As one of Australia’s largest industries, the Property sector is well-positioned to use its influence to address social issues and drive sustainable outcomes. Environmental, Social, Governance (ESG) is a major consideration for landlords and occupiers, bringing to light issues like climate change and resource scarcity.
While these are important environmental factors, ESG covers a much broader range of issues, such as labour practices, product safety, data security, diversity, and business ethics, which are important parts of investors’ due diligence.
Currently, 40% of CO2 emissions worldwide come from real estate (Carlin, 2022) while 10% of Australia’s Carbon emissions are a by-product of the commercial property sector (DCCEEW, 2024). To achieve Australia’s net zero target by 2050 swift action needs to be taken within the property market to reduce carbon emissions.
Forcing the Stakeholder’s hand
With an increasing environmentally conscience population dealing with the effects of climate change, corporate occupiers demand a higher level of ESG reporting and compliance. To effectively improve ESG performance, it must be morphed into a company’s corporate strategy, with 70% of investors advocating for the integration of ESG into a firm’s framework (PWC, 2024).
Rather than doing the bare minimum, landlords and occupiers need to demonstrate leadership to show their stakeholders they mean ‘business’ by implementing ESG practices into everyday operations. Those landlords who seek high-profile tenants who are subject to ESG reporting and do not move forward with ESG practices will be left behind, as high-grade tenants will seek out landlords who keep up to date with the latest and greatest ESG programs.
Do Not Fall behind
Despite the obvious positive environmental and social benefits of environmentally friendly investments, a substantial monetary upside encourages firms to ‘do the right thing’, and those landlords who don’t will be left behind.
Increasingly landlords and occupiers are considering ESG value drivers in the deal process. As part of their due diligence, investors are now assessing how they can avoid value erosion and increase their value through environmentally conscious investments, creating a win-win situation for their investors.
Market trends indicate that buildings with a higher NABER rating receive a higher premium on rents, yields and increased occupancy. For each increase in rating, rents can be 4% higher and the higher the rating the lower the cap rate. In addition, energy accounts for 15% of a building’s operating costs, making it attractive to property owners to become ESG-friendly.
Like NABERs rated assets, Green Star-rated assets also produce better returns (Green Building Council Australia, 2023):
- 16.4% higher capital value/m2
- 13.5% higher annual return
- 23% longer WALE
- 66% less electricity
- 51% less water
There are many simple ways to improve a building NABER rating to reap the rewards:
- Replacing lighting with LED fixtures and occupancy sensors can reduce electricity for lighting by up to 75%
- Installing water-efficient fixtures
- Heating, Ventilation and Air-Conditioning (HVAC) account for most of the costs in a commercial building. Replacing old units can reduce electricity buy 10%
- Implementing proper ventilation and air filtration systems to maintain good indoor air quality.
ESG and Financing
Australian banks employ various ESG risk management strategies to ensure responsible lending and investment practices. These include Integration in Risk Framework, ESG in Credit analysis and assessment of High-Risk Sectors which determine the credit spread of a given loan.
Financial institutions have also updated their lending guidelines to include a ‘no risk appetite’ list of business they are unwilling to finance due to associated ESG risks. This typically includes sectors that are considered to have a higher inherent exposure to ESG risks or are misaligned with the lenders sustainability goals.
These align with a part of a broader commitment to sustainable goals and align with international regulatory expectations. By taking into account the environmental, social and governance impact of a loan, banks can determine the sustainability of the business they finance, ensuring their lending practices align with their broader ESG goals.
An example of this is the Commonwealth Banks’s $2.2 billion sustainability loan to the Royal Adelaide Hospital raising the standard for sustainability goals and social inclusion in major infrastructure projects. As part of the terms, Celsus (management firm) is required to report publicly how it’s fulfilling its objectives for social inclusion and sustainability.
Sustainability-linked loans (SLLs)
SLLs create a direct two-way link between sustainability performance and funding costs. As such, pricing marginally increases or decreases depending on the sustainability performance of the borrower, which is assessed by a third-party.
Whether financial or not, incorporating a penalty provides ‘skin in the game’ and enhances the credibility of the loan while incentivising the borrower to exceed current sustainability performance. The SLLs present an incentive to change behaviour, creating an opportunity for different outcomes that are more likely to get corporate borrowers interested.
An example of this is Sydney Airport’s $1.4 billion SLL. If the company meets its sustainability targets, it receives a monetary deduction from its repayments; however, if it fails to meet its goals, it receives a non-financial penalty. This incentivises the borrower to meet its targets for a financial reward but also protects the lender’s reputation for ESG practices.
Setting up a Profitable Exit
ESG is now critical to secure a profitable exit in commercial real estate. With investors and funds so focused on meeting environmental targets to please stakeholders and secure funding, ESG has never been more crucial to a building’s success. With higher rents and lower cap rates associated with higher ESG ratings, investors looking to divest their portfolio will see higher prices and a more profitable exit if they focus on ESG efforts.
The Future of ESG
There are currently two rating systems in place, NABERS (National Australian Built Environment Rating System) and Green Star, which are voluntary programs scored out of six that assess a building’s ESG rating based on a range of environmental indicators. However, a NABER energy rating is compulsory whenever an office building larger than 1000m2 is either sold or leased (NABERS, 2024).
There are no mandatory real estate-specific ESG reporting requirements; however, ESG regulation will become more stringent. There is legislation in place from the Australian Treasury for large companies to produce mandatory climate reports over the next few years that meet at least two out of three criteria as follows (Button, 2024):
Group 1 (reporting period starting July 2024)
- Revenue > $500 million
- Assets > $1 billion
- Employees > 500
Group 2 (reporting period starting July 2026)
- Revenue > $200 million
- Assets > $500 million
- Employees > 250
Group 3 (reporting period starting July 2027)
- Revenue > $50 million
- Assets > $25 million
- Employees > 100
As such, landlords seeking large-quality tenants subject to these reporting guidelines will be forced to upgrade their buildings to meet the tenant demand and see premium rents.
For further information contact:
Hugh Menck
Head of Capital Transactions
+61 432 560 589
Archer Halliday
Analyst | Capital Transactions
+61 497 599 959
For a complete list of weekly commercial transactions in Queensland, visit McGees Wrap Up | McGees Property Brisbane
Disclaimer: The information provided in this blog is for general informational purposes only and does not constitute legal, financial, or professional advice. While we strive for accuracy, we make no guarantees regarding the completeness or timeliness of the content. Always seek independent advice before making any financial or real estate decisions. We are not liable for any loss or damages arising from your reliance on the information provided.
Liability Limited by a Scheme approved under Professional Standards Legislation
