80% of vacant office space ‘no longer rentable’ under ESG guidelines

Eighty percent of the office space that is vacant and available for lease today is no longer rentable under European ESG regulation requirements, according to global real estate investor Hazelview Investments.

In a note from the company, which addresses the question “How can institutional investors translate ESG regulations into risks and put a price on them?”, the answer seems to be - at least in part - coming from providers of independent ESG labels.

The driving force behind the shift to sustainable ESG-compliant buildings is the EU Commission, through its array of guidelines and targets. The EU, via its Sustainable Finance Disclosure Regulation, SFDR) demands that the building sector reduces its CO2 emissions by at least 60% by 2030, and achieve climate neutrality by 2050. Germany, and all the big European capitals, have agreed to commit to this.

Of course the reality is that large numbers of outdated buildings have first to undergo major adaption to the new standards, which has profound consequences for the rental market. According to a study by the European Union’s Carbon Real Estate Monitor (CREEM) and the Global ESG Benchmark for Real Estate (GRESB), around 17% of German office space will no longer be lettable as early as 2030. Currently about 35% of buildings in the EU are over 50 years old, and nearly three-quarters of the building stock is energy inefficient. Only about 1% of the building stock is renovated each year.

Many owners and developers in various European countries have already foreseen these risks and are already taking the necessary action, whether in offices, logistics prop- erties or social housing. Independent ESG labels from providers such as BREEAM, DGNB and LEED are gaining in importance as a ‘seal of approval’ for real estate developments. Indeed, many investors orientate themselves around the addition or deduction of such ESG-vouching seals of certification. In London, for example, properties with the BREAAM seal are achieving on average between 3.7% (“very good certification”) and 12.3% (“excellent certification”) higher rents.

Claudia Reich Floyd, portfolio manager for Hazelview Investments and head of the German team in Hamburg, says: “For investors, the question is increasingly how to translate that into risk and associated return requirements.”

Hazelview Investments itself, for example, incorporates ESG parameters into its own risk analysis, which influences the cost of equity the investment house charges institutional clients. At the same time, the firm actively works with management teams of listed real estate investment trusts (REITs) to partner with them to improve efficiency. According to Hazelview, the spread in the cost of equity between the best and worst performers is between 40 and 50 basis points, or an 8% difference in capital, says Reich Floyd: “This relative risk spread (‘greenium’) is consistent with examples from the bond market.”

Hazelview, headquartered in Toronto, employs more than 80 staff and manages nearly €9bn in real estate assets across the globe.