Sustainability is no longer a choice but an industry requirement and the additional costs are outweighed by the positive implications and added value, writes Cundall’s Simon Wyatt

Simon Wyatt, Sustainability Partner at Cundall

Simon Wyatt is sustainability partner at Cundall

The drivers to create a sustainable built environment have come from almost everywhere – society, industry, government policy (although minimally). Of all these, money is perhaps the most powerful.

For those who have been advocating for a sustainable built environment for a while now, the financial markets and products have promise in store. They are increasingly being required to disclose their environment, social and governance (ESG) performance.

This requirement can be attributed to the formation of the International Sustainability Standards Board (ISSB), an independent body that sets standards within the International Financial Reporting Standards. This has led the market for sustainability to evolve rapidly. Sustainability is no longer a choice for developers, but a requirement to attract investments.

The EU is leading the way with the requirement for the financial sector to report against the Sustainable Finance Disclosure Regulation (SFDR), which requires exactly this. Unsurprisingly, the UK is not far off and anticipates the launch of their sustainable disclosure requirements (SDR) and the UK green taxonomy in 2025.

But, with capital being global, we are already seeing Asian and American funds looking to align with these requirements to ensure they can access the global capital markets. This raises the question of what the future looks like for developers and whether the ESG premium prices will lead to developers scaling back their activities.

We have already seen a number of institutional investors either blacklist buildings with fossil fuel or require the asking price to be reduced to cover the cost of electrification

The industry has become all too familiar with several developments pausing over the past three to four years. The ones that have progressed have been those with good ESG criteria aligned with funds and investor’s ESG disclosure and reporting requirements. In instances where developments cannot demonstrate alignment, there tends to be little appetite from investors to proceed.

Meeting these ESG requirements will come with additional cost for developers, based on a recent report by the UKGBC, the cost uplift for offices is around 6.2%. This is becoming less of a choice and more of an inevitable need to make their properties attractive to investors. However, it should be seen less as a risk than as an opportunity to increase asset value and secure investments.

Going forward, we should expect to see properties split into two tiers, ones that are fully aligned to investor ESG requirements and then the traditional developments that have minimal sustainability drivers. There will be an additional cost for the former as these buildings would require extra certifications and accreditations such as SFDR, CRREM and even the more recent UKNZCBS. That said, they will have significant potential in increasing asset value, whereas the latter has a significant risk of becoming a stranded asset or attracting a brown discount, buildings that are less desirable and predicted to drop in value as they do not meet institutional investors requirements.

We have already seen a number of institutional investors either blacklist buildings with fossil fuel or require the asking price to be reduced to cover the cost of electrification. This shift not only mitigates risk but presents an opportunity for developers to increase the value of their assets.

Most large institution investors are already reviewing their portfolios to understand their stranding and ESG risks. They are either developing climate resilience and decarbonisation pathways for appropriate developments or offloading sub-prime assets that are likely to devalue and strand.

A large London developer recently had a number of occupiers threatening to leave their building unless they had a credible decarb plan. This trend is only set to develop further.

Therefore, any speculative developers need to be aware of the institutional investor market requirements before starting on site to ensure they don’t end up with a stranded asset with little or no opportunity to offload.

We are witnessing an institutional shift in the industry, and this is not a barrier, but a positive change for everybody

It is challenging to know exactly how the additional costs to meet ESG requirements will influence trends in property development. But what is amply clear is that the business-as-usual philosophy is no longer a viable option.

Yes, those developers who are doing the minimal and not spending the required amount to meet ESG regulations will have lower costs, which might appear to make them seem profitable. However, they will not achieve premiums in return like those buildings that meet ESG regulations. JLL’s recent report has shown that these buildings can attract rental premiums at the range of 10% and value premiums in the range of 12%.

There is no future in sub-prime property as these developments will not win investment. Sustainability is our only option. We are witnessing an institutional shift in the industry, and this is not a barrier, but a positive change for everybody. The leaders will move in this direction and the rest will be forced to follow.

Simon Wyatt is sustainability partner at Cundall