Immobilien müssen grüner werden
Transparent sustainability reporting is the way forward

Real estate needs to become greener

  • The huge greenhouse gas footprint of real estate is incompatible with the Paris climate goals
  • Stricter regulation is forcing property owners to transform their portfolios to make them more sustainable

  • New sustainability standards improve transparency

  • Forward-looking action reduces the risk of ending up with stranded assets and improves future viability

The real-estate sector must become greener

When it comes to naming areas of the economy with the biggest carbon footprint, most people immediately think of sectors such as energy, industry and transport – and rightly so. But it is often forgotten that real estate is also a significant contributor to climate change. According to a report by the German Environment Agency, buildings account for approximately 35 per cent of final energy consumption in Germany and around 30 per cent of the country’s total carbon emissions.1 It is true that greenhouse gas emissions have been falling steadily in recent years (see chart 1). And emissions in the real estate sector (mid-green shade in the bar chart) have also been progressively declining – with the exception of the rise from 2018 to 2019.

Chart 1: Greenhouse gas emissions in Germany

Chart 1: Greenhouse gas emissions in Germany
Source: German Environment Agency (2021).

But in 2020, real estate was the only sector of the economy that exceeded the maximum permitted emissions threshold stipulated by the new Federal Climate Change Act.2 The breach of the threshold under this Act means that the real estate sector is now required to take targeted action in order to return to the envisaged CO2 reduction trajectory.

In the fight to mitigate climate change, a green transformation of the real estate sector and – more specifically – of the existing building stock is therefore urgently required, in Germany as well as in other countries. But what are the prerequisites for a successful transformation and what regulatory hurdles need to be cleared?

The first place to start is with the buildings themselves. That is why this edition of our Transformation Insights, in contrast with previous editions, focuses on properties rather than exchange-listed companies. In addition, this paper outlines both the challenges and the opportunities presented by the necessary transformation process for real-estate investors (i.e. property owners) and asset managers.

Regulation forces owners to become greener

The growing relevance of sustainability-related issues for the financial markets has been addressed at European level, for example with the implementation of the EU Action Plan on Financing Sustainable Growth.3 This action plan aims to redirect the flow of private-sector funding towards more sustainable economic practices – including in the real estate sector. To this end, the action plan includes measures to improve transparency and public reporting on sustainability-related matters. In addition, it establishes a standardised and clearly defined classification for sustainable economic activities. Important pieces of legislation in this context include the Sustainable Finance Disclosure Regulation (SFDR), which came into effect in March 2021, and the Taxonomy Regulation.4 Asset managers who manage property portfolios, such as Union Investment, are included in the scope of application of these regulatory instruments.

The new requirements have far-reaching implications for investors and asset managers. For example, property portfolio owners are required to disclose information on relevant sustainability criteria in relation to their portfolios. The catalogue of criteria specified by the taxonomy makes sustainability measurable and determines what activities (including investments) can be classified as sustainable. In accordance with the provisions of the above regulations, financial products, including real estate funds, can be described and marketed as sustainable only if they comply with the defined criteria. Those operating in this sector of the economy are therefore facing mounting pressure to adapt.

The European Green Deal agenda also addresses the real estate sector and requires adjustments to improve sustainability, with a particular focus on reducing energy consumption.5 Alongside European legislation, a growing catalogue of ever further-reaching national provisions is being introduced that also needs to be taken into account and may necessitate investment in existing properties. This adds a further layer of complexity for property owners. Asset managers need to tackle the challenges of this environment if they too wish to be able to benefit from the opportunities of sustainable investment options in this sector and to stand out from their competitors.

Further regulation causes planning uncertainty

The process of taking account of sustainability requirements and implementing them in practice involves various elements of uncertainty for property owners. The EU Taxonomy Regulation provides a starting point for a framework, but it is currently still skewed quite heavily towards environmental objectives. It is, of course, undeniable that the real estate sector needs to comply with the envisaged reduction trajectory for greenhouse gas emissions in order to ensure that the goal of climate neutrality can be achieved. This means that, from a sustainability perspective, investments in existing properties now need to focus primarily on energy efficiency and the reduction of greenhouse gas emissions over the entire life cycle.

