value-add or core fund. “These are all the complexities that require an ESG team to navigate,” Epsom says. “And so, the focus of our work really is how do we scale this? That is not so much a technology challenge. It is about how we find a systematic way through without forcing a ‘one size fits all’, which never really works in many cases.”

However, there is clearly much more to be done on ESG compliance, not least greater collaboration across the industry. In a survey undertaken by the British Property Federation (BPF) and JLL, nine out of 10 senior leaders do not believe current UK government policy will deliver a net-zero property sector by 2050. Among other recommendations to turn ESG pledges into “credible action”, the BPF and JLL believe the government should mandate the sharing of energy consumption data between property owners and occupiers of large commercial buildings. 

GRESB’s coverage indicates the scale of the challenge globally. The firm’s real estate assessments cover $6.9 trillion in assets under management – 150,000 assets across 74 countries – or as Olink suggests, nearly half of the institutionally invested market. She believes that GRESB participants are “making strides” in obtaining performance data but there are “significant gaps” in data collections by property owners due to lack of data sharing between tenants and landlords. 

In Europe, GRESB’s data coverage for energy and GHG is slightly over 70 percent, which is an improvement on previous years. “But more work needs to be done,” says Olink. “Data sharing is crucial, as only when landlords have a solid view about consumption of every asset, can they proceed to set up decarbonization KPIs.”

Despite such hurdles, Epsom adds, the objective remains clear. “The energy efficiency piece is important, but ultimately if we can switch off the fossil fuels and have the entire building as electric, drawing on the rapidly decarbonizing grid and any on-site renewables, we can achieve a zero-emission building.”

Expanding metrics

Nearly 90 percent of European property leaders surveyed by PwC and the ULI for the Emerging Trends in Real Estate 2023 report highlighted the importance of creating social impact alongside financial returns over the next 20 years.

The report suggests the operational performance of buildings is no longer solely attributable to the ‘E’ in ESG. It has considerable implications for the social impact as tenants face pressure from high rents and increasing energy costs. GRESB bears out this trend. 

Anna Olink, business development director, real estate, EMEA at environmental benchmarking firm GRESB, says the investor community has been increasingly interested in metrics across the ‘S’ and ‘G’ since 2021. The GRESB Standard now reflects net zero, physical climate risk and transition risk, as well as diversity, social equity, and inclusion.