The past 24 months have seen a seismic shift in investor behaviour, and the nature of transactions has shifted dramatically. We have seen the adoption of the EU Taxonomy, SFDR, SDR and several other new legislative shifts at EU, national, and even local levels across the EU and UK.
Our clients and partners have experienced these changes alongside inflation, cost of living crises, and the subsequent “great pause” of investment in the industry as the market reprices. We have seen vendors and purchasers changing their attitude to commercial, physical and transition risks arising from climate change and net-zero targets.
ESG has gone from being a topic on the table of contents for investment committee meetings to being a fundamental value driver. This article looks at the trends we expect to see across the industry in 2024.
1. The Increased Importance of EU Taxonomy Alignment
As central banks and regulators seek better data quality and accuracy of reporting under both SFDR and CSRD and soon also the SDR, companies and funds are asked to report on the percentage of their assets and economic activities aligned with EU Taxonomy. Moreover, we see increased demand, lower finance costs, and a value premium attached to EU Taxonomy-aligned assets.
Several surveys and physical asset enhancements are often required to align with these regulations and meet the minimum standards. Such investments are now a consideration when buying, selling and valuing assets and investments.
Most major funds and market players have already started this journey; those who have yet to will need to begin this year.
2. EPBD and the Adoption of Smart Technologies
The Energy Performance of Buildings Directive (EPBD) and associated work on introducing minimum energy performance standards based on the Energy Performance Certificates (EPC) of buildings will see older and underperforming buildings fall foul of these regulations. This will potentially make them ineligible for re-finance and disrupt the revenue model, driving a significant push towards deep renovations of buildings to improve the EPC (BER).
However, a sole focus on EPCs based on design intent rather than real-world energy usage can be problematic. Investments based on these limited data models can miss opportunities to reduce energy consumption and decarbonise buildings.
Data quality is critical when devising a meaningful building optimisation plan. Therefore, using intelligent building technologies for better energy management and reduced environmental impact will be essential for those investing in their assets.
These technologies provide real-time data that helps optimise building operations and energy use and can inform the register of opportunities necessary to improve EPCs and genuinely decarbonise buildings. Every penny spent on interventions that can improve the EPC and genuinely decarbonise a building is a penny well-spent.
3. Enhanced Scrutiny of Green Building Standards
The industry is witnessing a surge in adopting green building certifications like LEED, BREEAM, NABERs, HQE and DGNB. Properties are increasingly designed and retrofitted to meet these high environmental standards, with the goal of reducing carbon footprint and enhancing energy efficiency.
However, recent research suggests that the link between decarbonisation and Green Building Certification is not as strong as once thought. Still, the market recognises these standards as a recognised indicator of environmental performance, and they do not appear to suffer because of this scrutiny.
We recognise the value of these tools, but we would note that the “devil is in the details” and that not all scorecards are equal. Some outstanding credits can be very impactful, and others are less so. The approach should be driven by objectives and outcomes rather than achieving maximum points.
4. Increased Integration of Renewable Energy Sources
There’s a growing trend towards incorporating renewable energy sources such as solar panels and wind turbines in buildings. This shift reduces dependence on fossil fuels and aligns with the European Union’s ambitious climate goals.
We are also seeing innovative new business models from start-ups and even utility providers whereby the capital expenditure for the equipment and installation is borne by the supplier of the PV system and the renewable energy is sold to the client at a significant discount (when compared with energy from the grid).
A skills gap and poor integration of systems in this sector have become a risk factor in the industry. The rapid rate of expansion of offerings also brings data and critical infrastructure risks with it through malware attacks through vendor IT equipment.
5. Data Quality and Rise of ESG Reporting
With the dawn of SFDR, SDR, and, now, CSRD, many real estate investors and large companies are engaging in more robust ESG reporting, offering greater transparency regarding their sustainability efforts and performance. This transparency is crucial for investors and stakeholders, who are increasingly making decisions based on ESG criteria.
The issue hampering many of these companies is the quality and coverage of their data. Many clients need help capturing tenant data; in some cases, the captured data needs closer scrutiny. The use of software platforms and IoT is increasing, but even these systems require audit and review to ensure accuracy and remove anomalies. Aggregation of ESG data and tasks will become the norm with platforms such as obi® ESG.
6. Social Value and Community Engagement
We are seeing an increased emphasis on the ‘S’ in ESG, with companies focusing on social responsibility initiatives. This is because many clients struggle to generate sustainable shareholder value, especially in the social aspect. Implementing a social value impact strategy helps define the business’s culture around social responsibility and articulates its goals for social impact investing.
Another aspect we see at the asset level is social value measurement. This includes affordable housing projects, community engagement programs, purpose-built student accommodation, senior living and ensuring equitable access to amenities. Clients becoming more interested in tracking and reporting on their social value initiatives.
The rise of RESVI (Real Estate Social Value Index) and other standards allows clients to set meaningful action plans surrounding their impact on the design, construction, and operation stages of a building’s life cycle, focusing more on externalities.
7. Collaboration and Partnerships for Sustainable Goals
Increasingly, real estate companies, governments, NGOs, and other stakeholders are embracing collaborative efforts to attain sustainable development goals. These partnerships are essential in addressing complex environmental and social challenges.
