Strategic Takeaways: Current Sustainability Trends in Real Estate 2024
Introduction:
As the institutional landscape continues to evolve, staying ahead of sustainability requirements remains critical for Investors. The shifting market dynamics underscore the importance of proactive strategies that address climate risks, regulatory changes and the growing demand for transparency.
Alliance Global Advisors (Alliance) is acutely aware of these trends and actively prepares our clients to navigate this complex terrain, ensuring they maintain momentum and capitalize on emerging opportunities. We invite you to connect with our team to learn more about our work in this space.
Key Takeaways on the Current Sustainability Landscape:
For the past few years, the sustainability landscape has highlighted increasing climate-related risks[1] to real estate, driving insurance costs[2] and emphasizing the urgent need for emissions reductions, particularly in buildings. The energy transition is becoming more accessible as costs for critical components like solar panels continue to decrease. Better utility data collection has allowed building owners to estimate the payback periods of sustainability CapEx items more accurately. At the same time, innovative partnerships and government incentives are becoming essential for enhancing property-level returns and reducing long-term risks.
Climate Impact on Real Estate: Real estate portfolios are increasingly at risk due to climate-related events like heat waves, droughts and wildfires, which are also driving up insurance costs
Urgency for Emissions Reduction: To mitigate climate risks, greenhouse gas (GHG) emissions must decline by over 45% by 2030, with buildings being a major contributor to global carbon emissions and energy demand. This has driven many Investors and tenants to sign Net Zero Carbon pledges
Drive towards Data Collection and Transparency: Over the last few years, the number of 3rd party software solutions to collect and analyze utility data has increased. This has been driven by the need to report to GRESB and other sustainability reporting frameworks
Government Incentives: Initiatives like the Inflation Reduction Act and Department of Energy (DOE) grants are helping reduce costs for net zero developments and energy efficiency retrofits
Government Penalties: Many local jurisdictions are looking to impose fines on commercial buildings with high energy use intensities. This provides local governments with revenue without raising sales taxes, homeowner property taxes or other politically unpopular taxes. The new local reporting rules require building owners to accurately track utility data:
Boston - Building Emissions Reduction and Disclosure Ordinance (BERDO)
Washington, D.C. - Building Energy Performance Standards (BEPS)
As well as proposed legislation in discussion for Chicago, Seattle and St. Louis
Energy Transition: Key components like solar panels and EV batteries are becoming more affordable, with expectations of further cost reductions over time. PropTech firms continue to address building management systems and key components of HVAC systems
Net Zero Carbon Construction Costs: Although Net Zero construction may require a higher initial investment, costs are mitigated by green materials, rebates, tax benefits and increased efficiency. Advanced procurement practices can reduce perceived cost premiums
Innovative Partnerships: Many real estate owners are forming partnerships and sourcing from non-traditional suppliers that can further reduce costs and improve long-term ROI
The Alliance Perspective:
Financial Implications of Climate Risks: Real estate portfolios are vulnerable to climate-related events, which are driving up insurance costs and highlighting the need for climate resilience strategies
Economic Feasibility of Sustainability: Improved methods of utility data tracking are allowing real-time analysis of sustainable CapEx items. Many buildings can lower their utility costs and improve their NOI through projects that have low up-front costs
Risks to the Property: Failing to adapt to climate change could result in significant long-term risks, with potential economic losses if buildings become uninsurable or below investment-grade
Risks to Investor Relations: Failing to be able to meet Investor reporting requirements on energy, water, waste and greenhouse gas emissions can result in lower capital inflows
Multifamily Focus: Responsible Property Management:
The Responsible Property Management Standards (RPMS) Policy is being recommended by the NY Bureau of Asset Management (BAM) for adoption by key NYC pension systems, including New York City Employees’ Retirement System (NYCERS), which has already implemented it[3]. The policy, driven by increased regulatory scrutiny, establishes comprehensive standards for residential investment managers, including seven Principles, each accompanied by one or more Standard Practices and supported by Best Practices, followed by a set of public Disclosures. It aims to improve sustainability, reduce housing instability and manage investment risks while ensuring financial returns. The policy requires adherence from investment managers (regardless of where the properties are located), emphasizing transparency, tenant rights and maintaining green building standards.
