ESG stands for environmental, social, and corporate governance. It is a set of standards defined by three broad pillars that can be used to guide a company’s operations – environmental governance, social governance, and corporate governance. The first pillar is focused on green and sustainability efforts, the second on the firm’s relationships with those it works with and the communities where it operates, and the last on transparency and good decision making in the firm’s activities.

 

Used in the context of the real estate industry, ESG can be used to measure the impact of building and managing homes, their place and role within a community and the increased interaction between stakeholders in the industry from the capital markets to the developers, professionals, landlords and tenants. Given the current rhetoric around climate change (and the fast increase in home running costs), ESG has become an increasingly important point of consideration for property investors in the UK.

 

Unfortunately, the build environment is a major contributor of greenhouse gas emissions worldwide, and it is no exception in the UK, where it accounts for 42 per cent of those emissions.1 To attain the “net zero by 2050” goal set out by the Paris Agreement, those who shape the build environment – which includes the property sector, of course – now find themselves at the forefront of a movement that will steer the future.

 

It is an ambitious undertaking that will require cooperation from all involved. Promisingly, it’s not only governments and regulators who have shown commitment to the cause; capital markets, developers, and even private individuals are stepping up, too.

 

A survey conducted by JLL last year that involved almost 1,000 executives, investors, and corporate occupiers found that 83 per cent of occupiers and 78 per cent of investors believed that climate risk is financial risk, while 79 per cent of occupiers expected carbon emissions reduction to be a part of their corporate sustainability strategy by 2025.3

 

JLL’s research has also found that properties with good energy efficiencies are likely to benefit from a “green premium” estimated at 12 per cent on valuation while those with the lowest energy efficiencies would likely be subjected to a “brown discount”, reducing values by up to 30 per cent in the future.3 ESG will be at the centre of the future of the industry and will impact all stakeholders.

 

Correcting Past Mistakes

Part of the problem is the age of the UK housing stock. With 20 per cent of homes built before 1919, it is one of the oldest in Europe.1 New homes are more energy efficient than old ones, but considering that 80 per cent of all homes that will exist in 2050 have already been built, decarbonising current properties is a major priority.1

The government is leading the charge for change, announcing new requirements for the Energy Performance Certificate (EPC) last year.2 The EPC is a rating for a property’s energy efficiency. It has seven grades, from A to G, with A indicating the best energy efficiency and G, the worst.2

 

Figure 1

 

Under the newly announced regulations, all rental properties will eventually need an EPC rating of C and above to be legally let, compared to the E rating required currently.2 New tenancies will be required to achieve this target by 2025, while all tenancies should meet requirements by 2028.

 

Energy efficiency in properties can be improved by upgrading a number of building features, including the windows, insulation, and heating systems. Assessors are deployed to carry out Energy Assessment Surveys, mete out EPC ratings, and suggest improvements that can be made to get the rating higher.2

 

Figure 2

 

Ensuring that a rental property has a valid EPC is the responsibility of the landlord – not the tenant. In 2025, the penalty for not having one will be raised to £30,000 from the current £5,000.2

 

The average estimated renovation cost for getting a property to a C rating is £4,700.5 To mitigate costs, landlords may apply for vouchers from the £2 billion Green Homes Grant to cover at least two thirds the cost of hiring tradespeople, up to £5,000.5 Disadvantaged and low-income homeowners may be eligible for grants that cover 100 per cent of the cost, up to £10,000.5

 

Improving energy efficiency in homes is expected to result in savings of £220 in energy bills per year on average by 2028.5 Although still some way into the future, this would seem like a bright spot that property owners, who are currently feeling more squeezed than ever by rising fuel prices, could look forward to.

 

Building a Greener Future

Decarbonising existing housing stock will no doubt be a big step in the right direction, but UK’s “net zero by 2050” target cannot be achieved without addressing the other part of the equation – developments that are being built now, which will become homes of the future, and which will set the foundations for sustainability standards down the line.

 

Some forward-looking developers have already acted. Sensing increasing investor appetite for green, social, and sustainable (GSS) bonds, London & Quadrant Housing Trust (L&Q) issued and sold the property sector’s first sterling-denominated sustainability-linked bond (SLB) in January this year. 6 The £300 million ten-year bond was oversubscribed two times.6

 

The SLB comes with three key performance indicators (KPIs): to reduce the company’s Scope 1 and 2 greenhouse gas emissions by 20 per cent by the end of March 2024; to improve energy usage in the homes it builds; and to build 8,000 new homes by the end of March 2024, 30,000 by 2030, and 100,000 by 2050.6 Half of all these homes built will be affordable housing.6

 

Figure 3

 

In a surprisingly bold move, L&Q has agreed to pay a stiff penalty of 12.5 basis points (bp) annually if it fails to meet even one of the three KPIs.6 This could potentially amount to a total of 93.75bp for the firm.6

 

Investor demand has not only propelled GSS bonds, but also better transparency in the industry. The Sustainability Reporting Standard for Social Housing (SRS) is a reporting framework for ESG disclosure designed specifically for the property sector.4 Created by a group comprising housing associations and investors, it covers 48 criteria, all based on ESG requirements, including net zero targets, affordability, and safety standards.4

 

Reporting against the SRS is completely voluntary.4 Social housing bond issuer The Housing Finance Corporation (THFC) was the first organisation to do so with the ESG performance of its borrowers.4 Its report showed that all of the housing associations it was funding met building safety and quality standards, while 95 per cent of its new builds had EPC ratings of A and B.4 The organisation took it upon itself to be a trailblazer in hopes that others would follow suit.

 

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This article is part of the One Global Labs’ 2022 UK Real Estate Report. Download the report here for more commentary on hot topics, such as inflation, generation rent, housing supply shortage and much more.

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