Real estate investment trusts are increasingly adopting sustainable investment strategies to align with environmental goals, evolving market demands, regulatory pressures and resultant risks of taxes, stranded assets or fines. These strategies not only mitigate risks associated with climate change and move the industry towards net zero, but enhance long-term value creation, improve asset performance and attract ESG-conscious investors.
Top-down and bottom-up
Market demands are both “top-down” from stakeholders and “bottom-up” from occupiers. Green buildings are appealing to eco-conscious customers, leading to higher demand from occupiers and often higher rents or property values.
REITs are routinely incorporating green lease clauses, which require occupiers to adhere to sustainability guidelines, such as energy and water conservation, waste reduction and recycling.
These leases aim to align the interests of investor and occupier in pursuing sustainability objectives, creating a more collaborative approach to environmental responsibility.
A key part of this is data, including real-time energy monitoring tools to help occupiers reduce consumption. However, the quality of this data needs to improve for reporting purposes. Creating platforms or systems for the collection or input of this data in a standard way will assist with the investors ability to interrogate it.
Other aspects of green leases include offering sustainability training and education to smaller occupiers that are not familiar with regulations, and hosting sustainability events and competitions to encourage occupiers to adopt environmentally friendly practices.
Setting net-zero targets and the path to achieving those will be at the heart of any sustainable REIT investment strategy. Part of that will be energy consumption of the building and producing or procuring renewable energy equivalent to the total energy consumption of occupiers. This often involves integrating renewable energy sources of supply of green electricity to the occupiers, either through on-site self-generation or through corporate power purchase agreements.
Urban Logistics REIT is targeting an increase in on-site renewable energy, with plans to install photovoltaic cells on more than 10% of its buildings by 2024.
The regulatory framework
Mandatory reporting via legislation (the Companies (Strategic Report) (Climate-related Financial Disclosure) Regulations 2022), the Financial Conduct Authority’s sustainability disclosure requirements, as well as the volume of frameworks, standards, labelling and alternative disclosure requirements are overwhelming, even for experienced operators. There is no standard “standard” yet, but REITs are placing greater emphasis on transparent ESG reporting and aligning themselves with established frameworks, such as the Climate Disclosure Standards Board, Global Real Estate Sustainability Benchmark, Task Force on Climate-Related Financial Disclosures and Sustainability Accounting Standards Board.
Industry is driving standardisation of frameworks. The International Sustainability Standards Board is developing standards to provide “a high-quality, comprehensive global baseline of sustainability disclosures focused on the needs of investors and the financial markets” and the FTSE Russell has consolidated global standards and developed an Exposure Framework.
When labelling a REIT as “green” and publicising its green credentials, these regulations and guidelines must be considered to ensure compliance and transparency. Throw in cross-jurisdictional differences for comparison and investors would be forgiven for getting confused.
Sustainable buildings
REITs are either investing heavily in new energy-efficient buildings or are operating in the “brown to green” space, where they upgrade newly acquired or existing stock. For example, the PRS REIT’s 2023 ESG report reaffirmed a “focus on ensuring that the homes in its portfolio are highly energy efficient” – revealing that all homes added during the financial year had an EPC rating of at least B, with 87% of homes in its portfolio rated A or B.
By improving energy efficiency, REITs can improve EPC ratings with relatively simple changes, like LED lighting, HVAC upgrades and smart technology so the building is only running when occupied. As well as lowering operating costs, this will reduce the carbon footprint.
The Minimum Energy Efficiency Standard requires all property owners to improve the energy efficiency of their properties by way of a restriction on the granting of leases or the ability to continue to let properties with an EPC rating below an E unless certain exemptions apply. Failure to comply risks not only fines but reputational damage.
There is then a risk of stranded assets as the flight to quality continues. This gives sustainability a new meaning and it therefore has to be at the forefront of any investment or asset management strategy.
AEW UK REIT has shared some of its success stories when it comes to ESG-focused asset management, specifically making MEES improvements. At its Mangham Road industrial scheme, it has supported a series of changes, including a refurbishment and roof/insulation works, as well as implementing green covenants in leases. This has supported rent of £410,000 per annum, equating to £5 per sq ft, a 49% increase, with total valuation also moving from a purchase price of £2.175m to up to £5.4m after letting.
The direction of travel
While regulation and reporting requirements are helpful, none of these provide like-for-like comparison and this lack of consistency has resulted in the UK Net Zero Carbon Buildings Standard. This provides an agreed methodology, cross-industry standard and a clear set of requirements for a building to be classified as “net zero carbon-aligned”, along with information on how to report it. The pilot is being launched on 31 October. In doing so, the UK Green Building Council has set out a shared industry ambition and target that indicates what must be achieved by 2025 to achieve the UK’s environmental goals.
The convergence of these factors indicates a robust market outlook for sustainable property investment. As awareness and demand continue to grow, properties that incorporate sustainable practices are likely to command a premium, leading to a shift in investment.
Liz McKillop Paley and Nathan Rees are partners in the real estate division at Shoosmiths
Image © Shutterstock
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