What is ESG?

ESG (environmental, social, governance) is used as a framework to assess how a commercial real estate portfolio manage risks and opportunities within a shifting market.

The three elements of ESG can be summarised as follow:

• Environmental: Assesses the environmental impact and environmental management.
• Social: Assesses how a property / company manages relationships and provides a suitable environment to ensure physical and mental health and wellbeing are maintained;
• Governance: Assesses a company’s leadership and management philosophy, practices, policies and internal controls.

Investing in commercial real estate with lower risk when assessed from an ESG perspective can increase asset value and lower operating costs in addition to making ite easier to comply with local, regional and national requirements.

Within this blog, we look at how improving energy efficiency can impact the ESG rating of a commercial property.

What are the Energy Targets?

Legally binding emissions reductions targets were set by the government under the 2008 Climate Change Act, updated in 2019 with a commitment in the UK to achieving net zero by 2050. With the UK’s largest industrial and commercial buildings accounting for a third of total emissions from all buildings, if these are to be met, it is likely regulation will follow within the commercial property sector.

The 2015 Minimum Energy Efficiency Standard (MEES) Regulations set minimum standards for Energy Performance Certificates (EPCs) for private rented properties in England and Wales. An EPC measures the energy efficiency of a property on a scale of A-G, A being the highest possible achievable band and G being the lowest.

The government stated, all new tenancies must achieve a minimum EPC rating of an E as of 1 May 2018. Since then, it has been confirmed that an EPC rating of B will be required to be achieved where possible by 2030 in the Energy White Paper published in December 2020.

Currently, it is planned to have a phased implementation of the regulations with an interim milestone of an EPC C rating by 2027 leading to an EPC B rating by 2030. The intention behind having an interim milestone is to encourage landlords to take action before 2029-30.

Landlords are currently not required to carry out improvement works if the cost of the changes required to meet the MEES threshold is not recoverable within a seven-year ‘payback’ period i.e, if the cost-saving of the energy efficiency improvements do not pay for themselves within seven years, they are not legally required to be undertaken.  Recent consultations confirm that the government is looking to simplify the process of working out the payback by replacing the current requirement to obtain three quotes as evidence with a simpler pay back calculator stating:

“The Government does not expect that all properties will be able to meet the EPC B requirement, but it is important that every property is undertaking improvements to achieve the highest EPC rating that a cost-effective package of measures can deliver”

The production of this calculator should make determining the required and most cost-effective improvements to commercial properties much simpler for landlords/property investors.

How can you Improve Energy Efficiency?

The Building Energy Efficiency Survey 2016 reported that 67% of energy consumption in commercial buildings was used to provide building services including lighting, heating, ventilation, cooling, and hot water. Therefore, making these factors more energy efficient could potentially produce beneficial energy-saving gains as well as improving the working environment for tenants and reducing health impacts. A few examples are provided below:

Switching to LED Lightbulbs

Lighting can consume a significant amount of power especially in commercial buildings. As such, one way to instantly save energy and make a property more efficient is by choosing LED lighting. In general, LED lights consume 70% less energy than a standard incandescent or CFL bulb.

Installing HVAC Systems

Ventilation and air conditioning are important in any commercial space to ensure that workers in these spaces are comfortable. With most workers spending a bulk of their day in the workplace, a temperature controlled environment is a primary key to maximise productivity. As such, it is clear the social aspect of commercial property can be improved with better ventilation and air conditioning, however, by installing a new Heating, Ventilation and Cooling (HVAC) system, it is reported energy saving and therefore cost benefits are noticeable.

Low Flow Water Management System

Improvement within technology surrounding water use in commercial property has led to potential capital investments with short pay back periods. Aerators for faucets, reduced-flow showerheads, and high-efficiency toilet and urinal flush valves are available. Often the payback period for the initial investment is less than a year, especially when they are used often.

What Does This Mean for Property Investors?

Jeff Roberts, Managing Director said

“We have seen over the last few years the increasing trend of our investment fund clients in becoming more ethically and environmentally conscious, taking a far more sustainable approach to their investments and considering their potential impacts.”

The key issue for freehold investors is that there is a threat of depreciation to their assets where the minimum standards are not met or properties are not considered to be providing a suitable environment for people to occupy. In addition to this, freehold investors may struggle to find new tenant landlords willing to sub-let property if it means they will need to carry out improvements, risking capital expenditure.

An additional issue is penalties. New or continued leases for commercial property which are let in breach of MEES will remain valid. However, significant fines will be issued.

From a social perspective, the built environment has a major impact on its occupiers. There is an increasing demand for the importance of people's physical and mental wellbeing to be considered when assessing commercial property. Buildings that have been designed and are operated with human health and wellbeing in mind, for example, ensuring suitable air quality, water quality, light quality are available, provide more suitable investments than those which will require further capital expenditure to bring them up to standard.  

Finally, “corporate social responsibility” (CSR) has been gaining momentum as a growing number of companies look to emphasise their commitment to environmental, social and economic goals that extend beyond their commercial activities. Climate change poses major risks not only to the environment and human health, but also to the global economic system. As the impact of climate change is increasingly felt, the environmental part of CSR is becoming increasingly important.

By ensuring environmental factors are considered when undertaking Due Diligence for property transactions, companies can demonstrate that they are considering the potential impact of their commercial decisions and making a positive contribution to society, by reducing their impact on the environment and aiming to reduce the risk posed by climate change as we move towards net zero. Furthermore, there is evidence to suggest that by being committed to improving their CSR, investors may be able to build and enhance their competitive advantage and reputation.

Summary

Within this blog we have focused on energy consumption within commercial property, and how identifying where improvements can or will need to be made has the potential to provide value when determining the risk to investment. However, many other factors including management, climate change, water use, waste management and working conditions to name a few all have a part to play in ESG assessments and improving the CSR of companies, reducing their impact on climate change and the environment.

By ensuring a property is suitable from an ESG perspective prior to investment there is the potential to increase asset value. Furthermore, by identifying where improvements can be made to the existing systems within a property, cost savings with a short payback period for the initial capital expenditure can be made.