ESG strategies and workforce expectations to shape real estate decisions

ESG is increasingly driving real estate decisions

The move towards more efficient buildings comes not only from the introduction of tighter regulatory standards and disclosure requirements from policymakers around the world, but also through occupier preferences. That is one of the key takeaways from this year’s Knight Frank (Y)OUR SPACE report, which canvassed the opinion of 640 commercial real estate leaders globally.

Some 93% of survey respondents said their company's ESG strategy and/or commitments would influence their real estate decisions over the next three years, up from 85% in 2021. Of these, half said it would have a moderate impact on decision making. A fifth said it would influence them to a great extent.

Arguably, we are already seeing this shift with transactional data pointing to a dichotomy in investment markets between 'the best' green buildings and ‘the rest’, with a flight to prime quality stock. This will be driven even further by shifting tenant demand. Of those surveyed, 15% stated that at least half of their existing portfolio has an environmental/sustainability accreditation. In three years’, this is expected to rise to a quarter. A similar 13% have between a quarter and half of their portfolio with an accreditation which is expected to rise to 23% in three years' time.

Real estate plays a key role in talent attraction

Talent retention plays a key role in this flight to quality and sustainable spaces, with survey respondents stating that real estate was strategically important in this regard. With office occupancy at around 40%, compared to 65-70% pre-pandemic, better quality and more appealing office space is important not only in attracting new talent, but also in bringing existing staff back to the office. As part of raising the appeal, corporates are focusing on the provision of wellbeing amenities with over half expecting their staff to demand facilities to support mental wellbeing, 44% expecting gym facilities to be a required provision and 34% needing cycle storage and facilities.

One way to demonstrate a building's ability to support wellbeing is through the WELL and Fitwell building certifications. For Fitwell, the US leads with 964 projects followed by Canada (95) and the UK (87), Brazil and Taiwan round out the top five with fewer than 20 projects each. We also crunched the numbers of the number of WELL projects, which number around 47,000 globally, and found that again the US leads with 56% of these projects, followed by Canada, Mexico, the UK and China. When looking at types of spaces, retail dominated with more than 40% followed by offices with around a third. To uncover the density of office projects per employee we crunched the numbers, shown below, where the Bahamas leads with 0.06 WELL certified projects per 1000 workers.

The ongoing regulatory challenge driving construction activity

We've covered the scale of the challenge posed by potential changes to minimum energy efficiency standards (MEES) previously, and Deloitte's latest Crane Survey notes that the level of construction activity is rising in London due to regulatory pressures. The report also notes that due to lack of clarity around how to achieve net zero, and anticipated minimum standards, developers are targeting wider ESG standards (such as BREEAM, NABERS, WiredScore, etc.) and promoting their benefits.

Outside of the capital, our M25 report takes a closer look at offices in the South East where 54% of office space ?is expected to fall short of the proposed 2027 MEES requirement of an EPC rating of C or above, rising to 80% for the proposed minimum EPC B by 2030. Whilst these dates are some way off, both fall into the typical lease length for an occupier or hold period for an investor.

To meet regulatory minimums, upgrade or remedial work will be required. Due to the growing focus on carbon reduction, retrofitting will grow as a preferred route to market for developers. A recent study comparing new build, conversion, and refurbishment found that embodied carbon emissions from refurbishment were at 2.1%, conversion at 10.3% and new build at 27.9% - 31.3%, illustrating the significant difference between adaptive reuse and new development.?With build costs and labour costs having risen significantly in recent years economic factors may prove restrictive for retrofits.

It is not just the office sector that faces a huge regulatory hurdle

Many have written about needing to implement minimum energy efficiency standards across all of our housing stock – with the most recent call for a minimum of EPC C by 2033. Our latest analysis finds that more than half (56%) of residential properties in England fall below the potential minimum of EPC C.

On average, over the past five years, some 148,000 properties increased their EPC rating with only half meeting the required C grade or higher. If this rate were to continue it would take over 200 years to bring the entire housing stock up to the minimum standard. To meet a 2033 deadline, 5% of the UK's total housing stock needs to be upgraded annually; that's 1.4 million homes each year.

There will, of course, be exemptions. Listed properties, for example, despite the fact they are often among some of the least efficient housing stock. Around 198,000 residential properties in England, or fewer than 1%, are listed. When we examine EPC ratings, 91% have an EPC of D or below, with less than 1% rated EPC A or B. With cost a hurdle facing those requiring upgrades, there is an added layer of complexity and possible cost depending on the permissions required for listed homes.

The Department for Energy Security and Net Zero (DESNZ) is looking to incentivise homeowners with lower mortgage rates when they take steps to improve their homes energy efficiency. They announced ￡4.1m to go to 26 innovative green finance projects, delivered through the Green Home Finance Accelerator scheme.

On a very sobering note…

There is now a 66% chance we will pass the 1.5C global warming threshold between now and 2027 according to a recent report by the World Meteorological Organisation. Whilst this doesn’t mean we have crossed the threshold set by the Paris Agreement in 2015, temperatures would have to stay at or above 1.5C for 20 years for this, it offers a glimpse of what that could look like. Crucially for real estate owners and operators this provides a warning that for longer-term planning, mitigation strategies should include temperatures higher than previously thought.

What else I am reading

After writing last month about record high emissions, one firm says those from electricity generation could have peaked in 2022, this comes as wind overtook gas as the dominant source of electricity for the first quarter in UK?- a "huge milestone", the New York city building capturing carbon, New Zealand Green Building Council launches a carbon calculator and the ￡130m green loan for student homes.

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