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The real estate industry is no exception as the world becomes increasingly focused on sustainability and reducing carbon emissions.
Understanding and keeping up with the latest developments in sustainability is crucial in today’s rapidly changing landscape.
In this instalment of ’10 Minutes with…’, we spoke to Keith Doyle, Senior Associate in our Commercial Real Estate Department. Keith shared his perspective on the importance of sustainability in the industry, the challenges and opportunities that come with implementing green practices, and what the future of real estate might look like in a world increasingly focused on sustainability.
In recent years we have seen a significant rise in the trend of ‘greening’ in Irish real estate; how has the market responded to this emergence?
The wider sustainability focus in real estate is a trend that seems to have become a ubiquitous talking point overnight, but in reality, it’s been on the agenda for some time. For example, you could point to early initiatives like The Building Energy Rating certificates that have been required for anyone letting or selling a property on the open market in Ireland since 2009. However, there is no doubt that we have entered into a new phase with many investors, funders, landlords and tenants now acutely aware of the importance of sustainability and the need to embody it in the buildings they own, occupy and fund and in the contractual arrangements that underpin all of those activities.
Recently, we have seen the emergence of green lease clauses, which are designed to enhance the traditional lease and are geared towards meeting sustainability goals. Although they are not universally adopted here as things stand, they will more often than not appear in substantial office transactions, and are increasingly taking root in the industrial and retail sectors.
To an extent, we’re still scratching the surface in Ireland, with the UK, US and continental Europe ahead of the curve. But things are only moving in one direction, and Ireland is part of that trend.
What do you believe are the main factors driving this shift towards sustainability and adopting a greener approach in real estate?
There are a number of factors influencing this continual shift. When looking at the top end of the market, major factors have been demands from investors and blue-chip tenants alongside funder requirements. For example, suppose you’re developing a building with a mega-corporation such as Facebook, Google or Salesforce; you can be certain that organizations of that size have already incorporated ESG into every decision and will have stringent minimum requirements for buildings they’re willing to invest in or occupy. However, it is important to note that adopting sustainable practices is no longer limited to these large corporations. It has become commonplace for most progressive organizations to prioritize this approach due to factors such as the pressure of attracting and retaining talent and projecting their environmental and social responsibility credentials.
Likewise, funders have seen the writing on the wall for assets that are not only less desirable now due to factors such as energy inefficiency, but which will also become increasingly difficult to market without a significant upgrade or upcycling of the existing asset(s). It’s also becoming a separate and vital offering from funders to some asset owners to borrow and invest in future-proofing their assets before they become likely to depreciate or attract lower rents into the future, if not become redundant and unlettable outright.
The implementation of key initiatives that document and certify sustainable building practices has had a big impact. International certification systems such as Leadership in Energy and Environmental Design (LEED) is particularly attractive and familiar to US-based clients. The Building Research Establishment Environment Assessment Method (BREAM) is the UK equivalent, which has grown in prominence and become a familiar metric and signifier of a building’s green credentials. There are also some Irish-specific examples; the SEAI has an Excellence in Energy Efficient Design (EXEED) rating, for example.
These certifications tend to be modular and adaptable enough to cover either the performance of a building considered as a whole or a particular aspect of the building, whether that is at the design and build phase, tenant fitouts or operations and maintenance throughout the building’s lifetime. These certifications often come with an expiry date and the requirement that they must be maintained and renewed or lost. It requires an ongoing commitment from the landlords and tenants to maintain sustainability standards and to agree on the division of labour and cost.
As green real estate continues to evolve in Ireland, what role will sustainability certifications like the ones mentioned have?
For many investors and tenants at the higher end of the market, these certifications are already effectively non-negotiable; they are expected prerequisites. The sustainability agenda is however far broader in scope than those prestigious certifications. In terms of mass implementation of sustainability targets, the drivers for everyone else will be legislative and financial to an extent. The certifications mentioned are voluntary by their nature, whereas for example the BER cert that we previously discussed arose from the implementation of an EU Energy Performance of Buildings Directive, and there’s certainly more to come domestically and from the EU in terms of the legislative and regulatory agenda. That will generate its own momentum and mandatory minimum standards. As recently as January of this year the EU’s Corporate Sustainability Reporting Directive entered into effect, requiring detailed sustainability disclosures from corporates alongside the traditional financial reporting requirements, including a dedicated section on the impact of sustainability factors on the company’s business and the external impacts of a company’s activities on the environment.
