ESG Club
PI Partnership – M&G Investments
ESG IN REAL ESTATE DEBT: FUNDING THE TRANSITION TO NET ZERO?
Recent turmoil in the banking sector has further highlighted the role real estate lenders can play by stepping in to provide capital for borrowers as banks retreat, while potentially delivering a stable, long-term source of income. With many lend- ers now gravitating towards high quality assets with strong ESG credentials, we consider what role real estate debt can play in funding the transition to net zero.
Duncan Batty and Dan Riches are directors of real estate finance at M&G Investments.
The built environment is responsible for around a third of global emissions, the majority of which stem from building operations¹. As momentum behind sus- tainability in real estate continues to gain pace, lenders can play a key role in how the sector evolves as it strives to meet net zero goals.
In the EU, where almost 75% of building stock is energy inefficient, real estate is the single largest energy consumer, with heat- ing, cooling and domestic hot water ac- counting for 80% of the energy consumed by citizens². The European Parliament adopted measures earlier this year to re- duce real estate energy consumption and greenhouse gas emissions, while increas- ing the rate of renovations to improve existing standards³. Currently only 1% of existing buildings in Europe are renovated each year. New developments will have to be carbon neutral from 2028 onwards.
Substantial renovations are necessary across geographies to improve existing real estate stock and reduce energy loss.
In the UK, real estate accounts for 40% of total energy use and around a third of emissions⁴. The government has laid down ambitious plans designed to spur a ‘green revolution’ in real estate, requiring all homes and businesses to meet rigorous targets in order to lower energy consump- tion. Indeed, policies are already obliging developers, landlords and occupiers to focus on the environmental performance of buildings.
36 | portfolio institutional | October 2023 | Issue 127
Addressing energy efficiency in real estate Regulations setting out Minimum Energy Efficiency Standards (MEES) are making it increasingly unlawful to rent properties that do not meet the Minimum Energy Performance Certificate (EPC) require- ments, bar some exemptions, with land- lords facing serious sanctions for non- compliance. This means lenders will also have to navigate the changing regulatory landscape and consider ESG criteria when deploying capital. Currently, non-domestic buildings in England and Wales need an EPC rating of E or higher to be viable for lease. From April 2030, rented properties will be required to have at least a B rating. This poses a significant challenge for the real estate sector given that the vast majority of existing commercial stock in England and Wales – around 64% – falls below the B threshold for energy performance⁵. In real terms, over half a million individual assets need to be compliant with MEES within the next seven years⁶.
In Europe, a set of standards and accom- panying technical reports have been established to support the energy perfor- mance of buildings standards, with the European Commission aiming to reach the target of at least a 60% reduction in emissions in the building sector by 2030 compared to 2015, and achieve climate neutrality by 2050.
Although there is little guidance on the level of capital required to decarbonise non- domestic assets, it will be a costly endeav- our. Substantial renovations are necessary across geographies to improve existing real
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