ESG & Real Estate - now firmly on the agenda

By Paul Henson is a Partner and Head of the London Real Estate Disputes Team at Irwin Mitchell.

Environmental, Social and Governance (ESG) issues are firmly on the c-suite agenda for all businesses; and real estate is no exception. Investors and other stakeholders including employees and law‑makers are now increasingly focused on ESG performance. It is therefore incumbent on property businesses to examine what they do and how they do it – and to make sure they are appropriately positioned to succeed over the short and longer term.

In relation to the real estate sector, the “Environmental” is focused on reducing carbon emissions both during the construction process and in the physical occupation of buildings. The UK Government is looking to achieve net zero greenhouse gas emissions by 2050 and want to improve the quality of building to help achieve this. The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 established new Minimum Energy Efficiency Standards (‘MEES’) in the residential and commercial private rented sector, introduced in two phases.

From 1st April 2018, phase one of MEES regulations came into force and deemed it unlawful to let residential properties with an Energy Performance Certificate (“EPC”) below an 'E' rating. From 1 April 2023, MEES regulations will cover all commercial premises and so a landlord will not be able to let a non‑domestic property (which currently falls below the band E) unless it undertakes work to bring it up to the required standard.

The government has been busy consulting in this area and last year published an “Action Plan” on EPCs (having consulted in July 2018). It is likely to introduce gradual changes during the course of 2021 (and thereafter) but apparently recognises that enforcement of the EPC regulations has not been up to standard and we can therefore assume that more significant sanctions for breaches will soon be brought in.

It is also possible that an increase in use of EPCs might be required, including more or updated trigger points for them, so that they are no longer valid for 10 years and are required to be updated when works such as extensions are undertaken to a property. The government also wants EPCs to contain more useful information for consumers so that the recommendations they make are easily understood and implemented. In this regard, the assessment of energy performance has improved over the years to the extent that properties can easily drop a number of bands once a reassessment has been undertaken and building owners would therefore be unwise to place too much reliance on an old EPC.

The government also consulted on an extension to MEES at the end of 2019 and stressed that its preference was for buildings to be required to achieve an EPC band of “B” by 1 April 2030. It estimated that the capital investment required by all building owners to reach this trajectory is £5 billion. Its least preferred option was for a minimum EPC band of “C” by 1 April 2030 at a cost of £1.5 billion, which was not considered to be ambitious enough.

Within the consultation, the government made clear that the existing exemptions would continue. These include:  the inability for building owners to obtain third party consent to undertake the required works; the seven-year payback test; and whether the measures could significantly devalue the property. The seven-year payback test ensures that building owners are only required to make cost effective changes that can be determined on a building by building basis. This assumption provides that the saving in energy costs over the seven-year period must be equal to or greater than the cost of the required energy improvement works.

The industry is still awaiting the government’s views on the responses given to the consultation but what is clear is that building owners must now consider EPCs within their asset management strategy so that older buildings, or those who possess EPCs which are some years old, should consider the options carefully. We advise building owners to consult with their surveyors and EPC advisors at an early stage.

And what about “Social” and “Governance” issues relating to ESG real estate? Whilst there may not be quite such a comprehensive legal framework to these aspects, the societal impact of real estate is far- reaching, ranging from occupier and community relations to health, safety and security. From the social perspective, an important community asset can add great value to a local area and “placemaking” is already a well-known buzz word amongst the development community.

There is no shortage of examples of how recent events will impact on the “social” aspects of real estate: 

• when workforces return to the office, employee welfare and building design will be high up the agenda. Employees are likely to want more and better designed space to work in and there will be increased focus on hygiene and welfare offerings.
• for some sectors, workspaces might be smaller and re-imagined as more of an opportunity for collaboration, as it has been proven that much of the “day job” can successfully be done from home.
• the pandemic has led to an increase in insolvencies and vacant premises. Might we see pressure on landlords to put empty premises to greater societal good? As we recover from the turbulent events of the past year, will there be a societal demand for landlords to exercise forbearance even after legislative restrictions on their enforcement rights are lifted?;
• Issues arising from remediating building cladding will remain on the agenda for some time to come.

In terms of Governance, this relates less to physical real estate and is more focussed towards the way in which real estate businesses are led and might affect the choice of party that a business contracts with. There is an increased expectation on the part of investors, employees, customers and other stakeholders that a business should conduct itself in a transparent, fair and lawful manner. Demonstrating a good performance on issues such as diversity and the gender pay gap is likely to contribute to a business’s success and thus its appeal to investors.

What is clear is that ESG issues are not going away and given the importance they hold in the eyes of government, investors, employees and other stakeholders, those in the real estate world would be wise not to ignore this and to embrace the current trend.

This article first appeared in CoStar on 25 February 2021.