COMMENT: With the world’s leaders having come together in Glasgow for COP26, following a year of climate-related disasters, it would be fair to say that the sustainability agenda has never been more important.
Ever-growing concerns around carbon emissions have led to increased scrutiny on the real estate industry, and rightly so. The industry accounts for 40% of global emissions, and any hope of delivering the Paris Agreement’s goals are dependent on us taking action to reduce our impact.
This is, of course, not lost on the industry – and we are seeing a concerted effort from many to significantly reduce their emissions across their portfolio. Whether it is the sharp rise in green bond issuance or the adoption of climate tech, sustainability is fast becoming the critical issue for many within the industry.
However, though progress is being made, the industry cannot rest on its laurels. We know that regulatory pressure soon follows increased scrutiny. Most recently we’ve seen the European Commission announce proposed revisions to the EU Emissions Trading System (ETS) to include the heating of buildings and the Energy Taxation Directive (ETD) to provide greater clarity over the incentives for sustainable energy.
Wide impact
There’s no doubt these changes will have an impact on the wider industry. The ETS and ETD combined will serve to drive up the cost of heating in energy-inefficient buildings, while incentivising low carbon and energy-efficient innovation within the sector.
In practical terms, what this could mean is that developers whose assets remain energy inefficient may see a significant reduction in occupancy rates, with sharp rises in the cost of carbon-intensive heating and a general reluctance to let energy-inefficient buildings. A trend that is already apparent across the industry.
Though these regulations apply to all assets, it is older assets that were designed with little consideration for energy efficiency that will come under the greatest threat. Retrofitting will therefore be incredibly important for developers, for if they fail to do so we may begin to see many assets condemned to functional obsolescence.
This is of course a very significant threat for the industry; however, it remains some way off becoming a reality. That said there are still potentially more immediate consequences of these regulations, particularly when it comes to the value of real estate.
Knock-on effects
It’s something we were keen to try and understand more about, and working with JLL, we recently produced a white paper to understand what the impact on values might be and how the industry is responding.
Our research shows that the short-term cost implications are likely to hit tenants, rather than landlords. The ETS will certainly result in a rise in heating bills, however this is a cost that is ultimately passed down to the occupiers. Similarly, the ETD will penalise fossil fuels for heating more effectively via existing tax mechanisms, but once again it’s a cost that will filter down to the occupier.
However, it is worth noting that the knock-on effect is that over time landlords will likely see reduced rents and increase letting periods for less energy-efficient stock, as well as see discounted exit yields as sustainable buildings become the new normal.
Therefore, although the regulations themselves may have little impact on real estate value in the short term, the knock-on effects may have much more far-reaching impacts when it comes to value of energy inefficient assets, particularly as the cost of carbon rises.
A consequence that the industry is all too aware of. In speaking to EPRA members, the consensus is that the immediate impact of regulations would be marginal and that their existing carbon strategies were ahead of the legislation when it came to reducing emissions.
Despite the minimal short-term impact of the ETS and ETD revisions on real estate values, the industry remains acutely aware of the existential threat the climate crisis poses and is taking steps to address this.
There is no doubt that the decarbonisation of the industry will take a considerable effort and the pressure to achieving this will only increase. However, most importantly, the journey to doing so is underway.
Hassan Sabir is finance and ESG director at the European Public Real Estate Association
