Q&A Nuveen Real Estate: ‘Repricing is a chance to speed up net-zero refurbs’

At a time of falling property values, high inflation and ongoing economic uncertainty, how are real estate companies approaching their ESG goals? In an interview with PropertyEU, Abigail Dean, global head of strategic insights at Nuveen Real Estate, shares her views on where the sustainability agenda is headed.

What are the biggest ESG challenges facing investors this year?

Abigail Dean: With real estate values going through a price correction, the percentage of value that needs to be spent on transforming buildings to net zero will go up and this may make it more difficult to justify the level of investment required in some buildings.

This will be particularly challenging for core investments where significant capex isn’t necessarily in the business plan, and in sectors and locations where the investment necessary will only protect existing value, rather than enhance it, i.e. where there is a brown discount as opposed to a green premium.

That being said, there will be potential opportunities for value-add investors to acquire real estate in need of transformation. In addition, balancing the growing requirements for regulatory and voluntary reporting alongside the need for ambitious implementation will present resource challenges.

Meanwhile, there is a growing need to focus on social issues and also to address biodiversity and nature positivity – particularly in light of the forthcoming Taskforce on Nature Related Financial Disclosure framework and the COP Montreal Biodiversity Conference which set a 2030 goal to ‘take urgent action to halt and reverse biodiversity loss’. Real estate has been very focused on carbon so far and the need to consider biodiversity and social issues more deeply will present skills, knowledge and resource challenges.

Will the economic downturn impact industry efforts and financial resources in achieving ESG targets?

Abigail Dean: Conventional wisdom suggests that sustainability is ripe for cuts when businesses reduce costs. The Global Financial Crisis of 2008 saw momentum slow for ESG innovation in real estate and there are signs that we may see something similar ahead. A recent study conducted by KPMG found that about half of CEOs surveyed ‘are pausing or reconsidering their existing or planned ESG efforts in the next six months’.

This comes at a time of emerging scepticism toward ESG from some investor groups, notably from US states with a higher dependence on the traditional oil and gas industry. This is a limitation on the ability of the finance industry to take ESG factors into account. However, there are good reasons why ESG is likely to remain a priority – particularly for real estate investors:

  1. ‘Climate risk is investment risk’: the mainstreaming of ESG

It is hard to compare the ESG world now to that of 2008. ESG roles have been integrated into governance structures and there has been a leap forward in the understanding of the link between climate risk and investment risk. Now that the costs of transforming buildings to be net zero carbon (NZC) have started to be incorporated into underwriting, they cannot be ignored.

There is also a greater body of data to show that ‘greener’ buildings tend to outperform. NCREIF office returns data shows outperformance for LEED Platinum buildings over 1, 3, 5 and 10 years. Both JLL and Knight Frank have identified a rental premium of 10%-12% for London office buildings rated as Outstanding by BREEAM.

This growing evidence of a price premium associated with green buildings will help to give more confidence to investment managers that investing in green improvements can deliver a return. The valuation community is taking an active interest and is aware that factors such as NZC stranding risk and green building certification are featuring more heavily in underwriting and investment decision-making. We should therefore expect that as soon as the market signals are strong enough, this will be factored more meaningfully into regular appraisals.

  1. Repricing is an opportunity to accelerate NZC transformation

Assets that do not meet current ESG standards are likely to be repriced, given the level of investment that refurbishment to a NZC standard requires. We expect to see a bifurcation in the coming price correction, with higher quality, sustainable buildings holding their value better, and this trend being strongest in Europe. The transformation of well-selected buildings into NZC assets, particularly in locations where demand outstrips supply, represents a strong opportunity to add value.

Looking to the social element of ESG, a recession also favours asset classes that specifically cater to those in financial need, such as affordable housing.

  1. Regulation will drive the ESG agenda forward

A wave of recent and forthcoming regulation makes it virtually impossible for businesses to walk away from their ESG agendas. The Sustainable Finance Disclosure Regulation (SFDR) in the EU, the Monetary Authority of Singapore (MAS) Guidelines on Environmental Risk Management (EnRM) for

Asset Managers, the Securities and Exchange Commission’s proposed climate disclosure requirements in the US and the forthcoming Sustainable Disclosure Requirements (SDR) in the UK all set out stringent transparency requirements.

This combines with a raft of building regulations across the US, Europe and Asia-Pacific that ramp up the energy efficiency requirements for buildings in the coming decade. These factors, combined with the reputational damage that would undoubtedly accompany a step down on ESG commitments, mean that ESG is likely to remain a significant focus area for real estate investment.

Is the industry ready for new ESG regulation and what is its effect likely to be?

Abigail Dean: SFDR has presented real challenges for the real estate industry, but these have largely been related to the fact that some elements have been open for interpretation and not always easily applied to real estate investment. For example, how to define a sustainable investment and how to apply the regulation to investments outside of the EU when the regulations make specific references to EU standards such as EPCs and NZEB.

As we move into the reporting phase of the regulation and as more information sharing takes place, these issues should hopefully be overcome through industry engagement and sharing of best practice.

It should be noted, however, that as different jurisdictions start to release ESG disclosure regulations, there is a risk that these might contradict each other, placing entities that are subject to multiple sets of regulation in a difficult position.

The ongoing effect of these regulations is likely to be an acceleration of the upskilling of compliance, accounting, investor relations and reporting teams across the industry to develop a better appreciation of ESG and for ESG to become a more significant part of their role functions. The regulations are also driving greater visibility and transparency of ESG issues across the industry and seem to have fed into a greater demand for ‘green’ product.


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