We also see many partnering with social enterprises and start-ups, who can provide outstanding support and initiatives that underpin ESG commitments. The retail sector is where we have seen a significant focus on partnering, whether engaging with local suppliers and providing space for farmers’ markets or engaging with food banks and neurodiversity initiatives such as JAM Card.
These retail assets are often major community hubs, leveraging a network of partners to maximise their impact on the local community.
8. Focus on Health and Well-being
Real estate developers and occupiers are paying more attention to the health and well-being of occupants. This includes designing buildings with better air quality, natural lighting, and green spaces that promote physical and mental health.
WELL has introduced a range of accessible new standards for building managers, and Fitwel has become a recognised standard. In one of the more robust alternative investment sectors, senior living, we have recently seen the WELL Institute collaborating with the world-renowned Mayo Clinic to research ways in which we can better support occupants of buildings in later life.
This is also a significant driver for major office occupiers and technology firms, many seeking to make their offices “commute-worthy” in a post-COVID world. A compelling employee value proposition is a massive driver for investment in WELL and other standards for these firms.
9. The Increased Importance and Challenges with LCA
The construction sector has seen an increased focus on Scope 3 emissions throughout the past year, a trend unlikely to lessen in 2024. With the newest highly insulated buildings, embodied carbon is growing in comparison with operational carbon. Investors are increasingly focused on reducing upfront embodied carbon, but until recently, very few have been using the data from this analysis to make better choices about materials used in construction. We have already seen individual countries like Denmark take a more robust approach to setting limits on carbon with their BR18 regulation.
What is also apparent is the diversity of approaches being taken when calculating LCAs and the impact of the national grid on these assessments. For instance, when recently comparing a Danish asset against a similar asset in Dublin, it was noted that the Danish asset appeared to be less carbon-intensive by a substantial margin over a 60-year period. Initial assessment highlighted that the main difference was the availability of district heating (as opposed to heat pumps) and the difference in decarbonisation between the Irish and Danish grids (which was substantial).
However, closer scrutiny highlighted that BR18 in Denmark advocates the Partial Calculation Method (PCM), which omits many of the inputs one would use when performing an LCA for EU Taxonomy purposes, as was the case with the Irish building.
The difference in the calculation method was more than 30% based on the consultant’s own report. Again, this highlights that the details matter greatly when we seek to compare assets for carbon accounting purposes, and boundaries matter a great deal.
10. Investment in Biodiversity Offsetting for the Real Estate Sector
As urbanisation continues to impact natural habitats, developers and investors increasingly commit to offsetting biodiversity initiatives. This involves investing in the restoration, creation, or enhancement of natural habitats to compensate for the biodiversity impacts of their developments.
In many cases, the opportunity to invest in biodiversity initiatives onsite may be limited due to physical constraints and smaller footprints in the building’s location. This gives rise to the potential for investing in biodiversity off-setting, where small investments can have a disproportionate impact e.g. projects which focus on the rewetting of peatlands.
Off-setting has become a controversial subject in decarbonisation, as many firms initially invested in this area rather than tackling their own value chain emissions, effectively being seen to “buy their way out”. In the case of biodiversity off-setting, an argument could be made that it’s often a better option and can be conducted alongside more local investments.
From 2024 onwards, carbon offsetting and biodiversity offsetting will become increasingly important.
11. The crucial role of Sustainable Procurement and Carbon Pricing for Informed Investment Decisions
Sustainable procurement plays a crucial role for investors and property developers, influencing decision-making processes and shaping the overall sustainability performance of real estate projects. Selecting energy-efficient technologies and materials can lead to lower operational costs over the property’s life cycle, and investing in durable and resilient materials can reduce the need for frequent replacements and maintenance, resulting in long-term cost savings and a reduced carbon footprint.
In this context, an immediate connection can be seen between the role of sustainable procurement and carbon pricing, which can be used by companies as a tool to help identify revenue opportunities and risks, as an incentive to drive energy efficiencies to reduce costs and to guide capital investment decisions.
Both these practices are linked by the broader goal of integrating environmental considerations, particularly the reduction of carbon emissions, into supply chain management and promoting informed investment decisions. The combining of the two can generate different advantages, such as encouraging suppliers to improve their ESG performance, reducing products’ environmental and social impacts, facilitating access to more responsible products with lower embodied carbon, and eventually meeting the growing market demand towards greater environmental transparency and sustainability, that increasingly requires, access to products with Environmental Product Declarations (EPDs).
Conclusion
The European real estate industry in 2024 is at a pivotal juncture, with ESG factors becoming integral to its evolution. Later this year, we will also see an increased focus on corporate responsibility and due diligence with the introduction of the new CSDDD legislation.
These trends reflect a shift towards more sustainable and responsible business practices and align with the broader societal and environmental goals. Almost all the factors highlighted above are now a consideration in purchaser and vendor due diligence processes, and the demand for ESG-aligned products is becoming increasingly sophisticated.
One thing is certain, our legislative landscape is shifting rapidly, and those who stay ahead of these trends and adapt their operations accordingly will benefit in the short to medium term.
