Prioritising sustainability in the real estate sector

Today at COP26 is the first time that the conference has had a day dedicated to the built environment amid growing concern that the sector, which is responsible for around 40% of greenhouse gas emissions, has been neglected in the push to tackle climate change. If we are to make the successful transition to net zero, we must dramatically reduce the environmental impact of buildings and how they operate. The lifecycle of buildings and their embedded carbon footprint are critical elements of the circular economy, where design for flexible use and the use of sustainable construction materials needs to be fully embraced. Without sufficient action, many significant players in the real estate sector will find themselves with stranded assets.

Post-pandemic, the real estate sector has shown significant appetite to create greener buildings and communities, and to embrace the opportunity to build back better. A significant proportion of investors, funders and occupiers have set challenging targets for the green credentials of the buildings they will create, finance and occupy. That sounds positive, but is their ambition matched by reality?

To understand the potential mismatch, it is worth looking at the motor industry. The target to phase-out the sale of all new petrol and diesel cars by 2030 sounds just as positive as the proposed rachet on energy efficiency performance standards by 2030 to ensure rented commercial real estate achieves an EPC rating of at least 'B'. There is no doubt that achieving this will be a huge milestone in reducing UK transport emissions.

But if you take a look at vehicle numbers and the continuing sale of petrol/diesel cars this reveals a somewhat less-rosy picture. There are around 32 million of these cars on our roads today and there will be many millions more rolling onto the roads between now and 2030. We see headlines that second-hand car prices are being driven up due to the huge demand for – and the reduced supply of – new cars. Some believe that there will even be a run on new petrol/diesel cars towards the end of the decade as drivers rush to get their hands on a new car for the last time. The average life of a car before it is scrapped is 14 years, so these vehicles could be responsible for tail pipe emissions for many more years.

Schemes will be needed to scrap existing cars (taking into account economic and environmental costs) and support the move to zero emissions vehicles. Added to that is the need to invest in the infrastructure to create a functioning nationwide electric vehicle charging system, including the need to boost green power supply to the electric grid.

2030 is less than a decade away and stakeholders need to quickly take hold of the challenge, create and implement the relevant schemes and tackle the central question: “who will pay for it all?”

Parallel problems exist for real estate. As we all know, the green agenda is now mainstream. Having an agenda is one thing. Having a plan is another. But successfully delivering that plan is something else entirely.

In real estate, we see two major challenges. The first is that, while there is great hunger to invest in, finance, build and occupy greener buildings, there is simply not enough of a pipeline: demand far outstrips supply. Savills Research estimate that over 1 billion square feet of office space in the UK is below the proposed minimum EPC 'B' rating. That will require substantial investment to change. As with cars, how long will that take and who will pay?

Secondly, there is a conflict between landlords and tenants over who is responsible for what, and who pays. This was vividly brought into the public consciousness after the tragedy of the Grenfell Tower fire, when the question over who was legally responsible to pay for the costs of remediating cladding was anything but clear.

In theory, there is clear alignment in desire from both landlords (including investors and funders) and tenants to create greener buildings: landlords want to boost the green credentials of their buildings, and tenants are looking for buildings to occupy that chime with their own sustainability targets and commitments. However, this alignment may lead to arguments over who should pay, particularly where the benefits between owner and occupier are shared.

Some of the key issues to consider include the impact on the value of properties which fall below energy performance standards, the risk of stranded assets, lending restrictions and insurance premiums, how required improvements will be funded, and what policy and financial frameworks are needed to support investment.

Any organisation which is serious about the climate-related risks and opportunities for their business will need to measure, assess and disclose energy usage and carbon emissions from their buildings and implement a portfolio-wide decarbonisation plan. This will require the real estate sector to improve its data gathering, governance and data processing in order to increase trust and to minimise false or misleading claims about green credentials. We recognise that gathering that information is particularly challenging for occupiers and landlords, and green lease provisions are continuing to evolve to meet this requirement, but much more needs to be done.

We are helping clients to navigate the transition by identifying impacts and advising on risk mitigation and asset optimisation strategies. This includes:

• the investment in and financing of transformative opportunities, including drafting contractual mechanisms and negotiating the full range of property and financing documentation needed;

• strategies in relation to sustainable/green finance products and the application and impact of regulatory change and enforcement on owners, lenders and occupiers;

• tax structuring for optimising investment into sustainable real estate and infrastructure projects;

• the legal challenges of data collection and storage;

• updating green lease drafting to encourage and drive more meaningful change.

Ultimately, the real estate sector is now under significant pressure to meet emissions reductions targets as part of the integrated decarbonisation of transport, buildings and energy systems. This work is well underway and can be seen in the work we do with clients advising on planning policy and sustainable development schemes, the integration of new construction methods and building management systems in construction contracts, the rollout of extra low voltage (ELV) infrastructure and renewable energy supply, and retrofitting existing commercial building stock. Together with our clients, we are ready to help match ambition with reality and lead the real estate sector’s transformation.