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Investor interest in environmentally sustainable real estate assets is soaring. According to one source at a large global property consultancy, his business has recently witnessed an 800% uptick in enquiries for ESG real estate investment opportunities.

The problem is that as things stand there are not many real estate funds that are being marketed as environmentally sustainable. Given the pent-up investor appetite for this type of product, why is there such a disconnect between supply and demand?

In Europe, funds are classified using EU Sustainable Finance Disclosure Regulation (SFDR), which was introduced in 2021 to improve transparency in the sustainable investment market. Article 9 funds – also known as ‘dark green’ funds – have sustainable investment or a reduction in carbon emissions as an objective. Article 9 funds also have to assess their portfolio against the principle of ‘do no significant harm’ by considering principal adverse impact (PAI) indicators. These indicators are defined as “negative, material or likely to be material effects on sustainability factors”.

As things stand, there are only a handful of real estate funds in Europe that qualify as Article 9. Bridges Fund Management recently raised £350m – £50m more than its original target – for an Article 9 fund focused on assets in alternative and needs-driven sectors, such as low-carbon logistics, healthcare and lower-cost housing. There is also an Article 9 fund set up by a global investment manager focused purely on the living sector in Germany.

The latest fund badged environmentally sustainable was launched by Fiera Real Estate in June. Although the fund does not technically qualify under Article 9 because its structure was created before the SFDR legislation came into being, its criteria is aligned with Article 9.

“In our recently launched logistics sector-focused fund, we will be targeting net-zero construction for all projects,as well as market-leading ESG credentials within the design,” says Charles Allen, head of UK real estate at Fiera. “This not only satisfies growing expectations from the investment community and our internal net-zero carbon ambitions, but it also serves as an indication as to where we believe the market is headed.”

The market may well be heading in that direction, but the problem is that while the SFDR system was introduced to give greater clarity and transparency to investors seeking sustainable investment opportunities, it only appears to have muddied the water.

“In attempting to clarify matters, more confusion has actually been created over the definition of a ‘sustainable private real estate fund’ as it is open to interpretation,” says Jane Boyle, sustainability director at JLL. “Article 8 funds are those that have an E or S characteristic. Whilst this is quite vague, it could include things like a year-on-year energy or carbon target, that is not aligned to SBTis [Science Based Targets initiative], or non- specific targets.

“In contrast, article 9 funds have sustainable investment objectives (SIO), which could include aligning with the Paris Agreement, such as net zero carbon funds with a social objective. It’s open to interpretation whether some funds being marketed as Article 9 adhere to the definitions.” Another issue is that to qualify as an Article 9 fund, undercthe wording of the regulatory technical standard 100% of the fund’s assets must be sustainable from the outset.

Transition funds

“That means that those funds that are transition funds and aren’t sustainable at the moment, but their purpose is to transition assets to be sustainable, don’t qualify as Article 9, which given the vast majority of assets in places like the European Union, and obviously the UK, are old and energy inefficient, is problematic,” says Robbie Epsom, EMEA head of ESG at CBRE Investment Management.

Ali Ingram, head of sustainability, capital markets, EMEA, at JLL, agrees with Epsom’s assessment that better definitions are needed globally that can be understood by everyone as this will encourage asset owners – and particularly those who own existing assets – to improve the sustainability of their portfolios and at the same time eradicate any possibility of greenwashing.

“Ultimately, we need a clear and defined global and legal definition of a transition fund/brown-to- green if we are going to help LPs and therefore capital flows identify the real players in the space and encourage more of these types of funds,” says Ingram. “I believe that the greenest fund out there is in fact a transition fund looking to acquire assets not yet on net-zero carbon pathway and implement net-zero carbon strategies, versus a fund which invests in existing green assets.”

The industry is collectively trying to address the challenges highlighted by Epsom and Ingram, with property investors and investment bodies such as INREV meeting with organisations including the FCA and the Task Force on Climate-Related Financial Disclosures to discuss what environmental metrics and regulatory framework the real estate sector should work towards.