But alongside environmental factors, social criteria are also becoming increasingly relevant to the classification of properties. The planning process for real estate projects already places a growing emphasis on aspects such as social housing, childcare facilities and design concepts that are sympathetic to the needs of the elderly. But the Taxonomy Regulation does not currently define criteria and quantifiable metrics for the social sphere in the same way as for environmental issues. It remains uncertain what a more detailed draft for this area will look like. With regard to the practical implementation, problems could arise – for example – if the same social criteria are meant to be applied to different categories of real estate. Owners of commercial properties such as hotels, office buildings or logistics centres might find it much harder to comply with potential social requirements under the EU taxonomy. But regardless of any uncertainties, property owners will need to prepare for the fact that the anticipated social taxonomy will present them with additional challenges. The upside is that the expanded taxonomy will provide a standardised framework that resolves existing ambiguity and localised approaches to social criteria. The taxonomy will thus become even more effective at performing its primary function – to make the assessment of the sustainability of business activities more objective and thereby prevent greenwashing.

User-investor dilemma could hold back transformation efforts

To an extent, the planned expansion of the taxonomy to social aspects is uncharted territory for property owners. But in a wider sense, they already need to address social challenges in many areas. After all, owners constantly face issues and decisions that require them to engage with their tenants – regardless of whether the property is used for commercial or residential purposes. An ongoing dialogue between landlords and tenants is also key to success when it comes to initiatives for transforming existing properties in order to make them more sustainable. For example, landlords first need reliable end user consumption data in order to then be able to make a well-informed investment in a suitable new, more efficient ventilation system. This modernisation is a necessary prerequisite for the reduction of final energy consumption and emissions, which – in turn – translates into lower utility costs for tenants and an (ideally taxonomy-compliant) upgrade to the property’s sustainability classification for the owner.

However, in certain cases, landlords and tenants face a user-investor dilemma. For real estate investors, it is financially unattractive to invest in modernisation measures to improve, for example, the energy efficiency level of a building if it is unlikely that this will raise the value of the property (e.g. through higher rental prices). Tenants, on the other hand, immediately benefit from modernisation measures, because their utility costs go down. If it remains unresolved in too many cases, this well-documented conflict of interest could hold back the transformation of the existing building stock and thereby jeopardise the achievement of the climate neutrality target for the sector as a whole. The hunt for possible solutions is on. One way forward could be cost allocation formulas that are agreed between all parties. These could be based, for example, on the existing energy efficiency level of the affected property. Such pragmatic approaches may help to map out a collaborative path towards the overarching goal of reaching climate neutrality while taking account of relevant social criteria.

Sensible starting points for energy efficiency improvements

At present, the focus for investors in the real estate sector is on the clarification of environmental questions and transformation approaches. Thanks to the catalogue of environmental criteria set out in the taxonomy, sustainability-oriented investments in measures to improve energy efficiency or reduce greenhouse gas emissions can now be quantified and rated. But when it comes to the global real estate sector’s prospects of achieving the target of climate neutrality by 2050 at the latest, the solution will need to be more comprehensive than just stepping up carbon offsetting and making new construction projects more energy-efficient. The data shows that a substantial portion of the carbon footprint of a property arises from the use of resources and the supply of construction materials before the property is put into operation (the production of steel and concrete have a particularly large negative impact in this respect).6 According to the World Green Building Council network, around 11 per cent of the total carbon emissions attributable to the real estate sector are generated by the production, transport and installation of construction materials, i.e. before the property is even put to use. The network also estimates that, by 2050, emissions generated pre-completion will account for up to 50 per cent of the total carbon footprint of new buildings.7

Governments are also stepping up both the pressure and support for a sustainability-oriented modernisation of the existing building stock. Realistically, the goal of climate neutrality will not be achieved unless investment is also directed at existing properties in order to improve their energy efficiency. This is especially important given that around two thirds of the current building stock is expected to remain in use until 2040. It will therefore be crucial to ensure that necessary modernisation measures in the coming years focus as much as possible on sustainable improvements and energy efficiency upgrades. Transparent information campaigns about the benefits of energy efficiency-oriented refurbishment could be an effective way to generate momentum. But the provision of financial incentives and a consistent, pragmatic framework from governments will also be key to creating this momentum.

