ESG considerations play an increasingly important role in investment, financing and location decisions across the real estate industry. Four Colliers experts talked to Property Forum to discuss the role of sustainability in the post-COVID-19 world.
Has the COVID-19 pandemic (and the necessary introduction of various safety measures) shifted focus away from sustainability in real estate?
Quite the opposite. Prior to the emergence of COVID-19, sustainability trends, such as workplace wellbeing and community impact, were already gaining good momentum across various sectors. The pandemic has only forced these factors up the agenda by spurring interest and awareness from society.
The industry’s response to the pandemic has not only demonstrated its ability to manage a public health crisis but also shown a glimpse of its social transformation power; landlords providing rent deferrals to smaller businesses and vacant spaces to key workers are clear examples of this. Social purpose is now a typical C-level and boardroom conversation and a tool to attract and retain talent.
In light of the virus, there’s also been a lot of discussion on the impact that buildings can have on our health, and occupier expectations are growing faster than ever before. Indoor air quality, once a backseat concern, has been pushed to the top of the priority list not least because some of the safety measures introduced last year relate to ventilation systems. We see this having an impact on the way space is leased and developed. Buildings that can demonstrate good indoor environmental health are becoming more attractive and will potentially command premium rents.
On a macro level, the record numbers flowing into ESG funds, which outperformed the broader market during the pandemic, signal a huge financial shift towards sustainable investments in all asset classes which will eventually make sustainability the norm.
How do you see property investors in Europe tackling climate risk?
It’s early stages but the importance of local climate risks, such as coastal flooding and wildfires, is only rising in investment decisions and gradually coming to the forefront of decision making. There’s a big push from key stakeholders of property funds to align with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD).
The TCFD has been a game-changer in many ways as it provides a structured approach to identify physical and transition risks (and opportunities), and ultimately to disclose the financial impact of these. Some fund managers are integrating the framework’s reporting process into their existing risk management processes. However, this is not common practice and we are yet to see the risk implications being formally applied in the valuation process.
In a recent report from ULI, some investors revealed they were starting to pull back from investment in some submarkets due to a lack of climate resilience. Market forces such as this are set to increase as more reliable climate-related financial data becomes available and as lenders and insurance underwriters become more climate-conscious.
So the potential long-term effects of climate change are already impacting location decisions?
Yes. Without a doubt. “Climmigration” – the relocation of communities because of climate change – has long been with us. For the last 50 years, people and communities globally have opted for different habitats after drought or repeated flooding threatened their livelihood.
But the effects of global warming impact corporate location strategy just as much. In various ways, all depending on a company’s primary process. Manufacturers and other resources-intensive businesses are most directly impacted because of physical risk – to their own operations or to those of their suppliers. They are reconsidering their footprints and supply chains in the light of increased natural hazards. This leads them to locate closer to their markets. Finding adequate talent pools and a robust supplier basis are key considerations for their location decisions.
The indirect impacts of climate change affect more than just manufacturers. And these indirect impacts are multiple. Firstly, consumer buying behaviour is changing as people increasingly opt for “climate-friendly” products – a trend to only grow exponentially. Secondly, there is the regulatory impact. We have all seen government policy interventions such as carbon taxes, subsidies for green energy and low-carbon technologies paralleled by cuts to those destined for fossil fuels, and tighter energy efficiency standards. Both developments lead companies to reconsider how they produce and ensuing: where to produce. Already today, businesses are idling investments in older plants for the benefit of setting-up new, environmental-friendly facilities. Where to locate these operations triggers a new round of location decisions.
Clearly, there is a cost associated with such overhauls. This creates another challenge for corporate location strategy since not all costs can be passed-on to B2B clients and end-consumers.
