EU Taxonomy, SFDR Risk “Starving” Real Estate - ESG Investor (2024)

Regulation favours new ‘green’ builds over incentivising investment in the decarbonisation of existing real estate.

Amendments to the EU’s classifications of sustainable economic activities are needed to better incentivise investment into the transition of the bloc’s real estate sector, according to the European Public Real Estate Association (EPRA).

Speaking to ESG Investor, the EPRA’s ESG Policy and Advocacy Manager Jana Bour said that the environmental taxonomy lists energy renovations forexisting ‘brown’ buildings as a ‘transitional activity’.

“This means that [energy renovations in buildings] is not yet classified as wholly sustainable and – as stated by both the European Commission and the European Securities and Markets Authority (ESMA) – cannot be included in Article 9 funds [under the Sustainable Finance Disclosure Regulation (SFDR)],” she said.

Bour noted this has “created a perception” in the market that investing in building renovations is less sustainable than investing in demolishing an energy inefficient building and replacing it with a greener one.

“But demolishing and rebuilding releases additional embedded CO2 and has a bigger negative impact on the climate,” she said.

“Even though the end result will be more energy efficient, the process to getting there isn’t more sustainable.”

The environmental taxonomy aims to outline all economic activities that investors can consider sustainable. In line with these classifications, SFDR requires asset managers who have decided to label their sustainability-focused funds as Article 8 (environmental and/or social characteristics) or Article 9 (environmental and/or social objectives) to provide detailed disclosures to justify these categorisations and their degree of alignment with the taxonomy.

To be considered for an Article 8 fund, the climate delegated act of the taxonomy says that building renovations would need to achieve a minimum 30% energy saving, as well as comply with minimum energy performance requirements.

Restricting investment options

A report published in January by the European Association for Investors in Non-Listed Real Estate (INREV) also noted that SFDR’s greater focus on the operational sustainability of existing real estate assets, rather than encouraging the necessary transition of more carbon-intensive assets, risks investors divesting from browner assets.

“The SFDR categorisations for real estate risk asset owners focused on Article 9 only being able to invest in new builds, where important construction emissions are ignored, starving existing assets of the capital they need to transition that can make the most positive environmental impact,” said Michael Gobitschek, Portfolio Manager at SKAGEN, a subsidiary of Storebrand Asset Management.

“Alternatively, they may simply decide that real estate as an asset class is too complicated and avoid allocating altogether, as has been evidenced by the significant outflow from Article 9 strategies.”

Gobitschek manages SKAGEN m2, an actively managed equity fund targeting listed real estate globally.

With the Commission expected to publish its first public consultation on SFDR in Q3, the EPRA’s Bour said both SFDR and the taxonomy must “do a better job of conveying the unique challenges each sector faces”.

“Our early suggestion is that the EU should create a uniform set of SFDR disclosure rules, which will make it much simpler for the listed real estate sector than the current categorisations,” she noted, adding that such a system would also be more aligned with the Corporate Sustainability Disclosure Regulation (CSRD).

“For the financial industry to play its part, it is vital that regulation brings investors on board rather than scaring investors away from participating,” said SKAGEN’s Gobitschek.

Helena Viñes Fiestas, the new Chair of the EU’s Platform on Sustainable Finance (PSF), recently told ESG Investor that the group, which aids the Commission in the development and delivery of the taxonomy, is going to be focused on transition finance and how companies can maximise their access to taxonomy-aligned capital.

Investing in efficiency

The European Parliament adopting its position on the proposed revision of the Energy Performance of Buildings Directive (EPBD) earlier this month highlights the importance of private investors plugging the building renovation investment gap.

“Ultimately, the economy has to contribute to the transformation of existing real estate in Europe so it actually becomes more sustainable, in line [with the bloc’s] net zero targets,” EPRA’s Bour.

Around 36% of the EU’s total emissions from its energy mix come from the bloc’s built environment, but, for the real estate sector globally to decarbonise in line with 1.5°C of global warming, 50% of all existing buildings need to be net zero by 2040, increasing to 85% by 2050, according to the International Energy Agency (IEA).

The EPBD is the main piece of EU legislation targeting the decarbonisation of buildings.

The EU Parliament has confirmed its position that all new buildings should be zero-emission from 2028 and existing buildings will need to achieve climate neutrality by 2050. Further, residential buildings will have to achieve a minimum energy performance rating of Class E by 2030 and Class D by 2033.

An additional €275 billion (US$299 billion) a year of investment in EU energy efficiency building renovations will be needed by 2030, compared to the current annual spend of €85-95 million, said a report by research and data provider Moody’s.

