Laying The Right Foundations: Why ESG In Property Is A Trend To Watch

ESG

By Jake Pearlman

From the UK Treasury’s report on Green Finance, to the EU Sustainable Finance Taxonomy and the US ESG Disclosure Simplification Act working its way through Congress, ESG (Environment, Social and Governance) metrics in finance have never been more in the spotlight than in 2021. However, there are significant benefits to pursuing an ESG agenda in sectors outside of just finance, and many might overlook initiatives and benefits they could pursue if they don’t dig under the surface of the headlines. One area where the ESG benefits are clear, if sometimes overlooked, is the property sector.

There are innumerable benefits to pursuing an ESG agenda in property, whether from an investor, occupier or landlord perspective. These include everything from better wellness for employees to greater attractiveness to future occupiers, not to mention the inherent green credentials of prioritising ESG-boosting programmes. The question is whether participants in the property sector are able to capitalise on these potential gains and whether the UK government could do more to boost these growing green shoots.

There’s no place like home: benefits for occupiers

There are innumerable benefits to pursuing an ESG agenda in property, whether from an investor, occupier or landlord perspective.

For occupiers looking to improve their green credentials, leasing an office with ESG credentials brings more benefits than just a buzzword for the website. Naturally, reducing your company’s impact on the environment helps efforts to mitigate and reduce climate change and improve sustainability, a moral and ethical choice that is becoming more important each day.

But in addition to the ethical and moral ramifications, ESG-rated buildings often score high on the BREEAM rating scale, which measure not just ecology and energy ratings, but also the social and economic benefits for the employees working within the building. ESG and wellness often go hand-in-hand, so by pursuing an ESG agenda in choosing a workplace, companies can improve the health and wellbeing of staff also.

The resulting effect has wide-ranging consequences, as it goes without saying that a healthier and happier workforce is likely to equally improve talent attraction and retention, creating the best teams working from the greenest offices.

As early as 2012, data showed that 60% of occupiers recorded improved occupant satisfaction and comfort in a BREEAM rated building, with around 35% noting improved employee productivity. The data is clear: better buildings have an effect on their occupiers that can be measured in hard, tangible growth and retention gains. Upping productivity by a single percent and reducing staff turnover by ten percent may seem minor, but the impact on cashflow will be measurable.

Companies with an eye to the future will also find benefit in working from ESG-rated offices as the market changes and new financial reporting requirements necessitating energy use and carbon reporting come into effect. Increasingly detailed reporting requirements may soon come to encompass the workplace, at which point the occupiers ahead of the curve in ESG-rated spaces will not only be able to include better CSR credentials, but will not have to spend time or capital on assessing the energy use and carbon impact of an older, unrated building.

Meeting new desires: benefits for landlords and operators

If the benefits for occupiers are clear, then the benefits for landlords or workspace operators naturally follow.

Environmental technology concept. Sustainable development goals. SDGs

Again, there is a clear ethical benefit to owning and managing buildings that are more sustainable, but as with most ESG topics, there are measurable financial benefits too. In the first instance, the various benefits for occupiers mentioned above will translate into more attractive offices that a landlord or operator will find easier to market and lease. As ESG continues to rise up the agenda, it may become increasingly a ‘hygiene factor’ that buildings must pass to even meet average attractiveness to potential occupiers. Investing in ESG fit-outs or retrofits now could pay dividends further down the track.

Similarly, as ESG and carbon reporting requirements become more prevalent for occupiers, they will also increasingly apply to landlords and operators. Investing in ESG capabilities will set properties ahead of the game as these reporting requirements develop, giving a first-mover advantage to the businesses able to see the way the wind is blowing.

Residential landlords and developers stand to benefit as much as commercial real estate operators, with growing interest in social housing and eco-builds set to shape the markets in years to come. A growing concern over the high street in the wake of the pandemic could prompt new efforts at regeneration, which by its nature will trend more closely to ESG. In 2020, figures note that Greater Manchester housing providers collectively contributed £1.2bn in gross value to the local economy – with the recent release of the Sustainability Reporting Standard for Social Housing, similar benefits may become commonplace across the UK and businesses stand to benefit hugely if they can tap into this swell of support in coming years.

Whilst we aren’t currently seeing any tax or business rates considerations for ESG-rated offices, the Government’s focus on ESG, through its Green Finance Report, Energy Whitepaper and COP26 agenda, suggests that it won’t be long until these ideas make their way into a future budget. The financial services and energy sectors can be viewed as a bellwether for the direction of ESG, and the canny property business will take note.

Follow the money: benefits for investors

Given the benefits to occupiers, landlord and operators, ESG in property is likely to further develop as a rich vein for investors.

According to Refinitiv Lipper, over half of fund flows in 2020 in Europe were directed towards ESG products, to a value of almost £250bn. In the last three months of 2020 alone, European sustainable investments comprised 80% of the £110bn of global ESG fund inflows, according to Morningstar. The writing is clearly on the wall and whilst property is traditionally a slower sector to adapt to new changes, the rise in Proptech and digital solutions have upped the pace in the market.

Pivoting to face the ESG winds may not be possible for property investors to do as smoothly as in the pure financial sector, but we should not consider the property market to be too far behind the curve.

As we exit the pandemic, vacancies in the office market and population centres thinning out into the suburbs have left empty properties and landlords looking for new tenants – whether commercial or residential. Now that shorter leases are becoming the norm, options exist for investors to capitalise on an increasingly flexible backdrop to the market and the aforementioned greater occupier/tenant retention created by ESG buildings.

What’s next for ESG?

This is not to say that the transition to ESG in property will all be smooth sailing. The costs of retrofitting a property – commercial or residential – to meet new ESG metrics may be prohibitive, especially for smaller operators. Whilst this may offer an opportunity for investors to support the change, operators and landlords only just recovering from the pandemic may not wish to spare the capital until the disruption truly reaches its end.

ESG in finance is now mainstream, as is the ongoing energy transition and efforts to boost sustainability in the supply chain; property is therefore the logical next step for the ESG wave to wash over.

In addition, the time taken for an ESG fit-out or building conversion is naturally a void period in occupancy, cutting into cashflow even as it costs to upgrade the building.

What could potentially benefit the sector is government intervention in the form of a tax benefit for converting buildings to meet agreed upon ESG metrics or standards. We already see a similar strategy work with R&D, where a company can obtain a R&D tax relief which has had a huge effect in stimulating innovation across UK businesses, and wouldn’t necessarily be difficult to apply to ESG in the property sector.

The early bird

The growing interest in ESG visible over the past decade and now reaching a fever pitch in 2021 has many fans and few real critics, but its time that we moved the conversation into new areas. ESG in finance is now mainstream, as is the ongoing energy transition and efforts to boost sustainability in the supply chain; property is therefore the logical next step for the ESG wave to wash over.

Occupiers, tenants, investors, landlords and operators all stand to benefit if they can harness ESG in their business plans – the true winners, however, will be those that act soon and secure the best first-mover advantage.

About the Author

Jake Pearlman

Jake Pearlman is a senior manager at top-25 chartered accountants haysmacintyre, specialising in providing advice to a range of property-based clients. Jake is a top ‘35 under 35’ accountant in Accountancy Age 2019 and assists clients on services such as audit, structuring, tax advice and transaction services.

The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.