Then undeniably, increased consumer climate-impact awareness affects “micro-location strategy”. That strategy is about where to locate within an urban area, building certification (think LEED or BREEAM) as well as workspace equipment and layout. This is all-relevant for businesses that importantly rely on office space. And for real estate developers. Why? Because of the Millennials (commonly defined as people between the ages of 24 and 40 in 2021). Millennials are an increasingly important contingent of today’s workforce and are too aware that they are the so-called “Climate Change Generation”. Conscious that human behaviour impacts climate change, the ecological footprint of a company plays a major role in Millennials’ decision on who to work for.
In summary, my view is that location strategy cannot ignore climate change. Because of threats to today’s global supply chains. Because of end-consumers increasingly favouring “climate-friendly” products. And probably foremost: because the best of tomorrow’s workforce and business leaders will prefer to work for companies that work hard to have an ecological footprint.
How do the sustainability and the ethical impact of an investment affect the availability of real estate financing?
To put it very simply, the key question will always be: does the transaction itself make financial sense? ESG will never be the sole driver. The analysis undertaken to assess the value of an asset will highlight if the value will be impacted in any way through failing to comply with incoming carbon targets or regulations. Therefore, for example, if there are policies or regulations around ESG requirements that result in a shorter life span of an asset, then the lending terms offered will be less favourable.
At this time, ESG led requirements are not a direct reason for any adjustments in price or value by lenders, however lenders themselves have their own ESG targets, therefore those schemes that are ESG led could start to see better capital weightings for lenders and therefore potentially lower pricing. What is clear, as ESG policies and corporate compliance concerns begin to impact the value of assets, lenders will naturally look more favourably upon sectors and asset classes that support the ESG agenda, in order to meet their own targets.
Do you see the importance of having a comprehensive ESG strategy growing further in the coming years? Will this change be driven by regulation or by pressure from within the industry?
Absolutely. Developing a sound approach to ESG is rapidly becoming business-critical in real estate. Companies are having to discuss and report on their position in relation to a growing number of ESG themes from diversity and inclusion to the race to net-zero emissions, and this is only going to go get stricter. Having been on this journey ourselves, we can say first-hand that the right strategy, supported by a robust governance structure to implement it, is the most effective way to manage the associated risk and identify opportunities to deliver business value.
Appetite for sustainable action continues to accelerate across multiple fronts, particularly around the need to reduce carbon emissions at a faster pace. Driven by the Paris Agreement, governments across the world are now spelling out what their net-zero commitments mean in practice. This will undoubtedly impact business operations and market dynamics.
But given the growing interest and commitment from occupiers and the demographic change discussed above I believe the market will ultimately determine strategy goals. Regulation will still play a big part. The policy gap that has now been in place for several years is fast being filled. Progressive changes in policy areas such as minimum energy efficiency standards, carbon budgets, building materials, and biodiversity will all play a part in forcing the industry towards decarbonisation. To succeed, companies will need a solid ESG strategy to make the right investments and harness innovation.
What is the role technology can play in creating an ESG strategy?
Technology plays a critical role. The ability to access data and utilise it effectively is what underpins ESG strategy. Technology is what will give us that capability.
Looking at it as a three-step approach:
Step 1 is using tech to gather the data. That technology could take any number of forms. It is a sensor tracking energy consumption and output of a critical piece of machinery at the asset. It is the thermal camera that measures the temperature of all people who enter an office as countries come out of lockdown; it is the tenant experience app that users at that same office love because it helps them structure their day, and save time, and get discounts from local retailers.
Step 2 is using technology to sort, shape, store the data. There is limited benefit to knowing the data consumption for a building at one point in time. The benefit comes from aggerating it over time, in different conditions and comparing it to other buildings. This is where, as many real estate owners are experiencing, to maximise the benefits of an ESG strategy over a sustained period of time you have to have the correct data model to make sense of the mass of data you will have access to.
Step 3 is using technology to analyse and present that data and feed it back into the loop. Once you know from the data what causes, for example, a surge in consumption of energy, or water wastage you can then use technology to prevent re-occurrence or manage the incident appropriately. The technology will also now teach itself how to manage and self-correct these issues without manual intervention, meaning they get addressed earlier.
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