Adoption of RPMS Policy: The NY Bureau of Asset Management recommends that key NYC pension systems adopt the Responsible Property Management Standards Policy as part of their Investment Policy Statement for Real Estate
Residential Investment Managers: Managers are expected to adhere to the RPMS Policy, providing additional reporting and transparency to Investors. NYCERS has already signed the policy, with more LPs expected to follow
Regulatory Scrutiny: The adoption of RPMS is driven by increased regulatory scrutiny in the residential sector. Social and Community data is being evaluated with the same level of scrutiny as environmental performance data
Comprehensive Standards: RPMS includes 7 Principles with 26 Enhanced Standards, 22 Best Practices and 9 public disclosures for tenants and Investors. Reporting will be protected from FOIA requests
First Adoption by NYCERS: NYCERS was the first NYC pension plan to adopt the RPMS Policy, which will be incorporated into their Investment Policy Statement. New managers will be required to align with the policy, with an annual reporting requirement
Goals of RPMS: The policy aims to improve the sustainability and quality of residential investments, reduce housing instability and manage investment risks while attaining financial returns
RPMS Policy Highlights (the Seven Principles):
Tenant Screening & Selection:
Provide clear explanations of fees and criteria
Minimize the impact of past evictions and bankruptcies
Leases & Security Deposits:
Limit rent increases to CPI + 5%, with required notices for larger increases
Cap security deposits at 1.5x monthly rent and ensure timely returns
Housing Quality:
Maintain properties to meet green building standards
Tenant-Landlord Relations:
Monitor service levels and tenant satisfaction
Tenant Rights:
Protect tenants' rights to free speech and association
Tenant Stability:
Track reasons for tenant moves and rent increases
Evictions:
Provide 30 days' notice before filing for eviction and allow tenants an opportunity to cure
The Alliance Perspective:
Increased Regulation: Increased and additional regulation in the residential real estate sector is here to stay. Amid the evolving regulatory landscape, institutional Investors are likely to enhance their property management practices to stay ahead of changing regulations
Continued Adoption: The policy has been signed by NYCERS. It is likely that the Teachers’ Retirement System of the City of New York (TRS), New York City Police Pension Fund, New York City Fire Pension Fund and New York City Board of Education Retirement System (BERS) follow suit and adopt the policy
Enhanced Transparency: As the policy becomes more widely adopted, residential managers will increasingly be required to offer greater reporting and transparency to Investors
SEC Climate Disclosure Rules and Reporting Requirements:
As of April 2024, the SEC’s Climate Disclosures Reporting Requirements have been stayed pending judicial review; the SEC attracted multiple lawsuits over the new regulations. The SEC's Climate Disclosure Rules mandated that most SEC-reporting companies disclose Scope 1 and Scope 2 Greenhouse Gas (GHG) emissions, as well as climate-related risks and associated expenses. The final rules, which were originally planned to roll out in phases starting in 2025, provided greater flexibility, particularly regarding Scope 3 emissions and GHG calculation methods. While less stringent than international standards, the SEC focuses on materiality to a “reasonable Investor.”
