real estate funds

Building sustainability

Amid increasing pressure to be ESG-compliant, structures that invest in property are taking up the challenge to prove the green credentials of the buildings they invest in – and there are benefits to be had in terms of returns

Words:

Alexander Garrett

THE CONCEPT OF climate change usually conjures up images of extreme droughts, floods or weather events such as the heatwaves that have swept across the UK this summer. We don’t tend to think of high-rise office blocks and packed-in housing developments.

But there is one unavoidable statistic that demonstrates real estate’s crucial role in the global fight against climate change: 40%. That is the share of all the world’s carbon emissions that is estimated to be caused by buildings. More than 28% is accounted for by their operation, including heating and air-conditioning, and the remainder embedded in their construction and manufacture.

The battle to prevent global warming has no chance of success unless we can create buildings that are carbon-neutral or as near as possible to being so.

Environment is not just the E in ESG, it is also now, arguably, the most important component in the case of property investment. But social and governance – the S and G – also have a part to play at a time when the real estate world is increasingly recognising the need to meet standards and report ESG performance if it wants to compete for investment.

Awareness of the environmental impact of buildings has been around for a long time and that has resulted in a plethora of standards around the energy performance of buildings.

The UK-originating BREEAM (Building Research Establishment Environmental Assessment Method) and the US-based LEED (Leadership in Energy and Environmental Design) are two of the most common systems relating to commercial buildings and have been steadily gaining traction over three decades.

Increasingly too, the screws are being turned by governments for residential buildings. In the UK, from 2025 all rental properties must secure an Environmental Performance Certificate of level C or above.

PERFORMANCE PRESSURES

Improving the performance of existing buildings – for example, through cladding or other forms of insulation – represents an epic challenge for the building industry – and one that is still in its relative infancy.

Victoria Gillespie, Director, Funds and Corporate Services, at JTC, is responsible for the group’s ESG services. She points out: “Because there are so many components in the real estate sector, it’s quite a convoluted process.”

Much of the work that has been done in the sector isn’t always visible, she says, so any perception that the sector is late to the table on ESG is a little unfair.

A key issue for any property fund, real estate investment trust (REIT) or other structure investing in property is the multiplicity of regulations and best practices to adhere to.

In many countries, listed companies – which usually include REITs – are already mandated to provide some ESG information in their annual reports. And that is extending to other structures, too.

In the EU, for example, the Sustainable Finance Disclosure Regulation (SFDR) requires all fund managers – including those in real estate – to disclose how sustainability risks in their investment processes could potentially have a negative impact on the financial return of an investment.

In the UK, the Task Force on ClimateRelated Financial Disclosures (TFCD) is setting a new reporting standard on climate risks that will be mandatory for all fund managers in 2025.

Then there are the Principles for Responsible Investment (PRI), a UNbacked initiative that requires investment managers to incorporate ESG criteria in their investment processes for at least 50% of the company’s total assets under management.

Some 96% of the world’s top 50 asset managers had adopted PRI by the end of 2020, and real estate is a key focus.

Gillespie says: “Our approach when we work with clients such as real estate funds

40% of the world’s carbon emissions are said to be caused by buildings, with more than 28% accounted for by their operation

is to get them to focus on several specific things – where do they operate and where are they domiciled? And where are the decisions being made, where are their investors based, and where are their assets based?”

Consideration then should be made of the regulations and expectations in each of those different countries and jurisdictions.

“You could have a UK fund manager, for example, that invests in specific types of buildings within different European locations, and they would therefore need to be mindful of the local regulations – because when they’re operating in that environment, there could be additional regulatory requirements to doing so.”

CURB APPEAL

There are a number of drivers for those managing real estate assets to adopt a stronger environmental stance.

“You’re more attractive from an investment perspective if you align yourself with good practice that results in environmental buildings – or you’ve repurposed or helped communities,” says Gillespie.

“That’s a more attractive proposition because it seems to be a higher priority on investment criteria today.”

Put simply, buildings that achieve higher environmental performance standards also perform better in investment terms.

According to US real estate services company CBRE: “Green buildings will command higher rents and higher capital values, while incurring lower monthly operating and maintenance costs.”

Rents for LEED-certified office buildings in the US are 5.6% higher than those for non-certified office buildings, says the organisation.

And the highest certified buildings demand 0.51% more annual rental growth than non-certified properties – which in turn leads to higher capital growth.

The converse is also true. In the UK market, for example, buildings with a poor energy certification are said to carry a ‘brown discount’.

As a result, there is a strong degree of self-interest for property funds and other real estate owners to become engaged with the ESG agenda.

The strategies adopted by real estate funds and investment managers with respect to ESG can be diverse. Some focus on avoiding risk by not investing in buildings or assets deemed to perform poorly or be harmful to the environment. Others take a more proactive approach and invest in the best performing buildings.

Where new buildings are concerned, the materials used in construction are increasingly an issue.

Last year, Transport for London was given the green light to build a 17-storey hybrid timber office building above Southwark Station in south London, one of the first such buildings to be approved.

The 75-metre building is a crosslaminated timber design, allowing it to also achieve industry-leading embodied carbon reductions of 40%.

Buildings that achieve higher environmental performance standards also perform better in investment terms

FUTURE-PROOFING

It is even possible for asset owners to reduce the carbon impact of buildings that already exist.

Gillespie cites one example: “One particular building had been built but the client wanted to engage with us to look at the ongoing carbon footprint of that building, as well as its carbon footprint, over the 10 years since it was built. They are looking to invest with some carbon credits and utilise that as a tool to offset their carbon emissions.”

But ESG is not just about the environment; social is an ever more important consideration for the real estate sector, as Gillespie explains.

“I break that down into two bits – how a building is built and how it is operated,” she says. “On the first point, are you working with local builders? Are you paying a fair wage?

“And then, when it’s there, what is the impact on the local environment and on the community – are you adding transport links? On balance, does it provide more than it takes as a result of its existence?”

According to CBRE, affordable housing and wellness are two of the key real estate considerations today.

Jersey and Guernsey are keen to press their ESG credentials – the latter most notably with Guernsey Green funds.

In the coming years, there should be ample opportunity for them to capitalise on new opportunities, whether that be the installation of electric vehicle charging points or the retro-cladding of homes to make them more energy-efficient.

Green homes are with us to stay – and that means those who can support ESG reporting in the sector are going to be kept on their toes. n