On the financial end of things, it’s an interesting time because the availability of low-interest finance options to retrofit or undertake a staged upgrade of existing assets is a stumbling block for many in the current climate. But interest rates won’t remain prohibitive forever; there will be increasing state intervention in terms of grants and tax breaks to ensure the state’s meeting its own climate and energy obligations, and reducing the carbon in commercial buildings is an integral part of that.
At the moment, some landlords, particularly at the middle and lower end, are caught in a perfect storm where there is faltering occupancy and a scarcity of finance options to upgrade their buildings. But those conditions are transitory, whereas the trends for sustainability are here to stay.
Once the interest rates come down and the government gets more fully engaged, we can expect a renaissance in retrofitting existing stock as well as minimum standards for new stock, which must be met.
Can you discuss some of the benefits for landlords and tenants adopting a greener approach?
The benefits are manifold, a major one being tenant satisfaction and retention, which is of course, beneficial to both parties. By adopting a greener approach, you are also sustaining or enhancing your assets’ value as a landlord, and there’s undoubtedly an increasing realization of the ‘green premium’ that sustainability-certified buildings attract and generate over their peers. Attractiveness to funders is another benefit. If you are seeking to refinance or to otherwise leverage the property as security, funders are already integrating sustainability into the loan approval process.
Sustainability of real estate assets is often a requirement to meet the landlords’, or the tenants’ own started ESG goals. Many institutional landlords and tenants have made these commitments to their shareholders and to the public in one form or another. So whether it’s part of a PR and marketing strategy, a genuine commitment to a zero carbon future, or all of the above, it is a good news story and certainly beneficial.
Finally, green buildings are intelligent buildings. They have systems in place for monitoring water and air quality, incorporating renewable sources of energy, measuring energy use and finding creative ways to minimize energy use and ways to optimize it. They produce reams of data, showing patterns that can be instructive as to how best to manage the building and its resources in the most sustainable, but also increasingly in the most cost-effective way possible, with the benefits that accrue from that for tenants required to contribute service charges and for landlords, trying to get the most out of their building.
Earlier this year, The Chancery Lane Project published a suite of green lease clauses for use in commercial leases in Ireland. What are green lease clauses, and how are they incorporated?
Green lease clauses in effect, supplement existing or traditional leases rather than replacing them per se. A few approaches are taken with green lease clauses; sometimes, you see them incorporated as a standalone annex to a lease, almost a self-contained addition. In other cases, they are woven more seamlessly into the main body of the lease. That usually involves the enhancement of various traditional clauses to do with services, service charges, yield up, repair, consent to future works by the tenant, and adding substantive provisions that support the collection and collation of data. This data can include energy use, air quality, water quality and water use in the building for example. The data is made available to stakeholders, and a forum is provided for the landlord or tenant to meet and discuss the effectiveness of the existing regime in the building and to organically agree to enhance that cooperation or take on more ambitious targets to meet what will be an ever-shifting standard for sustainability goals.
You certainly can’t catch everything that will arise over a lease’s lifetime, particularly as sustainability norms evolve, but you can have clear mechanisms to allow parties to meet and agree to adapt the existing regime to meet those future needs.
What do you think the future of real estate will look like in a world where sustainability is a top priority, and what role do you see lawyers playing in this process?
As lawyers, we need to keep up with the ever-changing legal landscape and the discourse around sustainability, which has really exploded; there’s so much literature and noise about it now. Ultimately, we need to keep up with the needs of our clients and ensure that in the case of green leases, the lease captures the goals for the division of labour and cost and the forums for discussion to implement those goals. In short, it will be vital for lawyers to draft legal agreements that are fit for purpose and, most importantly, future-proof.
More generally, as we look into the future, some of these assets will struggle if they can’t be upgraded in time and attracting a certain calibre of tenants will become more and more difficult if owners are unwilling or unable to finance the retrofits. Vacancy rates will rise, and cut-price disposals will be on the cards. That price adjustment is already taking place more generally in the current economic climate due to more mundane economic factors. However, I could see that also becoming a significant issue for certain assets if they’re not upgraded, and capital will continue to be drawn to either new sustainability focused developments, or to retrofits and refurbs that meet ESG standards. Lenders and investors already understand the importance of this.
It’s both a challenge and an opportunity for people who own, who are investing in and who currently hold assets. Ultimately, it may force some people out of the market, but in the long term, it will eventually benefit landlords and tenants to have their buildings as efficient and sustainable as possible and, of course benefit society.
Author: Keith Doyle