The influential superpower that is finance is alive and kicking, asserting itself as a key driver behind the role ESG now plays in risk management.
Global finance is taking advantage of the opportunities now to reach net zero and avert a 1.5C temperature rise before the end of the century, or face irreversible destructive climate change. The finance driven ESG chain reaction is being felt right across real estate.
A key driver from a net-zero perspective, is the flux of companies committing to net zero targets and those who have set or are planning to set, targets aligned with climate science (science based targets). This is driving asset managers and investors, who expect an increase in demand for net-zero buildings, as well as fearing a loss of value to assets held which fail signs of a pathway to reaching net zero.
Following COP26, we are aware that the UK is not on track to meet its Nationally Determined Contributions (NDCs). Therefore, we can expect to see and are already are seeing, changing policies and regulation to speed up the transition to a low-carbon economy, as evidenced in MEES and the planned changes ahead.
Building regulations have played and will continue to play, an important role in real estate’s push to decarbonise. That said, the recent non-financial reporting directive (NFRD) from the EU complements the EU Taxonomy Regulation and Sustainable Finance Disclosure Regulation (SFDR). In essence, it acts as a terms of reference for a reporting mechanism that protects investment, ensures sustainable investments stack up and their capital allocations are not subjected to ‘greenwashing’. It is clear that an agreed international definition of a net zero building would help level the playing field and give credit to the strides real estate is making.
For example, Minimum Energy Efficiency Standards (MEES) were introduced from April 2018 across England and Wales, which defined an acceptable level of building performance, yet ahead of feeling the full effects of MEES by 1st April 2023, attention has turned to ESG disclosures with investors behind the push. In terms of a policy push from government at the time, EPCs appeared a step in the right direction, however are an imperfect measure. BBP REEB 2020 report found that there is no correlation between a building’s EPC rating and its energy intensity performance.
As well as increasing demand from occupiers and investors who are rallying around the ESG agenda, more regulation to drive climate change mitigation is expected. How this will impact real estate was a panel topic at our ‘Shaping a Better World From the Ground Up’ webinar.
“We need to take action because not only is corporate reputation at risk, but the financial model of real assets,” said Jonathan Hale, Sustainability Director, BNP Paribas Real Estate UK.
‘Green financing’ has grown predominantly driven through industry guidelines and this will be reinforced with hard law. The connection between a sustainability strategy and access to capital markets and market positioning is strengthening.
Etienne Prongué, Chief Executive Officer of BNP Paribas Real Estate UK, said staying ahead of regulations can provide a competitive advantage: “In very simple terms, on one side, it is facilitating capital or equity raising. And, on the bricks and mortar side, if you are delivering one of the most ESG compliant buildings, you're going to attract a larger pool of candidates.
“Therefore, there is potential for higher rents and better returns, so timing is important.”
Regulation has made the real estate market more transparent around climate and carbon risk, which is a good thing. It helps to assess and determine the response to risk. And it helps to satisfy the need for evidence of a sustainability strategy in practice from regulators, investors, clients and society at large.
On the flip side, it means more administration to fulfil reporting and disclosure requirements and a potential skills shortage for the strategy transition. Investors and asset managers need to balance tackling admin with driving the actual performance of assets. However, is the administrative burden a blessing in disguise that will enable greater numbers of individuals to support real estate as it adapts to new sustainable regulation?
Asset level net-zero technical assessments are starting to feature more prevalently within investment transactions. For asset owners, asset level insight paired with regulatory context and related valuation impact, provides transparency to better negotiate transactions. In terms of addressing asset level climate and physical risk, to better understand the risk of so-called ‘stranded assets’; it means long-term planning and understanding the commercial and technical implications of building decarbonisation pathways.
Ian Bragg, Head of Building Consultancy BNP Paribas Real Estate UK, said: “There’s a move towards completing ESG audits at the due diligence stage, which feeds into the investment decision process.”
That has subsequently filtered into the definition of prime stock in some markets. This presents an opportunity for short term value creation by releasing net-zero carbon stock to the market. However, from a mature market perspective, there is only a small window of opportunity for this before net-zero carbon stock becomes more commonplace.
Herein lies an opportunity in developing countries. Lessons learnt from net-zero buildings in developed countries can be paired with the appetite of poorer countries looking to lift their people out of poverty and develop their urban landscapes sustainably. However, timing is key here as the costs associated with net-zero buildings will need to be cheap enough for the poor countries to afford. This will be partly dependant on how widely adopted sustainable solutions are in the developed countries.
To be clear, both data quality and data coverage underpin the ability to deliver on net-zero, minimising risk and informing decisions. This means landlords and tenants collaborating and sharing data, so both can align their ambitions towards net zero.
On the subject of whether rigour is important on making strides towards net zero, Hale said: “We need to ensure the ESG related data from these properties supports informed decisions, which allow action to be taken. This means data coverage, data quality and auditing of data to mirror how financial reporting is treated, is a necessary step to enable firm foundations to be set when baselining and reporting against targets thereafter. The risks, opportunities and asset level performance of this connected thinking is the most important thing we can do.”
To view a recording of ‘Sustainable Regulations: The Future of Real Estate’ panel session, click here.
