Real estate sustainability due diligence 

It is hard to imagine financial due diligence without welldefined financial accounting standards. With sustainabilityperformance on the minds of investors and those that seek toattract them, the corollary is apropos; well-definedsustainability standards and frameworks are accelerating thepath to a more efficient real estate investment market. Realestate market participants may have much to gain in learningthe new “grammar” of Environmental, Social, andGovernance (ESG) and incorporating it into their diligenceprograms. 

Sustainability accounting standard setters are issuing new andconverging standards and frameworks that can be used toassess sustainability performance. These new standards willlikely increase the ability for both parties in a real estatetransaction to communicate in a similar language. Thismaturation means that investors looking to betterunderstand an investment’s sustainability performance,opportunity, and risk will be able to request information inalignment with its standard and framework of choice.

The rapid acceleration in the issuance of new and theconvergence of existing ESG standards and frameworks hasoccurred against a backdrop of societal change, increasedenvironmental regulation and risk, and reimagination of howreal estate users live and work. These trends make the needfor consistent, comparable metrics on which to communicaterisk and opportunity more critical. 

For managers seeking to raise capital, being able to furnishinformation on ESG factors in alignment with standards andframeworks may allow them to communicate that theinformation provided in diligence meets the boundaries,assumptions, and judgments expected from an investor.While judgments in accounting for ESG performance willpersist, a mature standards and frameworks landscape shouldlead to greater transparency among negotiating parties.Those able to furnish this ESG information will likely have acompetitive advantage and thus a greater access to capital.

Here are a few examples of standards and frameworks and how they might provide a common language between negotiating parties.

Task Force on Climate-related Financial Disclosures (TCFD)and evaluating climate resiliency

The TCFD was founded in 2015 by the Financial StabilityBoard. The TCFD framework provides organizations therecommended language to describe, among other matters,physical and transition risks from climate change. Disclosuresprepared in accordance with this framework could, forexample, assist a real estate fund in assessing its properties’climate resiliency to physical risks such as extreme weatherevents. The TCFD provides objective measures, a commonlanguage, by which a preparer can measure and disclose thisrisk, information which may be useful in diligence.

Greenhouse Gas Protocol (GHG Protocol) and assessing therisk of carbon emissions limits

The GHG Protocol was developed by the World ResourcesInstitute and World Business Council for SustainableDevelopment in 1998 and is the most widely-respectedaccounting standard on measuring and managing carbonemissions.(1) The GHG Protocol is undergoing a modernizationeffort and is expected to be updated in 2023.(2) However, itremains in use today and is of particular importance to real estate, as jurisdictions globally have mandated reductionrequirements on carbon emissions. In some jurisdictions, ifthose reductions are not met, real estate owners may belevied significant fines and penalties. For those involved inlegal and regulatory due diligence on real estate investments,understanding the current state of carbon emissions throughthe common language of the GHG Protocol will likely becritical to being able to assess the future cash flowuncertainty from those investments.(3)

Speaking a common language

The “grammar” (i.e., standards and frameworks) onsustainability will likely continue to evolve in an effort to meetthe needs of investors. Leaders should consider engaging in adialogue with those from which they seek to obtain ESGinformation or those to which they wish to provide ESGinformation. They should also identify which risks andopportunities are deemed most relevant and leadingstandards and frameworks that give the most appropriate“grammar” to address those risks and opportunities. If bothparties in diligence can have a mutual understanding on whatstandards and frameworks will be leveraged in informationprovided, the diligence process will likely be smoother andthe assumptions underlying valuation, will likely be better known. 

_{1. Gendre, “What is the Greenhouse Gas Protocol,” Greenly, Jan 22, 2023.}

_{2. Greenhouse Gas Protocol, “Survey on Need for GHG Protocol Corporate Standards and Guidance Updates,”Accessed May 3, 2023.}

_{3. Deloitte, “Deloitte response to the survey on the need for GHG protocol corporate standards and guidance updates,”March 23, 2023.}