The changing face of real estate

The real-estate landscape is changing in the face of climate change.

Extreme weather events are on the rise, creating serious risks for portfolios – and the sector itself is responsible for some 25% of global carbon emissions. As such, there’s a growing focus on sustainability throughout the industry.

Pressure to decarbonise real estate is therefore growing from all sides: regulators, investors, employees and consumers.

Let’s take a look at these stakeholders’ concerns. What are the different groups demanding – and what does it all mean for real-estate businesses?

On the regulatory front, organisations must get to grips with a mounting disclosure burden. The EU alone has introduced no less than six sustainability-related directives and frameworks:

1. The EU Taxonomy is a classification system for sustainable economic activities – including in the real-estate space. The Taxonomy provides a common definition for these sustainable economic activities and can be used as a tool by investors to assess the attractiveness of an investment.
2. The Sustainable Finance Disclosures Regulation (SDFR) sets out minimum disclosure rules for entities investing in real-estate assets like REIT funds.
3. The Corporate Sustainability Reporting Directive (CSRD) obliges firms with real-estate portfolios to report on their social and environmental risks and how their activities impact people and the environment. The reporting must be in line with the European Sustainability Reporting Standards (ESRS).
4. The Corporate Sustainability Due Diligence Directive (CSDDD) requires companies to put processes in place that will enable sustainability due diligence.
5. The Alternative Investment Fund Managers Directive (AIFMD) is a framework for alternative fund managers to bring sustainability and climate risks into their SFDR disclosures.
6. The Markets in Financial Instruments Directive II (MIFID II) imposes a duty to consider customers’ sustainability demands when offering investment products.

For their part, investors are prioritising sustainability when deciding where to put their money. A recent KPMG survey asked global real-estate investors whether sustainability is becoming as important as financial returns in their decision-making. Only 12% said no.

The reality is that decarbonisation strategies will underpin the long-term value of real-estate assets. As a result, investors are:

• pricing carbon-related risks and opportunities over longer horizons
• looking to decarbonise their portfolios in line with climate targets
• favouring lower-carbon businesses, as more institutional capital flows into ESG funds.

At the same time, traditional financial institutions have specific sustainability obligations and targets to meet.

For example, under The European Banking Authority’s ESG Pillar 3, they must monitor and manage their portfolios with regards to:

• climate risks – such as the risk of stranded, carbon-intensive assets, or loans on properties on flood plains
• the Green Asset Ratio (GAR) which is the proportion of a banks assets invested in EU taxonomy aligned activities and Banking Book Taxonomy Alignment Ratio (BTAR) which is the measurement of consistency of a company’s financial reports and the EU taxonomy – to understand the extent to which they’re financing environmentally sustainable activities
• fossil fuels, other carbon-intensive sectors, and the greenhouse gas emissions they’re financing.

What’s more, the European Central Bank’s Guide on Climate Related and Environmental Risks has specific provisions for real-estate portfolios. Financial institutions with such investments must monitor and manage their exposure to:

• the physical risks associated with climate change
• transition risks – such as policy initiatives on energy-efficiency standards
• disclosure expectations – amount or proportion of carbon-related assets, carbon intensity etc.

Climate change is transforming what consumers and employees want from their homes and workplaces.

In the residential market, people are increasingly prioritising environmentally friendly homes. According to a 2020 survey by Savills, green credentials were important to 49% of people looking to buy a property.

Plus, in today’s inflationary climate, people recognise the cost savings that a more energy-efficient home can achieve.

Meanwhile, in the commercial space, UK law obliges businesses to reach net-zero carbon emissions by 2050. As a result, corporates are looking to invest in sustainable buildings – which will have the knock-on effect of reducing operational costs.

It will also enhance the employee value proposition. People are increasingly choosing to work for companies that reflect their environmental and social ideals.

All of which is being reflected in the real-estate market. Studies by the Massachusetts Institute of Technology indicate that globally, certified buildings offer a 7.7% rental premium per square foot ; and their leases last more than a year longer than those on non-certified assets. [1]
 

As we transition to a warmer world, the risks will become starker, and insuring assets will become more expensive. For real-estate organisations, the cost of inaction will be high.

However, decarbonising their portfolios is a daunting task. It can be difficult to know where to even begin.

To get started on your decarbonisation journey, we’d recommend considering the following steps:

• Set credible carbon-emission reduction targets for your organisation.
• Identify and adopt the most relevant reporting standards and frameworks.
• Implement governance processes to enable more effective use of carbon data.
• Identify the climate risks to your portfolio, and your likely future portfolio requirements in a warmer world with increased climate events.
• Consider climate adaptation, biodiversity, material use and circular principles which, while are currently secondary factors to carbon are likely to see regulatory changes in the future.

KPMG’s experienced real-estate team offers in-depth knowledge, expertise and insights from across the sector. We can help you navigate a changing market – please get in touch to see how we can support your organisation.

[1]ESG: Shaping the Real Estate Landscape to Come – KPMG Luxembourg