In Europe, the key initiative for the coming years is the European Green Deal, a strategy aimed at achieving climate neutrality by 2050. One of this project’s milestones occurs in 2030, when the European Commission expects to achieve a net reduction in greenhouse gas emissions by at least 55% compared to 1990.
European Union law
The real-estate sector is crucial to the successful implementation of the Green Deal.
The most important EU regulations in this respect include the Energy Performance of Buildings Directive (2010/31/EU) and the Energy Efficiency Directive (2012/27/EU), both revised in 2018-2019 as part of the “Clean Energy for all Europeans” package. Directives include measures to achieve highly energy-efficient building stock while improving the quality of life in Europe.
Some of the key measures still to be implemented are:123:
- By 25 January 2025, all EU member states must establish requirements regarding the minimum number of electric-vehicle charging stations at non-residential buildings with more than 20 parking spaces (excluding buildings occupied by SMEs)
- Smart technologies are promoted, as are solutions that support the health and well-being of building users
- EU member states must adopt long-term renovation strategies aimed at decarbonising existing building stock by 2050.
The main catalyst for changes in the real estate market is the EU legal framework. Nevertheless, investors’ needs are equally important for the industry’s sustainable development.
The annual GRESB assessment (the global ESG benchmark for property companies, funds and investors) confirms that transparency in mitigation risks associated with ESG in the real estate industry is gaining significance4. A total of 1,520 entities participated in the 2021 assessment; the benchmark now covers nearly 117,000 assets. This is more than double the number encompassed in the 2015 survey5. Even in 2020 during the COVID-19 pandemic, participation in the assessment increased by more than 20% compared to the previous year, proving the growing need for transparent ESG information in the industry.
According to investors, granted certificates can boost a building’s attractiveness, as they bring transparency and standardisation to the transaction. Certificates provide an independent, third-party assessment that is based on common and understandable definitions and standards.
Attractiveness to tenants
Tenant demands are directly associated with risk level. Lease agreements of the best commercial properties usually last between five and ten years. Therefore, a property’s ability to attract credible tenants not only in the near future, but also over the long term, is crucial for investors. Assets that don’t keep up with the market and that are not environment- or user-friendly are riskier, as they involve properties in danger of being marked by a lower level of commercialisation.
Reduced reputational risk
As a result of changes in business models, a growing number of tenants are avoiding buildings that don’t meet the required environmental standards. Similarly, some investors also avoid tenants who might negatively affect the environment, employees or broader society. Close association with ‘risky’ entities can damage reputations.
Impact on property values
At present, there are no valuation standards considering ESG aspects as an individual factor affecting a property’s value. European Valuation Standards (EVS 2020) point out that the above do not exist in isolation and therefore don’t intrinsically affect the value. However, they overlap with other factors, and they do have an indirect impact on value6. For instance, high-energy efficiency is typical for modern buildings equipped with energy-reducing systems and ensuring effective access to daylight. This, in turn, creates a more friendly working environment and makes the space more attractive to tenants, who are willing to pay higher rent. This leads to an increase in the property value. Lower energy consumption also translates into lower operating expenses, which also positively affects the property value.
In its Valuation and sustainability section, EVS 2020 appears to contain something of a warning to valuers when it comes to being guided by trends or subjective feelings. The valuer should base an opinion of the property value on market evidence reflecting the experience of market participants7.
EVS 2020 also points out that sustainability issues may be more important for a particular class of market participants (the so-called early adopters) because of either their internal policies or their activity strategies. Therefore, valuers will need to evaluate when these issues will reflect the common behaviours of typical market participants (as demanded by the market value definition). Until then, the ESG-related assumptions included in valuations may lead to the assessment of an individual value reflecting the specific conditions of the particular investor.
Despite this, EVS 2020 already describes the concept of ‘green value’8, but stipulates that this concept has not yet been unified and grounded. Currently, it is understood as a market value component created by sustainable-development factors.
Similar to TEGOVA, RICS9 also states that even though valuers need to reflect market conditions (and not create them), they should be aware of implications that sustainability issues may have on the real estate market over the short, medium and long terms10.
Over the longer term, investing in green buildings may be associated with lower risk and reduced operating costs, translating into potentially higher rental income, lower operating expenses and lower yields, resulting in higher value.
Overall, there is no doubt that ESG is becoming a permanent trend that in the coming years will be a central factor driving changes in the real estate market both locally and globally.
1Directive 2010/31/EU of the European Parliament and of the Council of 19 May 2010 on the energy performance of buildings, art. 9, point. 1
2Directive (EU) 2018/844 of the European Parliament and of the Council of 30 May 2018 amending Directive 2010/31/EU on the energy performance of buildings and Directive 2012/27/EU on energy efficiency, art. 2a, point. 1
3Directive 2012/27/EU of the European Parliament and of the Council of 25 October 2012 on energy efficiency amending Directives 2009/125/EC and 2010/30/EU and repealing Directives 2004/8/EC and 2006/32/EC, art. 5, point. 1
4Formerly Global Real Estate Sustainability Benchmark
6European Valuation Standards 2020, TEGOVA, III Valuation and Sustainability, point 5.23, page 218 (EVS 2020)
7EVS 2020, III Valuation and Sustainability, point 5, page 214 (EVS 2020)
8EVS 2020, III Valuation and Sustainability, point 5.16, page 217
9The Royal Institution of Chartered Surveyors
10RICS Valuation – Global Standards, VPGA 8, point 2.6 Environmental matters, c) iii), page 112