By Michał Grabara, director, Capital Markets, Knight Frank
ESG has become a key factor in investment decisions, so in order to better understand the impact of this area on capital markets, in June 2023, Knight Frank conducted a survey of 45 asset managers worth almost £300 billion, focusing on the UK and continental Europe. Here are the key findings:
- 100% of our investor sample stated they employ green leases, with 36% of them linking remuneration to ESG targets.
- 77% have minimum environmental certification criteria for new acquisitions. Of those respondents targeting EPCs (Environmental Performance Certificates), over 50% require a minimum B rating.
- 74% currently use CRREM (Carbon Risk Real Estate Monitor) to analyse their existing portfolio; more than half require CRREM analysis as part of acquisition due-diligence.
- 58% of the sample are actively looking to acquire poor ESG-performing Assets to improve/upgrade and reposition.
- 44% own or are developing a NABERS-rated building (National Australian Built Environment Rating System).
ESG – corporate actions focused on the environment, social responsibility and corporate governance – are key in all asset classes; real estate is no exception.
It is well known that buildings are responsible for around 40% of global carbon emissions. As a result, it is becoming a firm objective for international organisations and local authorities to introduce regulations to reduce the operational and embedded carbon footprint. Now, the operational carbon footprint is the emissions associated with the operation of the building and the resulting energy consumption. The embedded carbon footprint is related to material flows in the life cycle (during construction or remodelling or demolition processes).
Across the EU there are similar regulations coming into force. The European Performance of Buildings Directive has staggered targets, with a minimum EPC of D by 2030, and all buildings to be net-zero emissions by 2050. However, stringency and adaption varies from country to country. For example, in the Netherlands, all office buildings are required to have a minimum EPC rating of C from 1 January 2023. Latest available data shows that 10% of offices fall short, rated EPC D or below, and 30% have no energy label but will need to comply or risk facing a fine.
We see that tenancy in the pursuit of sustainable construction is key. Indeed, tenants’ appetite has shifted towards more sustainable and healthier buildings. This can be attributed to internal company policies that are based on sustainability, as well as the needs to recruit and retain talent. Our latest (Y)OUR SPACE report includes responses from more than 300 global tenants showed that almost all respondents said that their ESG strategies and commitments will influence their real estate decisions over the next three years.
Focusing on those 45 investors that we surveyed about ESG and their property investments, here are some more crucial findings:
Of those surveyed:
- The investor mix was 64% investment managers, 16% listed property companies and 13% funds; the remainder included private investors, private equity groups, private property companies and local authorities.
- Three quarters of those surveyed considered ‘Core Plus’ investments, 56% targeted ‘Core’ and 51% had ‘Value-add’ business plans.
- 60% stated their primary sector of focus was offices.
- Some 62% invest across Europe with only a fifth focusing solely on the UK.
- The capital surveyed represents a global investor base. When asked what nationalities their capital represented, 58% stated that their funds included capital from mainland Europe, 38% represent UK capital, 29% represent North American and 24% cited Asian-Pacific capital.
- 40% of surveyed investors had £10 billion or more in assets under management.
Improving the performance of the estate is a key objective of the…
Three quarters of the investors surveyed said they want to improve their portfolios through refurbishment and repurposing. In addition, 58% would like to purchase underperforming assets under ESG to upgrade them. Several investors have launched so-called impact funds to help make this a reality. A further 22% of investors surveyed plan to sell assets with poor ESG performance in favour of acquiring those that can be described as ‘green’, with this figure rising to 40% among ‘Core’ investors.
… towards zero net emissions by 2030
Of the investors who have pledged a net-zero emissions target, one has already achieved this goal, 41% have committed to do so by 2030, 15% are aiming to achieve it before 2040 and the remainder are targeting 2050.
Minimum environmental certification a key ESG metric for new acquisitions…
77% of surveyed investors have minimum environmental certification criteria. Of those targeting EPCs, more than 50% require a minimum B rating, the proposed minimum energy efficiency rating in the UK from 2030. Similarly, 47% require BREEAM ‘Excellent’ or ‘Outstanding’ ratings.
… and 44% of investors surveyed require alignment with the Sustainable Finance Disclosure Regulation (SFDR) for new acquisitions, and 42% require EU Taxonomy compliance
ESG reports to be compliant with the EU Taxonomy, CRREM and the EPC Pathway report, which is becoming equally important as part of the due diligence process for investors buying existing properties. This is highlighted by the majority of investors already demanding alignment with the SFDR or the EU Taxonomy. The SFDR aims to achieve greater transparency on how to analyse risks to sustainability that occur as part of the activities of financial market participants.
Strong use of CRREM among investors
74% of surveyed investors currently use CRREM analysis, to assess the exposure of assets to stranding risks based on energy and emission data and the analysis of regulatory requirements. This will enable investors to design and implement the best strategy to minimise risk and move towards net zero goals. In addition, more than half require CRREM analysis before a new acquisition to understand the asset’s impact on overall portfolio performance.
Nine out of ten of those surveyed have social-based targets…
Wellbeing in the workplace is a goal for 73% of the investors surveyed, whilst almost 60% target community engagement initiatives and 46% are pursuing investment into local public realm and facilities. These could include amenities for physical and mental wellbeing, such as cycle facilities and support networks, both are amenities which occupiers expect employees to require according to our latest (Y)OUR SPACE research.
…with the majority aided by in-house expertise
87% of the investors surveyed stated that they have a dedicated in-house ESG team, with 44% saying that the team consists of five or more people. Size matters as all surveyed investors with £10 billion or more in assets under management have an in-house ESG team, whereas only 77% of those with £500 million to £5 billion do. This level of expertise is likely to increase ESG due diligence on new acquisitions as well as reporting for disposals.
100% of surveyed investors stated they use green leases as a way to realise ESG targets
The Better Building Partnership (BBP) defines a green lease as a “standard form lease with additional clauses included which provide for the management and improvement of the environmental performance of a building by both owner and occupier(s).”
With investors agreeing that green leases are a way to realise ESG goals, these are likely to become even more commonplace and standard across the industry. When asked what provisions they include within these leases, 97% selected energy/water/waste data-sharing, which is the minimum recommendation from the BBP. Around seven in ten look to have smart-building technology that can aid data collection and maximise efficiency through, for example, monitoring and automated systems for heating, cooling and lighting. Almost two-thirds include restrictions on alterations which may adversely impact energy-efficiency ratings.
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