Going beyond 'E' to include 'S' and 'G': ESG takes center stage in real estate

Deloitte China today releases Creating sustainable value: Real estate and ESG, a new study exploring the environmental, social, and governance (ESG) factors that in recent years have become a strategic imperative for all participants in the real estate sector.

Through nine articles by Deloitte specialists, the report sets the ESG agenda for participants in the real estate ecosystem, including property financers, developers, owners, and managers, real estate investment managers and investment trusts (REIMs and REITs), asset managers, and investors.

Deloitte China Real Estate Industry Leader Philip Law says, "The evolving regulatory landscape is a major topic of conversation, with China a key country as it pursues its goal of carbon neutrality by 2060. The report also explores ESG strategy implementation, and challenges in the life cycle of real estate development, operation and investment, showing how real estate companies and investors can make themselves 'ESG-proof'."

From 'E' to 'S' and 'G'

According to Deloitte's CFO survey of 114 CFOs in financial services and real estate, half of the respondents have incorporated ESG into their business strategies, but greater emphasis is put on 'E', with 48% seeing related disclosure improvements as an opportunity to gain better access to capital markets, versus 30% for 'S' and 'G'.

"Considering the fact that buildings account for around 90% of the electricity consumption, and over 60% of the carbon emission in developed cities like Hong Kong, it comes hardly as a surprise that the real estate sector's climate impact is under scrutiny," Law explains.

"Although environmental issues are of particular importance in the real estate sector, ESG goes beyond an isolated consideration of 'E'. A more comprehensive approach to ESG can drive long-term value, while neglecting it can damage reputation, lose clients, alienate employees, and increase operating costs."

To promote governance, the report recommends supporting a culture of ethics, compliance, and integrity that can drive long-term value. Since COVID-19, the 'S' in ESG has received more attention. Real estate companies can make it a value driver and enhance their social impact by participating in the rehabilitation of public spaces and affordable housing, and promoting high standards in labor practices, responsible marketing, and diversity. 

Regulatory developments add urgency to mitigating ESG risks

With China and the EU's climate change plans announced in July 2021 representing an important step in fighting climate change, the convergence of global reporting standards based on the recommended framework of the Taskforce on Climate-related Financial Disclosures (TCFD) has highlighted the urgency of strengthening climate change compliance and risk management.

Against the backdrop of China's "dual carbon" goals, regulators have been stepping up disclosure requirements for listed companies. These include the Ministry of Ecology and Environment's plan to introduce a mandatory environmental information disclosure system by 2025, the Hong Kong Exchanges and Clearing ESG Reporting Guide, and the Securities and Future Commission’s disclosure requirements for ESG-focused funds and rules for all collective investment schemes.

"In recent years, more regulations have been released that require listed companies to disclose corporate environmental information. In the real estate sector, carbon emissions intensity and energy saving rates were established as clear, mandatory standards from April 2022," says Deloitte China Climate & Sustainability Leader Allan Xie. "These regulatory changes are driven by China's aim to achieve carbon neutrality. Buildings are one of the country's three largest sources of energy consumption, with huge potential for emission reduction. The introduction of various regulations not only defines the minimum requirement regarding carbon emission for the industry, but also provides companies with directions for developing implementation roadmaps."

"Although the Chinese government has not specified binding standards or carbon emission control targets for green buildings, low carbon requirements are embedded into the assessment and rating process. Setting proper rules during design and construction planning is key," adds Deloitte China Climate & Sustainability Partner Jolin Gu.

ESG implications for real estate investment management, data management, and M&A

Real estate investment managers must move beyond "box-ticking" and integrate ESG aspects into their long-term strategies. Beyond mere compliance, the resulting transparency and comparability of funds and products affords managers new growth opportunities.

Strategies for ESG transparency and compliance require solid data foundations, making it imperative that real estate companies establish a single data model and define key ESG metrics.

To mitigate transaction risks in mergers and acquisitions, real estate players need to adjust existing ESG due diligence approaches to industry needs and standards, establish appropriate KPIs, review targets and identify ESG red flags.

"Real estate investors need to decide whether to be ESG adopters—doing only what’s required of them—or ESG pioneers that drive change in building design, construction, use, renovation, even demolition," says Deloitte China Southern Region Risk Advisory Leader Melissa Fung. "At the very least, they need expertise and resources to meet disclosure requirements and to integrate ESG risks into wider due diligence." 

The growing importance of green leases

Green lease agreements, which specify how owners and tenants will meet environmental requirements, are likely to play a bigger role for many real estate participants and even become standard.

Building owners and tenants should analyze the need for sustainability clauses and consider adding these "green" clauses to lease agreements. This can be beneficial during the use of a building and when financing or selling it.

"This report is the first comprehensive ESG thought leadership in the industry and its insights are only a starting point," says Fung. "Deloitte China is committed to continuing to work with all stakeholders in the real estate ecosystem to drive change and create sustainable value."

The authors of Creating sustainable value: Real estate and ESG will feature in an upcoming series of interviews to share their insights and spark further debate.