A significant focus of our firm is enabling and supporting investment into the UK commercial real estate investment sector. This work spans the full spectrum of investment activity, including advising investors investing directly and indirectly into real estate, helping investors (and investment, fund and asset managers) to raise both equity and debt, and supporting our clients in the asset management and ultimate disposal of assets.
Our advice covers the full range of sectors within commercial real estate, including offices, logistics & industrial, hotels, leisure & hospitality, retail, data centres, healthcare, life sciences, student accommodation, social housing and beyond.
The focus of our experience and specialisms in these sectors has become more complex in recent years. Without mentioning other significant developments such as Brexit, tax and transparency changes, other factors that fall within each of the three main pillars of ESG are impacting on substantial elements of risk, return, liability, reputation and the long-term future of real estate investment.
At a macro level, while the UK Government's legally binding commitment to reach net zero emissions by 2050 (and a number of other commitments for earlier targets) is the catalyst for many of the legal and regulatory changes we are navigating, much of the progress is driven not by government or regulatory policy but by the recognised need to ensure we are participating in real estate in a way that contributes to longer term socio-economic stability and seeks to counter the climate disaster we are potentially facing. From boardroom deliberations and commercial investment activity to dinner party conversations and discussions with family members, the ESG agenda is arguably the most universally tangible and important topic for generations.
The UK Government has legislated a binding target to reach net zero emissions by 2050 , and an important part of meeting this target will be the focus on real estate, with it being reported that buildings account for approximately 17% of the UK's greenhouse gas emissions, primarily as a result of burning fossil fuels for heating, and in a broader context it being report that approximately 40% of global carbon dioxide emissions come from the real estate sector. There is clearly a cost implication to meeting the various governmental and organisational net zero targets, but there is also opportunity, with research indicating that "green" buildings could generate increased occupancy rates of up to 18%, premiums on rental of between 2% to 8%, and utility savings of up to 15%.
A recent survey of global market participants indicates that almost 70% of survey respondents reported a heightened focus on ESG strategies in 2022, mostly due to higher energy prices and government-imposed ESG disclosure requirements; with 75% of all respondents noting that reducing energy consumption and carbon emissions is the top ESG consideration most likely to impact property value; and over 80% of respondents indicating that proximity to public transit (or lack thereof) impacts property value because easier commutes are associated with better employee well-being, with nearly 50% willing to pay a premium for buildings that support the physical and mental health of their employees.
Change is being driven for the first time by participants across the sector, including governmental and regulatory authorities, landlords, tenants, occupiers and their employees, and funders, most of whom now recognise the importance of engaging in the latest ESG discussions from a commercial and business perspective, as well as continuing to be a part of their ongoing corporate social responsibility. Through a deep understanding of the interface between business and communities, we're helping organisations to achieve sustainable, responsible, and resilient growth.
What is particularly striking is the pace of change and the challenge for many market participants to capture all considerations relevant to them. This is a far-reaching area that cannot be summarised succinctly, but we have set out below some of the key themes we see.
Minimum energy efficiency standards, coupled with changes in tenant / occupier expectations for more sustainable buildings that also improve the working environment as working patterns change. While the minimum energy efficiency standard ("MEES") was introduced in England in 2015 and required certain standards to be met in 2018, since 1 April 2023 landlords cannot let commercial buildings which have an EPC rating of lower than E unless an exemption applies, and the Government has consulted on future changes to raise the minimum standard from an EPC "E" rating to an EPC "C" rating by 2027 and an EPC "B" rating by 2030. Compliance with existing requirements, and understanding what is coming in the future, will be important to avoid breaching the regulations and the consequences associated with that, but also broader implications such as on valuation impact, lender expectations and capex requirements.
Sustainable funds, with investors looking to invest into real estate funds with sustainability credentials, and fund managers looking to launch and manage the same products, the introduction of clear labelling for such funds, based on the objectives of the fund, by the EU Sustainable Disclosure Regulation, is a key step to promoting transparency and understanding whilst partially mitigating the harmful effects of greenwashing. At the same time, that brings with it challenges for investors in understanding and comparing different investment opportunities and for managers in the additional regulatory requirements and how they present and report on those to investors. In the UK, the Financial Conduct Authority has consulted on its equivalent regime, the proposed Sustainability Disclosure Requirements and investment labels, with a Policy Statement anticipated in Q4 2023 along with proposed effective dates.
ESG in construction, where a plethora of considerations apply, including anti-bribery and corruption, carbon emissions, health and safety, modern slavery legislation, and increasingly the wellbeing of tenants through changes in design. A vast area, but some of the spotlight is on the procurement and use of energy and reductions in its consumption, climate change considerations when it comes to risks of flooding, droughts, and heatwaves, and also how businesses manage their supply chains and the wider environmental impact of them. Regulations around heat networks are anticipated in 2024, as they form a significant element of the UK Government’s strategy to decarbonise heating particularly for high-density urban areas.
Lenders are driving change in the sector as they seek to meet their legal and regulatory obligations, achieve their own net zero commitments and balance shareholder and investor demands for action. To meet their obligations and commitments, lenders are looking at the impact which the buildings they have financed (or are intending to finance) have on occupiers and the surrounding community as well as on the environment. Loans with a specific green, social or sustainability purpose and sustainability-linked loans, which support sustainable economic activity and growth, by linking interest rates to meeting certain agreed sustainability goals, are on the rise.
The role of boards is evolving. As organisations target net zero commitments, claims are anticipated from activist investors and other market participants in the context of climate change and with a particular focus on board commitment, actions and decision-making. Directors of companies in England have a number of duties, including the duty to act in the way they consider, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole. In doing so, directors must have regard (amongst other matters) to the interests of the company's employees, the need to foster the company's business relationships with suppliers, customers and others, the impact of the company's operations on the community and the environment, and the desirability of the company maintaining a reputation for high standards of business conduct. As we see a rise in property holding companies for overseas investors establishing themselves onshore in the UK, we anticipate that these considerations will increasingly come under the spotlight as different groups look to drive changes across the ESG agenda in business and challenge whether companies are meeting their own stated commitments in this area, whether from a liability and/or reputational perspective.
Teams across our real estate, M&A, funds and private equity, debt finance and dispute resolution groups are supporting clients in these areas. In a series of articles over the coming months we will be exploring these themes further and will be addressing a number of other commercial real estate investment industry changes and challenges, and how market participants can work together to ensure interests are aligned wherever possible in an ever-changing environment. If you have any questions on these topics in the meantime, please get in touch with your usual contacts at Trowers & Hamlins.
