Real estate and sustainability in 2023

Another year passes and we know that not enough progress is being made on sustainability in general and the race to net zero in particular. The COP27 United Nations Climate Change Conference in Egypt and the UN Biodiversity Conference COP15 in Montreal stressed the need for business to create action plans in order to make more progress on climate and nature. In this context, what will real estate do in 2023? What must it do? Sustain asked a number of real estate professionals for their take.

Sustain would like to hear your 2023 predictions, ambitions or opinions and will be updating this article until the end of the month. Contact us at news@sustain-re.com

Japan may become an ESG leader

The Japanese government has been slow to provide policy impetus to ESG in their domestic real estate industry. It is therefore surprising that in a country not known for embracing change, real estate managers have taken it upon themselves to make significant strides in this area.

GRESB, the leading global standard for portfolio-level ESG reporting in the real estate sector, counted 122 participants from Japan in 2022, a substantial subset of the 1,820 participants registered globally. It is not only the relatively high participation rate that is worth noting, but also the consistent outperformance since 2014 that demonstrates Japanese managers’ commitment to ESG, with an average annual GRESB score of 80 versus a
global average score of 74.2.

Japanese investment managers and developers are proactively setting their own ESG targets. Mitsubishi Estate, is targeting to adopt renewable energy in approximately 50 of their office buildings and commercial facilities by the end of fiscal 2022 and has been accelerating emissions targets set earlier. Mitsui Fudosan has similarly set targets for renewable energy use in its buildings in the greater Tokyo metropolitan area.

It will be worth watching whether ESG could become a longer-term catalyst in the Japan real estate market, with Japan assuming a leadership role for ESG among global peers.

Yoshiko Nakamura, vice president of Hodes Weill & Associates

Sustainability reporting will accelerate change

2023 is set to be a pivotal year in sustainability reporting and disclosure. We are seeing sustainability reporting move from being largely voluntary to becoming a regulatory requirement. In particular, the effect of the proposed US Securities & Exchange Commission, EU Taxonomy, and ISSB standards will likely stretch beyond the large corporations and investment funds doing the reporting. Tighter regulation will have a substantial impact on the real estate sector. 

There is a strong focus on climate-related risks, metrics and impacts, which will help to inform investment and asset management decision making. Is the property sector ready for a future where the financial performance of an asset might be starkly impacted by changing climate? There is a risk that this explosion in complex reporting requirements will require a huge resource investment by the companies to comply. The industry needs to work together to create a clear path through these requirements and support the transition to a greener economy built upon a foundation of robust disclosure and transparency.

Tanya Broadfield, director of sustainability at Savills

Climate risk is no longer an abstract concept, but a financial reality

It has proven difficult for investors to price climate risk into their decision-making, with myriad other factors to consider when trading assets. Our study of prices paid for offices in London, Paris and Sydney, however, shows a premium has emerged for buildings that have recognised sustainability ratings versus those that have not yet achieved these standards.

While a sale-price premium related to environmental ratings has become evident in the transaction market, MSCI’s work does not yet show actual building emissions have a definitive impact on performance. Reducing a building’s emissions is how the industry will eventually effect real positive change; therefore, the greater risk to a building’s value implied by high emissions should start to be accounted for during the valuation process because of the transition risk.

The threat of write-downs to a property’s value will encourage owners to make the necessary changes to a building in order reduce its emissions intensity. It also means that when these assets come to market, they will do so at a price that accurately reflects the level of capital expenditure required to bring them up to standard.

Will Robson, executive director, MSCI Research and David Green-Morgan, executive director, MSCI Research

Moving from ambition to mission

So far it has been easy for real estate owners to say they are committed to ESG and to announce plans for what they will do. However, whilst they’re full of ambition they are often low on specifics. I think 2023 we will start to see that pendulum swing away from ambition and towards specifics. That means collecting and recording accurate data, assembling it in a useful way and using it to quantify material changes. I think there’ll be a huge amount of work around that in 2023, where we replace ambition with mission.