SEC Climate Change Disclosure Rule Requirements:
Compliance was to be expected from most SEC-reporting companies
Would have required disclosures for Scope 1 and Scope 2 Greenhouse Gas (GHG) emissions
Allowed for flexibility in determining reporting boundaries for GHG emissions
Would have required disclosure of expenses due to extreme weather, oversight committees for climate risk and risk management processes
Larger companies would have started reporting in 2025; smaller companies by 2027
SEC’s rules cannot be replaced by other jurisdictions' climate change disclosure rules
The Alliance Perspective:
Proactive Reporting: Although the SEC Climate Disclosure rule has been paused, Investors are still asking for data. Alliance encourages managers to proactively track climate metrics and respond to the increasing demand for transparency from Investors, and utilize advanced reporting technologies to stay competitive in today’s environment
Technological Advancements: New technologies optimize asset and portfolio-level reporting. Software-enabled utility data collection facilitates better decision-making at the asset and portfolio level. Managers must leverage these technologies to stay competitive
Alliance Global Advisors is closely monitoring the rapidly evolving sustainability landscape. We expect the focus on transparency in reporting and risk mitigation through sustainability initiatives to remain a strong and ongoing trend.
If you’d like to learn more, you can meet with the Alliance team at the 2nd Annual RELPI/GRESB Americas Institutional Investor Forum 2024 on October 1, 2024 in New York, NY.
About Alliance Global Advisors:
Alliance Global Advisors is a women-owned consulting firm focused on empowering the institutional investment community to elevate best practices. Advising clients with over $870 billion in assets under management, Alliance partners with organizations to provide an independent perspective and innovative approach to critical strategic initiatives. Our partnerships allow senior management teams to focus on what matters most: diligently managing client capital, creating value and delivering exceptional returns in a performance-driven market.
Disclaimer: This blog was originally published in September 2024 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.
Glossary of Key Sustainability Terms:
Climate-Related Risks: Climate-related financial risks can be grouped into two broad categories – physical risk and transition risk. Climate-related physical and transition risks tend to manifest as traditional financial risks, including credit risk, liquidity risk, market risk and operational risk. For example, disruptions in economic activity caused by climate-related weather events like flooding or wildfires may affect household income and the ability to stay current on household financial obligations.
Sustainability CapEx Items: Property-level capital expenditures typically fall into two buckets: Energy Efficiency Improvements (such as LED lighting, building management system/HVAC control upgrades, insulation of water pipes, window replacements, occupancy sensors for lighting and heating, etc.) and Electrification Improvements that reduce the use of fossil fuels (such as converting the boiler or HVAC from natural gas to electric at the end of its useful life).
Climate-Related Events: Occurrences of severe weather or climate conditions that can cause devastating impacts on communities and agricultural and natural ecosystems. Climate-related events are extreme weather events that can persist for longer periods of time. A drought is an example of a climate-related event.
Greenhouse Gas (GHG) Emissions: Emissions are produced when hydrocarbons, such as natural gas and oil, are burned. GHGs include carbon dioxide (CO2), methane and nitrous oxide, all of which contribute to climate change.
Net Zero Carbon Pledges: A number of Investors and investment managers have signed pledges aligning with the science-based targets needed to limit global warming to no more than 1.5 degrees Celsius as defined in the Paris Agreement (Net Zero Asset Owners Alliance, Net Zero Asset Managers Initiative). The goal is for buildings to fully eliminate greenhouse gas emissions by 2050. The goal also includes annual interim targets for each year until 2050 (for example a 22% reduction by 2025; 49% reduction by 2030).
Net Zero Construction Costs: If 100% of energy demand is met by on-set renewable energy, it can be called a net zero energy building. Net zero innovations may require additional capital outlay but, in most cases, enhance investment returns. Components of net zero buildings include: energy-efficient design and construction; renewable energy sources; energy storage and management systems; and sustainable materials and construction practices.
Scope 1 and Scope 2 Greenhouse Gas Emissions: Three types of emissions, as defined by the Greenhouse Gas protocol, which works with governments, industry associations and businesses to set standards to measure and manage emissions. Scope 1 (direct greenhouse-gas emissions) and Scope 2 (indirect emissions resulting from the energy that a building purchases) are required reporting for many businesses.
[1] Reference Glossary of Key Terms for all terms in bold
[2] See Alliance Blog: The Rogue Wave: Rising Insurance Premiums and the Impact on Multifamily Valuations
[3] CIO: NYC Pension Adopts ‘First in Nation’ Guidelines for Private Real Estate Investments