It is an undeniable fact that climate-related risks significantly affect every sector, and real estate is no exception. Indeed, changes in the climate have an overarching impact on the operating and financial performance of an entity. As a result, investors today naturally expect to see more and more disclosures concerning climate risks in financial statements so they are in a better position to make informed decisions on their investment choices.
While the IASB does not offer explicit guidance on the disclosure of climate-related risks and impact, it does provide underlying principles within which reporting should be conducted.
According to a study (PDF, 2.3MB), the real estate sector represents approximately 40 percent of global CO2 emissions. This may lead to a considerable decrease in the valuation of real estate due to climate transition, as well as reduce the useful life of assets – especially those in disaster-prone regions. Today, communities worldwide are increasingly affected by devastating storms, floods, fires, extreme heat, as well as other catastrophes, all of which can substantially affect the value of a property. What’s more, there might be significant capital expenditure required to decarbonize certain assets – for example, upgrading to more energy-efficient lighting systems, or installing better insulation.
As the IASB pointed out (PDF, 1.5MB), there is an overarching requirement under IAS 1 Presentation of Financial Statements to disclose any information that enables investors to understand the effect of specific transactions, events and conditions surrounding the company's financial position and financial performance.
IAS 1 requires the disclosure of significant judgments and sources of estimation uncertainty. This means that matters such as estimates of future cash flows while valuing investment property, impairment assessment, or estimates to settle decommissioning obligations, should be disclosed.
Real estate valuation models need to consider accounting for the capital costs required for a building to decarbonize, or the physical risks to the building arising as a consequence of climate change. Let’s also remember that a real estate property may see a decline in revenue if it is not compliant as tenants may prefer high energy efficient buildings, and costs are likely to be higher given the increase in energy costs.
Under IFRS 13 Fair Value Measurement, disclosures are required for the inputs used in the determination of fair value, particularly for level three hierarchy, as well as sensitivity analysis with respect to change in these inputs.
In cases where real estate is not carried at fair value, climate change and additional capital expenditure due to decarbonization need to be considered in the impairment test models. Then, the appropriate disclosures should be provided in the notes concerning IAS 36 Impairment of Assets. What else? Useful lives and residual values need to be re-estimated, taking into account the impact of climate change. If the real estate is carried as inventory, there may be possible write-downs due to a decline in net realizable value under IAS 2 Inventories.
And let’s not forget IAS 37 Provisions, Contingent Liabilities and Contingent Assets… Climate-related changes can lead to additional provisions (e.g. restoration and restructuring provisions to meet environment targets) due to government-imposed levies on high-emission buildings.
It is essential for entities to ensure consistency between financial and non-financial reporting on key climate-related assumptions. This is also one of the main priorities for regulators all over the world, and is necessary to increase transparency in financial reporting. The European Securities and Markets Authority (ESMA) recently issued its list of priorities for 2023 IFRS financial statements (PDF, 2.2MB), where disclosure of climate-related impacts in the financial statements features, once again, as a top priority.
KPMG expertise
Are you on top of climate-related risk reporting for your real estate assets? Do you know exactly what is required in terms of disclosures? KPMG Luxembourg’s team of specialists has extensive knowledge and a deep understanding of how climate change affects the current financial landscape. Reach out to us today!
This article was co-written with Mukhrit Goyal, Senior Manager, KPMG Luxembourg.
