Some developers forecast that sales prices will increase in the future purely as a result of the zero-emission requirements currently being placed on buildings but there is no consensus as to what the ultimate effect will be. Robert David, Partner and Tomáš Kren, Senior Associate at Wolf Theiss’ Prague office talked to Property Forum about the increasingly important role ESG compliance plays in real estate transactions and potential regulatory changes that can affect the market.
With the ongoing energy crisis, real estate developers and asset managers should be paying more attention than ever to improve energy efficiency. Is that what you’re seeing on the market?
What we are clearly seeing is a greater awareness among clients and the real estate community in general over the issues of energy costs and implementing more energy-efficient solutions for their buildings. Whilst leading developers and investors have been making efforts to improve their energy performance ever since the Energy Performance of Buildings Directive was introduced in 2010, the current energy crisis is finally making everyone sit up and take notice of the issue.
Robert David
Partner
Wolf Theiss
How does the current regulatory environment in the Czech Republic support their efforts?
As is often the case, EU regulation leads the way, whereas the transposition and implementation of the latest environmental regulations into Czech law is lagging behind. Czech legislation also has a habit of contradicting itself, which means that to stay ahead of the curve some developers will follow the requirements set out in EU directives, even though these are yet to be reflected in Czech domestic law.
Nevertheless, we are seeing some developments being taken in the domestic regulatory environment. For instance, currently going through parliament is an amendment to the Building Act and Energy Act (Parliamentary Document No 313) which should remove the need to obtain a building permit or ERO licence when installing renewable electricity installations of up to 50kW for self-consumers (excluding hydropower plants) in built-up areas.
Prague has recently seen and is expected to see many more significant renovation projects. As historical buildings are often the least energy-efficient ones, how does legislation support (or complicate) their renovation?
The renovation of historical buildings in Prague remains a complex issue, irrespective of whether the renovation would make the building more “taxonomy-compatible”. On the one hand, protected buildings have clear limitations when it comes to implementing sustainability features (e.g. they cannot be fitted with solar panels). On the other, old buildings in the city centre are easily accessible by public transport, meaning that vehicle emission levels become less of a factor.
In this sense, the focus tends to be on promoting circular economy aspects or developing the “S” aspect of ESG. We can see this, for instance, with the reconstruction of the Savarin development, Crestyl’s mixed-use commercial development project in Prague city centre, where rather than implementing ESG elements on the protected high street façade, these elements will be implemented in the courtyard.
Tomáš Kren
Senior Associate
Wolf Theiss
What major regulatory changes can be expected that can have an impact on green developments?
Given the aim of making all buildings built after 2030 (or even 2028 in some cases) “zero-emission”, we can expect an increased production of all kinds of new regulations. The most crucial aspect for green developments is that the permitting process for new renewable energy sources needs to be accelerated.
With its Proposal for a Council Regulation laying down a framework to accelerate the deployment of renewable energy (COM/2022/591), the EU Commission aims to significantly speed up the permitting process for renewable energy and heat pump installations in Member States to a maximum of one month.
Good quality data is essential for calculating the carbon footprint of a building. Do landlords have access to such data?
To report a building’s carbon footprint, it is essential to collect good quality data and share it with all relevant parties, such as within supplier relationships (this should be addressed in the contract). Meanwhile, the data received from tenants needs to be carefully monitored for its quality.
The process for calculating and reporting a building’s carbon footprint is still evolving and a generally accepted formula for its calculation has yet to be established.
What role does ESG currently play in real estate transactions?
First of all, tenants and investors will generally target buildings that are BREEAM, LEED, WELL or similarly certified. And in the transaction process, ESG aspects have taken on increased importance such that carrying out ESG due diligence is becoming standard. In this respect, investors will pay close attention to the ESG clauses in supplier and client contracts.
But this is not always the case. In the recent sale of the Blumental project, which was developed and sold by Corwin, the transaction was conducted without any significant ESG actions. Of course, the value of the project and the resulting purchase price were probably helped by the fact that this was a high-quality building built in line with the latest ESG trends.
How does ESG compliance affect the sales price?
Some developers forecast that sales prices will increase in the future purely as a result of the zero-emission requirements currently being placed on buildings. This rise has been estimated by some operators at around CZK 10,000 per sqm for residential developments, but it bears underlining that there is currently no consensus as to what the ultimate effect will be.
So ESG compliance efforts will certainly affect sales prices to some extent, although it is impossible to predict by how much exactly. Taken together with the increased cost of materials, we might expect an increase of up to 30% in final sales prices.
How are ESG issues reflected in the wording of lease agreements? How is the issue perceived by tenants?
As things stand, ESG issues tend to be reflected through best-effort obligations, meaning that non-compliance with a sustainability clause does not carry any clearly defined negative consequences (such as contractual penalties or the right of termination). However, where a market-standard Czech lease template includes a sustainability clause, any breach of this clause – provided it has not been removed and provided the general grounds for termination (by the landlord) for breach of any obligation are left unchanged – will generally enable the landlord to terminate the lease.
Awareness of ESG issues among tenants varies, but there is a general need to educate tenants and support them in their ESG efforts, particularly smaller, local tenants. Generally speaking, foreign corporations take the lead on ESG issues and tend to place the highest demands on landlords. Indeed, foreign regulation tends to be more thorough in ESG matters, with requirements often including regular meetings of ESG managers on both sides of the lease agreement, landlord obligations to provide 100% of energy through RES and an option to refuse to modify premises if the modification would not comply with ESG principles (e.g. in terms of the materials used).
The absence of a universally recognised “green lease” template is also noteworthy, and we think this is something we will see being established in the next couple of years.
Sustainable financing has been gaining ground in recent years but we’re now seeing an overall slowdown in lending activity on the back of rising interest rates and economic uncertainty. With banks being more selective than ever, do you expect them to further tighten their sustainability criteria?
The volume of green, social and sustainability-linked bond and loan products is continuing to grow and develop. Right now, however, demand is exceeding supply, which is leading margins to tighten. One of the key reasons for this is the limited available volume of green assets.
The rules on structuring products and documentation are primarily set by the relevant market associations such as the ICMA and LMA. We can expect these rules to be further streamlined to prevent different financiers from having to meet different requirements.
As far as regulatory developments are concerned, there are several changes to keep an eye on. The first concerns the introduction of the Green Asset Ratio for banks, as well as the climate risk stress tests to be conducted by the ECB, with all related consequences. Also coming down the line is the European Green Bond Regulation, on which feedback from the markets has so far been mixed.