As John Forbes from John Forbes Consulting, which advises real estate investment managers, investors and others in the real estate industry, puts it: “I guess the big question for investors is does the future lie with specialist funds with an ESG focus building the swankiest, greenest, exemplar new buildings, or does it rest with the majority of the funds who will own the majority of the [existing] assets raising their ESG bar to cope with the pathway to net zero?”

Sustainable fund definitions

The EU’s Sustainable Disclosure Regulation (SFDR) is so far the only regulatory regime to define different levels of sustainability within investment funds. The regulation aims to create a more transparent playing field, partly to prevent greenwashing – where some financial firms claim that their products are sustainable when they are not.

The Accounting and Corporate Regulatory Authority and Singapore Exchange Regulation have set up a Sustainability Reporting Advisory Committee to advise on creating a sustainability reporting roadmap for Singapore-incorporated companies.

The committee is chaired by Esther An, chief sustainability officer of City Developments Ltd, and brings together a range of sustainability experts, investors and other stakeholders. 

An said: “Effective ESG integration and disclosure are critical to accelerating global efforts to build a greener and more resilient future for all. I am honoured and humbled to be appointed this important role and I look forward to working with fellow committee members who are respected leaders in their fields.”

In March, the SEC proposed rule changes which would oblige listed companies to produce a range of climate-related disclosures (see below), including greenhouse gas emissions.

The proposed rules are open to public comment until 20 May.

If finalised, the proposal would become the first-ever rule requiring all companies registered with the SEC to report, measure and quantify material risks related to climate change in their registration statements and periodic filings.

SEC chair, Gary Gensler, added: “Investors representing literally tens of trillions of dollars support climate-related disclosures because they recognise that climate risks can pose significant financial risks to companies and investors need reliable information about climate risks to make informed investment decisions. Companies and investors alike would benefit from the clear rules of the road proposed.”

The SEC measures are in line with the European Union requirements of the Sustainable Finance Disclosure Regulation and the EU Taxonomy, which provides a common language regarding environmentally sustainable activities. If the proposals are finalised, they will effectively merge climate-risk reporting into a company’s financial disclosures.

Around a third of US public companies include some information about climate-related risks. Real estate companies are expected to be substantially affected by the new regulations, both with regard to their own reporting and also the disclosures required by their tenants. 

US REITs have tended to be ahead of the curve on climate risk reporting, but developers and smaller listed entities are more likely to need a dramatic reporting upgrade.

One proposed requirement is that companies would need to assess the risk of events such as flooding, heatwaves or wildfires. However, aside from flooding risk, there is no standardisation in this reporting. If the proposals are ratified, more standardisation is expected to emerge.

A report from law firm White & Case notes that the proposals in many instances go beyond what listed companies are already voluntarily disclosing and says: “Given the scope and complexity of the proposed rules, comments are expected to be extensive, and there will likely be threats of litigation if the proposed rules are adopted.”

Indeed, the proposal is opposed by SEC commissioner Hester Peirce, who argued that existing reporting rules already required the disclosure of material climate risks, that it requires disclosure which is outside the SEC’s remit and that the cost of compliance has not been properly estimated.

The measures have elicited broad support from larger real estate organisations. “For long- term, meaningful action to occur, there needs to be consistency in reporting and data,” says JLL sustainability vice president Cynthia Curtis. “Then, it elevates

it more closely to the financial reporting and puts the topic smack in the middle of boardrooms and finance departments. And that’s an excellent thing.”

Matt Ellis, chief executive of proptech firm Measurabl, says the disclosures would be “a bold step toward regulating an area that has largely remained unregulated for too long”. 

Proposed SEC climate disclosure rules

The new rules will require US listed companies to make a number of regular disclosures, which vary depending on the size of the company; smaller companies have more time to comply. The rules require disclosure of:

The full version of this article appears in the May issue of Sustain