The Real Estate sector.
ESG, as in all industries, has become a key topic of discussion in all aspects of the alternative asset class space. The real estate industry has been grappling with this change in appetite towards ESG for a number of years and we are seeing this subject matter form a significant part of due diligence processes when acquiring assets.
Evan Laframboise (Chair of our ESG Committee) and I will be exploring each area of ESG and how this is impacting the real estate sector through a mini-series of articles. I have the pleasure of writing the first, covering the environment, which neatly ties in with the new legislation coming into force in April this year around Energy Performance Certificate (EPC) ratings. EPCs in short are designed to provide confirmation on how energy efficient your building is by providing it with a rating ranging from A to G. The legislation enacted means that you will no longer be able to let building if it does not have a minimum rating of E. This will change to C by 2027 and B by 2030. It should be noted that, whilst a breach of this legislation is not a criminal offence, it results in a lease being invalidated and is subject to financial penalties of up to £150,000.
The legislation is clearly an initiative from the UK Government to ensure that the real estate sector contributes to reducing energy commission to assist the UK to becoming net zero by 2050. A number of large real estate managers have clearly had the “E” of ESG on their agendas for some time and are able to adapt to this new legislation very quickly with minimal disruption both operationally and financially, but others are not so fortunate. This can be further complicated when managers and investors have a multi-jurisdictional strategy where there is a requirement to comply with differing requirements for similar types of EPC-like legislation.
It does beg the question whether some of the larger real estate players are able to adapt quickly enough to ensure they comply with the step up in 2027.
Another challenge will be reaching out for funding and agreeing CAPEX budgets (where required) to bring these buildings up to standards, which will inevitably take time and there will be a grace period to allow for this, provided demonstration can be shown for such plans.
The sense from many discussions we have had recently with our clients and advisors is that the EPC route to building energy compliance appears to “tick the box” but does not necessarily provide the impact intending as there are several carve outs when undertaking the assessment which arguably means that the true impact of the building upon the environment is not being truly demonstrated. This is because EPC’s are a theoretical measure of energy use and only include regulated energy from the base building. The actual energy use of a building can vary greatly from what is included in an EPC rating, which is why we are seeing the market lean towards the CRREM tool and NABERS certification which both consider actual energy use for the whole building. It seems likely that we may see some sort of reform to the EPCs ratings systems in order to ensure that it has sufficient impact upon contributing to the net zero commitment and align with other measurement tools.
As is the case with all ESG matters which are fast moving, regulation will need to quickly be implemented and ensure that EPCs are not manipulated to get lease agreements over the line without real intention of bringing the building up to standard.
I sit on a number of large real estate boards and it is fair to say that gone are the days when ESG was a small paragraph in an asset/development manager report.
This topic is now seen as high priority with extensive resource being drawn to ensure the collective goal is achieved. Specifically on the EPC legislation, we are working with our clients to ensure that when consideration is being given to new leasing arrangements thought is being given to the wider impact of the EPC legislation to ensure compliance (as necessary).