The impact of ESG principles on property values in the UK

Environmental problems are becoming more and more vivid all over the world. This of course resonates, including in the property market. More and more often large investors are checking their partners for compliance with ESG principles: environmental friendliness, social policy and corporate governance. In this article, only the first aspect will be considered – as the industry’s response to the government’s steps towards “net zero”.

The need to decarbonise the environment is forcing the UK authorities to tighten legislation, introduce new measurement requirements and report forms for practices that improve the sustainability of existing and under-construction facilities. In 2019, the UK government set a course for Zero Emissions – a concept where carbon dioxide emissions are equal to the absorption of carbon dioxide from the atmosphere. The current year should see the finalisation of property construction standards that are fully compliant with this concept. It is expected to take into account the interests of all parties and will be the reporting point for a new era in the industry.

Already at this stage, the profession of the property appraiser plays an important role. It is he who must give a competent and objective opinion on the compliance of each individual property with environmental principles, taking into account possible steps to modernise the property, as well as write the final conclusion on the value and prospects of rental and sale transactions. Therefore, the mission of the appraiser seems to be quite challenging and at the same time very important.

Situation in the commercial property sector

A survey of the commercial property market was conducted in Q3 2023 to gather opinions on the development vector towards the Net Zero programme. 41% of respondents indicated that they plan to completely restructure the functioning of their companies according to the environmental concept by 2030. For this purpose, for example, many tenant firms are engaging in close co-operation with landlords and developing their own ways of reaching Net Zero.

Analytical companies are conducting market research to identify general trends in rental pricing depending on the degree to which properties are adapted to environmental standards. At the moment, there is an increase in rental costs by 8-18% for those lots that are most compliant with “green” regulations. The findings require special attention from the government and any measures to improve the situation.

It is planned that more and more facilities will be brought into compliance with the Net Zero concept according to the regulations being introduced. Therefore, the cost premium will be reduced. At the same time, buildings that do not meet the stated requirements will be sold at a reduced price, making them less attractive to investors.

At this stage of interaction between all parties in the property industry, there is a lack of clear understanding of what exactly the next step should be in order to satisfy the interests of all participants. Certainly, each party is interested both in approaching and fully adopting ESG standards and in increasing the value of their assets. There is no doubt that the processes need to be accelerated by adopting additional regulations.

Difficulties in carrying out site assessments

No two buildings are identical, as any property is a unique combination of architectural solution and territorial conditions. Even typical projects have their differences due to differences in location. Therefore, there is no single way to bring a property into compliance with the Net Zero concept. Forming a modernisation plan for each individual building requires the following knowledge:

• the possibility of applying decarbonisation mechanisms in the industry;
• the technical specifications of the property in question;
• of a building’s life cycle.

It is important not only to have all this available, but also to be able to understand, evaluate and apply it correctly at the right time. Decarbonisation methods are particularly challenging: not all existing methods can be applied to every building, and some approaches need to be adapted to the situation if they are to be used.

The role of the appraiser in the environmental aspect of ESG

The Royal Institution of Chartered Surveyors prescribes that valuers should also rely on the depreciation of the building, the list of capital expenditure required and the level of compliance with the Net Zero rate when carrying out their work. However, these guidelines are not sufficient to clearly understand how exactly to make a final judgement. After all, the same level of sustainability can be achieved in different ways and at different costs. The same applies to the same retrofit methods: the cost of applying them can vary considerably from site to site.

The lack of benchmarking – the ability to compare existing approaches with equivalent approaches in other companies – is an additional challenge. Assessors always reach a verdict based on the data available to them. They keep an eye out for new information and take it into account immediately. Some markets allow the study of information on deal performance and metrics, which often becomes the basis for further research and subsequent reasoning for conclusions. However, there remains hope for the adoption of common standards that would form the basis of an appraiser’s work. Then we can expect to see a reduction in UK property costs for investors.

Importance of the assessment results for further processes towards Net Zero

The first step is to obtain all agreed data. Despite the different approaches to property valuation, it is important to avoid situations where sustainability is neglected in favour of cost-cutting. Large companies try to use common expertise in data collection, analysis and verification for property valuations. However, the next step is for all to move to standardised working conditions so that the results are truly objective and universal.

Proper pricing is not possible without the use of open sources of information. However, these data are now specialised and are not available to everyone who needs them. For example, these are:

• the content of legal advice to tenants and landlords;
• technical characteristics of the facilities;
• data on environmental problems in the area;
• ways to make buildings more environmentally friendly;
• modernisation plans and calculation tables.

It is necessary to create a special environment where it would be possible to freely communicate and exchange experience, establish business contacts between all participants of the UK property market: landlords, tenants, valuers, interdisciplinary groups. This would allow each party to improve the quality of their part of the work, as well as enable experts to better understand the processes of the segment.

Understanding the need for changes in construction and operation to improve sustainability is not a controversial issue nowadays, as everyone would like to live in a clean city or suburb and wishes the same for their descendants. However, the economic component of such aspirations often hinders general processes, especially against the background of the lack of universal approaches and requirements. It is difficult to exaggerate the role of the valuer: it is his conclusions that determine the further development of real estate objects. It is important that the cost pushes the owners to some progressive actions and leaves no chance for inaction. Either way, everything depends on the work of the property valuer. The sooner there is a platform for all market participants to discuss issues, the faster and more effectively the economy in this area will change.