ESG in the Construction Sector

The Greater London Authority (GLA) moved from Foster’s City Hall to Siemens’ ‘The Crystal’ last month. The eco-friendly alternative features triple-glazed windows, rainwater harvesting capabilities and roof-mounted solar panels that are responsible for 20% of its electricity generation. The structure facilitates ubiquitous natural light which reduces the need for artificial sources. Whilst this move is likely to be consequential of the financial burdens bequeathed by the current pandemic, it is impossible to ignore the proposed savings plan advocated by Sadiq Khan, given that The Crystal should ensure aggregate savings of £126 million over next 10 years.

Ecological Real Estate and Construction is climbing the corporate agenda; no longer is it just perceived to be a market niche nor mere regulatory precondition, but sustainability is now considered a commercial imperative for many industries, inducing both financial and moral dividends. This eco-shift is likely to be consequential of the growing pressures of climate change: buildings account for the largest share (40%) of EU energy consumption, whilst producing around 35% of total greenhouse gas (GHG) emissions. Currently, at a regulatory level, a building must achieve a minimum EPC energy rating of E so to avoid being rendered unlawful, which is likely to impact both the rental income and value of a property, and the government is looking to raise this to at least a C, if not B, by 1 April 2030.

These tighter regulatory legislatures are likely to catalyse a considerable shift in both construction practices and subsequent investment targets. Research earlier this year from JLL showed that sustainable buildings can have increased rental value of 6-11% and prompt lower void periods; both renters and buyers in search of new offices stipulate cost-effective features and are willing to pay more in the short term to guarantee long term value. This is because many are becoming increasingly aware that traditional buildings with lower green ratings are synonymous with a ‘brown discount’, which are predisposed to expensive running costs and augmenting depreciation, the latter consequential of the tightening legislative requirements that are rendering incumbent properties problematic. Hence, ignoring sustainable construction is likely to marginalise your ability to attract broader pools of potential tenants and reduce vacancies. Research by Deutsche Bank conjectured that companies with higher ESG ratings have a lower cost of debt and equity, outperforming median market performance in the medium and long-run.

In terms of companies who keep their high street stores environmentally tuned, Nielsen’s Survey highlighted how 81% of consumers globally believe that environmental awareness should be key in generating success and market share. It is believed that natural light, clean air and environmental consciousness are better strategies for setting the mood and increasing store foot traffic than bright lights and thumping music, attracting better ratings and generating greater revenues. The

environmentally centric paradigm is largely spearheaded by the millennial demographic, who are known for lobbying corporations who fail to actively mitigate against environmental degradation. More compliant environment strategy also improves employee productivity and retention, having positive effects on both the company and macroeconomic performance of the UK.

For portfolio investors, property that delivers enduring, intrinsic value has become preeminent. Once again, as the younger demographic adopt roles as portfolio investment managers, they are pioneering a new investment stratagem; these young professionals are not only conscious of how funds are allocated, but are now considerate of where funds are invested, with environmental and social rankings now becoming just as significant as financial metrics during investment valuations. Compared to other asset classes, which lack a universally accepted standard of ESG ranking, the presence of the Building Research Establishment Environmental Assessment Method (BREEAM) certification facilitates apposite Real Assets valuation. The Real Capital Analytics (RCA) data illustrates that there has been a significant surge in investment across assets rated BREEAM ‘Outstanding’, illustrative of investors are becoming increasingly aware of the importance of ESG fundamentals in generating alpha.

With the race to net carbon neutrality on in over 60 countries already, including the UK which has committed to this goal by 2050, it seems plausible to conjecture that Real Estate sustainability is here to stay. Demographic shifts coupled with increasingly complex government legislature and commitments make compliance with the green movement the onus of many corporate strategies. Despite expensive upfront costs associated with greener building, construction companies and property developers that fail to adhere are likely to lose out significantly in the long term as tenants and company stakeholders become focused upon wellness quality of buildings, and this is likely to keep sustainability at the forefront of many corporate and investment agendas for decades to come.

Analyst: Tristan May

Sector Head: Theo Thomas

Editor: Harry Forbes-Nixon