Johnnie Wilkinson, chief executive, Greenman Group

Increasing demand for ESG upgrades

Disruption provides the opportunity to double-down on resiliency for investors and occupiers. In Europe, an asset’s ESG profile has become critical for occupiers to help meet their corporate ESG goals, to boost hiring and employee retention. We believe the current energy crisis should cause occupiers of lower-performing assets with higher energy costs to become even more cost- conscious. Tightening regulation across Europe will further drive change. This is a “must-have” characteristic of European investments.

We expect demand for ESG upgrades will only increase among occupiers and owners that lack the technical resources to deliver cost-effective solutions. In the long term, we expect intelligent and consistent investments in ESG upgrades to produce higher occupancy rates (driven by tenant demand) and more liquid assets, protecting investors from the downside of “brown discounts” and achieving stronger pricing at exit. This is a good window to consider advancing ESG investments.

Alex Knapp, chief investment officer, Europe, Hines

The pace of change needs to accelerate

Investors in the property sector have definitely woken up to the risks associated with not achieving significant changes to the sustainability of our asset class. It’s now one of the first questions in any investor meeting. This heightened awareness and a greater alignment of interests between investors, managers and occupiers is going to be vital if we are to achieve the changes that are required to reach net zero by 2050. It’s great to see how seriously especially younger professionals focus on ESG and impact investments. Not only does the pace of change need to accelerate, but also the willingness to adopt new solutions and materials such as wood and other technologies if we’re going to get there in time. I hope that 2023 marks a step change in our sector’s approach to this very global challenge.

Pertti Vanhanen, Managing Director Europe at Cromwell Property Group

Occupiers to be more engaged on sustainability

We think 2023 is going to be a year where occupiers become much more engaged on sustainability issues. Rising energy costs and an increasing need for them to be seen to reduce emissions is changing the conversation.  Leasing activity will be focussed on good quality assets that use less energy and have lower running costs.  At Picton, we will be focussed on our ‘renewable’ roll out, making further progress against our net zero pathway and more widely looking to mitigate climate change risks. Hopefully next year the sustainability conversation within our sector goes further than just minimum energy efficiency compliance.

Michael Morris, CEO of Picton Property Income

Double down on cutting energy use

The current energy cost crisis stresses the need to double down on energy reduction. But what’s not measured can’t be effectively managed, so access to both landlord and occupier data has never been so significant. Armed with a more accurate grasp of exactly how whole buildings are performing, it’s possible to work with occupiers to drive down their own costs. This is also where smart technology, energy audits, and a phased upgrade of plant and systems to improve efficiency, will have a significant impact on cost reduction.

Energy prices are unstable, and markets are likely to remain volatile well into 2023, so the focus must be on both short- and long-term reduction strategies. The payback timeframes from PV (solar panel) installations are expected to fall significantly – and could even halve against the increased grid energy costs. Reducing reliance on gas can mitigate exposure to the risks of spikes in the energy market and utilise more clean energy, while helping to achieve net zero carbon emissions.

Vicky Cotton, ESG director at Workman LLP

Reuse materials to accelerate decarbonisation

In order to progress the sustainability agenda in 2023, the built environment sector must embrace the need to decarbonise. In order to do this we need a cross-industry effort to go further in understanding and delivering material reuse, extending the life of greater quantities of building materials than at present.

Not only is reusing materials less carbon-intensive, but it is also more commercially viable to minimise waste in the construction process.  As an industry, we need to do more to help developers identify reusable materials at the time when a building is being considered for repurposing, auditing buildings for reusable materials as a matter of course.

In addition, we need to see strong government leadership to support a wider decarbonisation agenda. Government can provide a crucial means of closing the gap between those investor and occupier organisations which are leading the way, and industry stakeholders which are either unaware or unengaged with decarbonisation.

A combination of stronger incentives and regulation will be essential to encourage a wider set of industry stakeholders to take action. We are currently working with the British Property Federation on recommendations aimed at ensuring that government policy on this pressing issue is more effective in the future.

Mat Lown, head of ESG and sustainability at TFT