It is widely recognised that the real estate industry is a major contributor to global carbon dioxide emissions. If we are to reach net zero by 2050 – as called for in the 2015 Paris Agreement – the industry requires clear and effective regulation now more than ever.

Lonneke Löwik, CEO, INREV 2

Lonneke Löwik

Action will not only help the planet: for real estate investors and managers, it will also protect the value of assets, future-proofing portfolios in the face of climate change.

The EU’s Sustainable Finance Disclosure Regulation (SFDR) is set to help in the transition to a more sustainable future. It provides investors and advisers with the information they need to make effective allocations that support the growth of a more sustainable industry, economy and environment.

By introducing common reporting and disclosure standards, SFDR represents a clear opportunity to promote real change across financial markets. However, as its current framework is designed for static investments that can easily be traded, it is less relevant for the real estate industry, which often includes long-term and more dynamic allocations.

Moreover, SFDR’s static model fails to address the pivotal issue of transitioning and retrofitting existing assets – the biggest challenge for real estate. SFDR does not consider the concept of ‘whole-life-carbon emissions’ – the summation of both embodied and operational carbon during the lifecycle of an asset.

This has the dangerous potential to create an environment that promotes unnecessary new development over retrofitting and energy efficiency initiatives. This is evidenced by the fact that SFDR includes only 28% of the 39% of total EU emissions generated by our industry. Worryingly, the remaining 11%, produced by the construction process and materials used, are not accounted for.

Real estate must avoid a single, predetermined roadmap and focus on a variety of tools

On top of this static model, further problems arise with SFDR’s disclosure categories when applied to real estate. While the categories – Article 8 and 9 – were not designed to be used as labels, they often indicate a ranking of intensity when it comes to sustainability targets.

Many market participants tend to believe Article 9 holds more ambitious targets, as it requires sustainability to be a direct investment objective. As a result, it often includes real estate funds already seen as energy efficient and ‘green’. By contrast, for Article 8, sustainable investing is not a core objective. Crucially, Article 8 concerns transition funds, which involve an important journey to retrofit and make assets more carbon neutral.

A fund made up of new builds may be labelled as Article 9, which can encourage managers to invest in new construction despite the embodied carbon this delivers, rather than reaping the environmental benefits that arise from the transformation of existing assets.

Thinking differently

If the industry is to successfully contribute to meeting the net zero ambitions set out in the Paris Agreement, it is vital that investors think differently about the impact of only committing capital to Article 9 funds. They should also consider the broader long-term benefits of improving existing assets and portfolios within Article 8 funds. It will require better education and clearer information to tackle the widespread misconceptions about Article 8 and Article 9 funds.

Although real estate represents a relatively low percentage share of the total investment market (around 3%), it over-indexes on the volume of carbon emissions generated. But if the real estate industry can effectively support a near-net-zero built environment, it has the capacity to greatly accelerate the decarbonisation of the broader economy and society.

Fit-for-purpose regulation has an important role to play in facilitating this outcome and helping the EU to fulfil its objective of achieving the ambitions of the Paris Agreement. But as it stands, SFDR has yet to realise its full potential.

Updates that aim to adapt SFDR to private markets, with real estate as a key focus, could improve its relevance and, crucially, quicken the pace of change across the industry. Fortunately, experts – including the Platform on Sustainable Finance, an advisory body established under the EU Taxonomy – increasingly understand the need.

Recently, the platform recommended that, as part of its review of SFDR being launched this autumn, the EC develop a set of requirements under which more emission-reduction strategies could qualify for Article 9 considering the unique aspects of different asset classes, citing real estate as an example.

But until then, real estate must avoid a single predetermined roadmap and focus instead on the variety of tools and frameworks available to help bring forward the transition; tools such as the CRREM Risk Assessment, for example, will enable real estate investors and managers to recognise the dangers of stranded assets and better understand the carbon-related risks embedded within their real estate portfolios.

Many interconnected components must align to enable meaningful change. For its part, SFDR needs to evolve further, and no doubt it will – as will the UK’s separate efforts to establish Sustainability Disclosure Requirements (SDR) following consultations earlier this year.

In the meantime, everyone in the real estate investment industry must decide exactly how they can contribute in the transition to net zero.

Lonneke Löwik is chief executive of INREV, the European Association for Investors in Non-Listed Real Estate Vehicles