The built environment is responsible for 40% of global greenhouse gas emissions, placing the real estate sector at a crucial crossroads. Proactive adoption of Environmental, Social, and Governance (ESG) practices could shape the future of real estate, enhancing its growth and resilience while contributing to a sustainable world.
Understanding ESG: What It Means for Real Estate
Let’s break down what ESG entails:
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Environmental: This focuses on enhancing property resilience and sustainability through initiatives like energy efficiency, waste reduction, and decarbonisation.
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Social: This aspect considers the impact properties have on communities and the well-being of occupants, emphasising health, safety, engagement, and diversity.
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Governance: Governance ensures accountability and transparency, fostering ethical behaviour and solid stakeholder relationships.
Current Trends in ESG for Commercial Real Estate (CRE)
ESG is no longer just a buzzword; it’s becoming integral to CRE capital markets. Here’s what’s happening:
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Surging Investment: Capital for impact funds skyrocketed from $2.6 billion in 2019 to nearly $34 billion in 2022. North America accounted for 53% of this fundraising.
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Sustainable Returns: In 2023, median returns for sustainable funds reached 12.6%, almost 50% higher than traditional funds.
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Green Goals: Of the 100 largest Real Estate Investment Trusts (REITs), 70% have set environmental sustainability targets, with over 80% owning certified green buildings.
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Legislation and Demand: Tenant requirements and laws are driving positive change. A projected 310 million square feet of net-zero carbon space is needed, yet only 23 million square feet is currently available.
ESG as a Value-Add Strategy
Implementing ESG strategies in real estate can yield significant financial benefits, such as:
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Cheaper Financing
- Fannie Mae Green Financing can alleviate the financial burden of sustainability initiatives.
- The Inflation Reduction Act (IRA) allocates $20 billion to support green practices.
- The Net-Zero Banking Alliance aims for net-zero emissions by 2030.
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Incentives and Tax Credits
- The IRA boosts sustainable practices with tax credits like the Investment Tax Credit (ITC), now capped at 70% of costs.
- Production Tax Credit (PTC) offers up to $30 per MWh for clean energy generation.
- The 179D ceiling has increased from $1.88 per square foot to $5.
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Reducing Operating Expenses
- Deep retrofits can lower energy use by up to 79%, cutting utility costs.
- Insurance premiums, which surged by 32% in 2023 due to natural disasters, can be mitigated through public and private incentives.
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Green Premium
- A Lasalle survey shows a 5%-15% green rental premium, with some cases reaching 45%.
- Significant premiums are observed in markets like New York (28%) and London (19%).
Opportunities for Growth
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Green Financing Options
- C-PACE financing can cover 100% of eligible sustainable improvements at competitive rates (7.5%-8%) over 20-30 years.
- Payments are added to property tax bills and are transferable upon ownership change.
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Tailored Green Retrofits
- Customised strategies yield better energy savings: 74%-79% in colder areas vs. 58%-64% in warmer climates.
- Innovative technology, such as coated glass, can reduce energy use by up to 12%.
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Building Certification
- WELL-certified offices correlate with higher employee satisfaction.
- Certified buildings can benefit from tax credits (up to $5,000 per unit) based on third-party certifications.
Final Thoughts for Investors
There’s a growing demand for real estate investors to engage in sustainable practices and ESG initiatives, presenting a profitable value-add investment strategy.
Key actions include:
- A thorough understanding of the underlying asset and investment horizon.
- Rigorous due diligence and financial analysis for risk assessment.
- Knowledge of available financing vehicles and incentives.
- Tailored business strategies for specific assets and portfolios.
For family offices and investors lacking in-house expertise, collaborating with external advisors with a proven track record in real estate investments and ESG knowledge can be invaluable.
In conclusion, the integration of ESG into commercial real estate isn’t just a trend; it’s a vital component for future success, sustainability, and profitability.