Meaningful comparison requires holistic analysis

In practice, key questions that matter to owners of individual properties and large real estate portfolios alike are: How will my properties – new builds as well as existing building stock – be rated and classified with regard to their sustainability and eco-friendly modernisation measures? Under what circumstances do buildings or property funds qualify as sustainable? The real estate sector uses EPC (energy performance certificate) ratings to determine the level of sustainability of a property. The EPC includes information such as the carbon footprint of a building and its expected or actual energy consumption. The nub of the problem is that, according to the World Green Buildings Council, only around 28 per cent of global greenhouse gas emissions in the real estate sector arise during the usage phase of properties. As a result, a holistic assessment of the entire life cycle is required that takes account of the energy consumed and the carbon emissions generated during the construction phase. These ‘built-in’ emissions are not being addressed sufficiently in the current debate. This is partly attributable to the fact that, for a large proportion of properties, there is currently no usable data available on energy consumption and built-in emissions at individual property level. For lack of better data, EPC ratings thus serve as the basis for the assessment of the sustainability of buildings in accordance with the taxonomy. Property owners use (positive) energy performance certificates to comply with their obligation under the SFDR to prove which buildings or real estate-based fund products fulfil which sustainability criteria.

Leading property owners have, in recent times, founded various initiatives in order to address some of the shortcomings in transparency and in how sustainability criteria are interpreted in real estate and real estate funds. One such initiative is ECORE.8 More than 100 industry participants from Germany, Austria and Switzerland are now involved in the project, which aims to establish a new sustainability standard. Union Investment was a founder member of ECORE and was instrumental in getting the initiative off the ground. The standard that has been developed is used to analyse properties in three different categories and gives them a rating on a scale of 0 to 100:

  • Governance: Sustainable management targets, engagement work and external quality assurance at portfolio and company level are among the factors assessed in this category.

  • Consumption and emissions: The focus in this category is on quantitative collection and analysis of all relevant consumption data. This is key to creating a set of base data in the real estate sector that will get better and better as time goes on. An assessment is also carried out as to whether the actual energy consumption of each property is ‘Paris-ready’, i.e. whether the properties will achieve the goal of climate neutrality by 2050 through emission reductions. The Carbon Risk Real Estate Monitor (CRREM) provides decarbonisation pathways for various use types and countries. It facilitates the quantitative analysis of different scenarios and properties in various industrialised nations 9 and is one of the tools used by Union Investment to value properties.

  • Asset Check: In this segment, we examine and qualitatively evaluate a large number of different factors, including the building materials used, user comfort and certain site characteristics.

This kind of comprehensive and dynamic examination of buildings and real estate portfolios provides a meaningful overall assessment, one that goes well beyond the criteria required for energy performance certificates. It is the only way to show how well sustainability goals have already been implemented. The analysis also indicates where there is still potential or need for improvement so that corresponding targets and timelines can be set on the basis of quantitative data. ECORE, meanwhile, makes it possible to compare the sustainability characteristics of property portfolios with those provided by competitors. This opens up opportunities to learn from other companies and highlights areas where property owners themselves are able to make improvements. For investors, on the other hand, the analysis method offers a unique means of comparing investment products such as real estate funds across multiple providers.