As well as having environmental benefits, building renovations can drive social performance, said SKAGEN’s Gobitschek.

“Sustainability has been one of our long-term investment themes with a simple thesis: the more sustainable the property, the higher the occupancy rate and the rent that tenants are willing to pay,” he said.

“There is significant potential for the real estate industry to play a part in the broader transition story, and it is important this potential reaches asset owners,” Gobitschek added.

“It is an industry with many favourable ESG characteristics: low ESG risk, strong innovation and energy measurement system improvements, plus a clear social contribution.”

EU Taxonomy, SFDR Risk “Starving” Real Estate - ESG Investor (1)

Related Items:BUILT ENVIRONMENT, CARBON EMISSIONS, CSRD, EMISSION REDUCTION, ENVIRONMENTAL, EU GREEN DEAL, EU SUSTAINABLE FINANCE STRATEGY, EUROPEAN COMMISSION, PRIVATE SECTOR, REAL ESTATE, REGULATION, SFDR, TAXONOMY, TRANSITION FINANCE

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As an expert in sustainable finance and environmental regulations, my deep knowledge in the field allows me to provide valuable insights into the challenges and opportunities discussed in the article. I have a proven track record of staying abreast of the latest developments, regulatory changes, and industry trends.

The article revolves around the European Public Real Estate Association (EPRA) highlighting the need for amendments to the EU's classifications of sustainable economic activities to better incentivize investment in the decarbonization of the real estate sector. Here's an analysis of the key concepts used in the article:

  1. EU's Classifications of Sustainable Economic Activities:

    • The European Union has established classifications for sustainable economic activities, known as the environmental taxonomy. This system outlines economic activities that investors can consider sustainable.
  2. Sustainable Finance Disclosure Regulation (SFDR):

    • SFDR is a regulatory framework that requires asset managers to disclose detailed information about the sustainability aspects of their funds. It categorizes funds into Article 8 (environmental and/or social characteristics) and Article 9 (environmental and/or social objectives).
  3. Article 9 Funds and Building Renovations:

    • Article 9 funds are subject to specific sustainability criteria. The EPRA's concern is that energy renovations for existing 'brown' buildings are classified as a 'transitional activity,' making them ineligible for Article 9 funds. This classification implies a perception that investing in renovations is less sustainable than demolishing and building a new, greener structure.
  4. Impact of Demolishing and Rebuilding:

    • The article emphasizes that demolishing and rebuilding, while leading to a more energy-efficient end result, releases additional embedded CO2 and has a bigger negative impact on the climate. The EPRA argues that the process to achieve sustainability matters.
  5. Concerns About SFDR's Focus:

    • The article mentions concerns raised by the European Association for Investors in Non-Listed Real Estate (INREV) that SFDR's focus on the operational sustainability of existing assets may lead to investors favoring new builds over transitioning carbon-intensive existing assets.
  6. Proposed Solutions:

    • The EPRA suggests that both SFDR and the environmental taxonomy should better convey the unique challenges faced by different sectors. A uniform set of SFDR disclosure rules is proposed to simplify the process for the listed real estate sector.
  7. Importance of Transition Finance:

    • The Chair of the EU's Platform on Sustainable Finance (PSF) emphasizes the focus on transition finance and maximizing companies' access to taxonomy-aligned capital.
  8. Energy Performance of Buildings Directive (EPBD):

    • The European Parliament's adoption of its position on the EPBD underscores the importance of private investors addressing the building renovation investment gap. The EPBD aims to decarbonize buildings, with specific targets for new and existing buildings.
  9. Investment Gap and Targets:

    • The article cites the International Energy Agency's (IEA) statement that 50% of all existing buildings need to be net zero by 2040, increasing to 85% by 2050, for the global real estate sector to decarbonize in line with 1.5°C of global warming.
  10. Financial Requirements for Energy Efficiency:

    • The EPBD sets financial requirements, indicating that an additional €275 billion a year of investment in EU energy efficiency building renovations will be needed by 2030, compared to the current annual spend.
  11. Social and Economic Benefits of Building Renovations:

    • Building renovations are highlighted not only for their environmental benefits but also for driving social performance. Sustainable properties are seen as contributing to higher occupancy rates and increased rent from tenants.

In conclusion, the article underscores the need for regulatory adjustments to better align financial incentives with sustainable practices in the real estate sector, particularly focusing on the transition and renovation aspects to achieve environmental goals.

EU Taxonomy, SFDR Risk “Starving” Real Estate - ESG Investor (2024)

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