By JENINE CRANSTON
Action is fast replacing intention when it comes to ESG in the real estate industry, with a focus on sustainability gathering momentum. All businesses must act now to avoid being left behind. Learn about the current ESG trends leading to transformational change and propelling businesses to take action.
Environmental, social and governance (ESG) factors are some of the most important considerations for every modern business. ESG has been talked about for a long time, but last year we saw a burst of momentum. There was a visible structural and transformational shift in the real estate industry, where businesses really started taking action on it.
We’re now seeing a much bigger emphasis placed on ESG, with its importance having grown enormously. Regardless of asset class, ESG has become fundamental to overall asset strategy for all client types, from the big end of town to privates.
While real estate businesses are at all stages of the ESG journey, it’s clear that appetite and ambition is growing rapidly and moving towards satisfying fast-growing market and investor expectations around taking action.
Looking at the UK experience, where there is a legislated commitment to net zero by 2035, we know that the move towards stronger ESG measures will only continue to gather momentum in Australia – and it will happen quickly. But let’s look at the state of play for ESG in real estate right now and the major trends driving change.
Mandatory sustainability reporting
We’ve known for some time that real estate is responsible for 40 per cent of greenhouse gas emissions globally and that urgent action is imperative to reduce this.
However, one of the biggest factors, although definitely not the only factor, that really propelled many businesses into actually taking action has been the looming introduction of mandatory sustainability reporting. This is a mandatory requirement for Australian businesses to provide detailed audit-ready reporting on their emissions, with the compulsory climate-related disclosures to affect all businesses via a phased-in approach until the 2028 financial year.
And the first deadline is barrelling towards us like a freight train.
Big businesses – with more than 500 employees, consolidated gross assets of $1 billion and more than $500 million in consolidated revenue – will be the first cab off the rank, with a requirement to start reporting from the 2025 financial year.
However, even this first phase will affect both big and small players, with local small asset owners leasing assets to tenants in this first group now having to provide ESG data as part of the supply chain.
This is the biggest change in financial and company reporting in a generation and will have a huge impact on real estate occupiers, investors and managers.
There are many asset owners who are not ready for mandatory reporting and will need to get on the front foot now, so they aren’t caught off guard when the reporting deadlines hit.
The key is having access to ESG data. Without data, you can’t measure, report or take positive action to minimise your emissions. Businesses will need to build internal capacity to gather the data, which will be a challenge, but there are reporting platforms available to help. For instance, Knight Frank has recently launched a digitised sustainability data management and reporting solution called Prism, which uses AI. The solution comes with technical support from Knight Frank’s ESG specialists.
You need to be strategic about the sustainability measures you are implementing for your business and assets, and when you are implementing them, as some are capital intensive. That’s where an ESG plan becomes crucial.
Investor and tenant appetite for ESG
While mandatory reporting looms and will become a reality for all businesses over the next four years, in the meantime we’re also seeing investors and tenants demand more from asset owners on ESG and this is pushing landlords to take action. In fact, investor demand has really been the key driver of market behaviour on ESG, particularly prior to the prospect of mandatory reporting.
Put simply, capital – especially if that capital is from the UK and Europe – wants to see strategy and action being taken on ESG for assets that they’re looking to acquire. Without a roadmap to improved sustainability, investors from the UK and Europe are pretty well off-limits for vendors. To understand this fully, it’s important to note that in these locations, ESG is not just ‘a nice to have’ for sustainability; there are legislative requirements dictating it. It’s also a reflection that more and more companies have their own net zero commitments, which means they need to occupy real estate or have real estate on their balance sheet that reflects the move towards that.
In the UK, it has effectively become a mandatory part of the sale process that, alongside technical due diligence, an ESG credentials document is provided that captures the criteria an investment committee requires to consider the asset. In 2022, our UK team saw this requirement grow from being non-existent to being part of nearly all sales in the city of London.
In addition to environmental credentials, respondents in a recent Knight Frank ESG Property Investor Survey of 45 global investors representing £300 million of assets under management found that social credentials such as wellbeing in the workplace – part of ESG – are a goal of 73 per cent of the investors surveyed.
The demand from investors on ESG makes it clear that there is a financial imperative for asset owners to take action, as it not only impacts the size of the buyer pool, but also asset value – and this is driving owners to take action.
Knight Frank undertook research presented in its Active Capital report that found that assets with a 5.5 Star NABERS rating or greater get up to an 18 per cent improvement in the asset value or sale price.
Three-quarters of investors surveyed for Knight Frank’s ESG Property Investor Survey of global investors say they want to improve the quality of their existing portfolios by refurbishing and repurposing. In addition, 58 per cent are looking to acquire poor ESG-performing assets with the aim to improve and upgrade.
Tenants are also, but to a lesser extent, contributing to the momentum being gained in the ESG space in real estate. Tenant expectations and attitudes towards assets are changing as they adopt their own ESG commitments and decarbonisation strategies, and they are looking for space with an ESG pathway, at the very least.
Again, this is where the financial imperative comes in. To attract better quality tenants, minimise vacancies and potentially secure higher rents, property owners must take action on ESG.
While real estate businesses are at all stages of the ESG journey, it’s clear that appetite and ambition is growing rapidly and moving towards satisfying fast-growing market and investor expectations around taking action.
Start taking action now
You need to be strategic about the sustainability measures you are implementing for your business and assets, and when you are implementing them, as some are capital intensive. That’s where an ESG plan becomes crucial.
But beyond this, you need a means to deploy the plan and this is where many businesses face challenges, because they don’t know how to take a report and put it into action.
There are now many experts out there advising on this and providing services to help make tangible steps towards achieving your ESG goals, so it’s important to seek help and take action sooner rather than later.
JENINE CRANSTON is a Partner and Head of ESG at Knight Frank.