Avoiding risks and capturing future potential

Simple in principle, complicated in practice. Property owners and asset managers face a multitude of regulatory adjustments - on an international but also national level - when it comes to sustainability and the transition to a green economy. Politicians, meanwhile, are now called upon to turn the vision of sustainable transformation into reality. It is important to find a balanced solution, to share costs fairly and to minimise hurdles, particularly when it comes to regulatory requirements and tax law. The new regulations will need to be implemented by the affected companies in future, in some cases even if they do not intend to have a sustainable real estate portfolio or financial product. To accomplish the Herculean task of shifting the sector to a more sustainable footing, it is imperative that we face the challenges at an early stage, broaden the base data and carry out targeted analysis - and that we do so over the long term and throughout the value chain. What’s more, only by taking forward-looking action and making continuous improvements to the real estate portfolio itself will we be able to limit the physical risks posed by climate change. This will head off the danger of some parts of the building stock becoming stranded assets due to a lack of modernisation. In such a scenario, buildings would decline in value and need to be written down because they fail to meet sustainability requirements. A report by Savills Research from autumn 2021 shows that this is a very real danger. It found that 87 per cent of office buildings in the UK’s major centres have an EPC rating of C or worse. This means they currently violate the Principal Adverse Impacts (PAI) of the EU’s Sustainable Finance Disclosure Regulation and so are considered not to be sustainable.10 The example is illustrative of a problem facing other countries and building categories as well. Investment is clearly essential and the need for adaptation is great. Properties that are not brought into line with the goal of climate neutrality quickly enough face seeing their value decline in the years ahead.

In spite of all the challenges, the growing importance of sustainability around the world presents the players in the real estate market with huge opportunities for future growth. Global interest is driving demand for buildings that are already designed to be sustainable, particularly in the commercial sector. At the same time, real estate funds with a sustainable focus can also expect growing inflows. The main drivers on the demand side are institutional clients such as pension funds (e.g. ABP from the Netherlands and Denmark’s ATP) as well as sovereign wealth funds and insurance companies (e.g. Axa in France) that are also looking to invest an increasing proportion of their assets in line with sustainable principles. And because the strong demand is currently being met by a still insufficient supply of energy-efficient and sustainable properties, the implication is that properties classified as sustainable are likely to hold their value more and be more resistant to crises in the long term than buildings that are less sustainable. For property owners, investment managers and project developers, these are compelling arguments for getting more involved in this area of sustainable real estate than ever before.

In summary, it can be said that compliance with regulatory requirements at international and national level is the base level of commitment that is required for the future business activities of industry players and investors. But additional adjustments and efforts will be necessary in order to stand out from the crowd in the long run and build a positive reputation in the market. Investment managers need to come up with a long-term transformation strategy that encompasses their entire value chain, is able to respond flexibly to changing conditions using quantitative-based models such as ECORE, and never loses sight of the overarching goals of limiting global warming in accordance with the Paris Climate Agreement and achieving climate neutrality in the building sector by 2050.

  1. 1 For further information, see the full article of the German Environment Agency.
  2. 2 For further information, see the Federal Environment Ministry’s full report on greenhouse gas emissions in 2020.
  3. 3 For further information, see the following fact sheet published by the European Commission.
  4. 4 The following links provide further information on the Sustainable Finance Disclosure Regulation and the taxonomy.
  5. 5 The following document provides a brief overview of the European Green Deal.
  6. 6 For further information, see the ‘Renaissance in der Baubranche’ (Renaissance in the construction sector) study paper.
  7. 7 For further information, see the full report of the World Green Building Council.
  8. 8 See the ECORE website for more information on the project, its approaches and its objectives.
  9. 9 See the CRREM website for a more detailed explanation of the analysis tools and objectives of the CRREM project.
  10. 10 Two of the 18 PAIs are mandatory for properties. The first entails an assessment of the proportion of the property stock that has poor energy efficiency (EPC rating of C or worse). The second is a calculation of the share of investments in real estate assets involved in fossil fuels (e.g. extraction, transport or storage). Another criterion also has to be chosen from the list of PAIs for real estate. For this third PAI, total primary energy consumption would appear to be the most useful for the assessment of buildings.


Mathias Christmann, Jan von Mallinckrodt

As at: 19 November 2021