Opportunities for real estate investments: ESG-compliant building, buying, selling and renting.

1. introduction

The stated goal of the European Union (“EU“) is to become the first climate-neutral continent by 2050. In order to achieve this ambitious goal of climate-neutral economic activity, the EU obliges financial market participants to participate in the achievement of the goal – in particular through disclosure obligations and a classification system for reviewing and defining the requirements for sustainable economic activities. Accordingly, the requirements for national legislators in implementing these EU goals and targets are also high. As a result, the real estate industry is also currently undergoing a profound shift towards a stronger orientation towards environmental, social and sustainable corporate governance and investment strategy, which is further catalyzed by EU regulatory activities. The central buzzword is “ESG“, which stands for the following topics:

– Environmental– for ecology and the environment,
– Social– for social responsibility,
– Governance– for good corporate management.

2) What are the EU ESG regulations that may have an impact on the real estate industry?

The main regulations issued by the EU are the Disclosure Regulation (Regulation (EU) 2019/2088) and the Taxonomy Regulation (Regulation (EU) 2020/852), which is supplemented by the Delegated Regulation (Regulation (EU) 2020/1816). These regulations all relate to environmental. The Disclosure Regulation is in force, the Taxonomy Regulation is applicable since 01 January 2022.

3. what does the EU regulation regulate in terms of disclosure requirements? Who is addressee:in?

For the European Commission, the creation of transparency and control is the decisive criterion for enabling future-oriented economic activity. The overriding objective of the Disclosure Regulation is to ensure transparency as to whether a product offered on the financial market is a sustainable product. Under the Disclosure Regulation, investors are to be informed in part in advance of the contract initiation process whether and to what extent the companies offering the products comply with ecological and social standards and the criteria of good corporate governance.

The ordinance covers so-called financial market participants (including companies that provide services in the context of portfolio management or collective asset management as well as insurance companies), which must comply with the requirements themselves. This also covers alternative investment funds (AIF) such as special real estate funds. Here, the implementation of the regulations must be carried out in particular by the capital management companies (KVGs). Real estate fund managers must disclose the extent to which they meet ESG requirements with their fund.

4. what does the taxonomy ordinance regulate? Who is addressee:in?

The Taxonomy Regulation implements a uniform classification system in the EU to define the benchmarks and requirements of sustainable economic activities. The Taxonomy Regulation is addressed to the EU and its member states, to the financial market participants already mentioned above and to companies that are required to publish non-financial statements.

The Taxonomy Regulation is intended to raise awareness among financial market participants and investors of the environmental impact of financial products. The transparency created in this way can, as it were, increase investor confidence and steer investment decisions towards environmental goals.

An economic activity is considered to be environmentally sustainable if it

• makes a significant contribution to the achievement of one or more of the defined environmental objectives: (a) Climate protection; (b) Adaptation to climate change; (c) sustainable use and protection of water and marine resources; (d) Transition to a circular economy, waste prevention and recycling, (e) Pollution prevention and control; (f) Protection of healthy ecosystems;
• does not significantly harm one or more of the environmental objectives (Do No Significant Harm rule),
• in doing so, compliance with a minimum social standard and
• meets the technical evaluation criteria set out in the EU Regulation.

5. what are the effects of the regulations when buying or selling real estate?

The classification of a property as ESG-compliant is already a value-creating factor and thus indispensable in particular for maintaining the value of a property. Currently, the scope of the Disclosure Regulation and the Taxonomy Regulation does not yet cover the entire real estate industry. Not to be overlooked, however, is the trend toward casting ESG issues in a variety of legal obligations. We are at the beginning of this trend, so further impact on the real estate industry is to be expected. In addition, the regulations may soon establish themselves as landmarks for the real estate industry, compliance with which will provide a competitive advantage.

The German legislature and the federal and state ministries have already implemented the EU requirements and are currently setting new requirements for property owners, such as the Heating Cost Ordinance (HeizkostenV), which places new requirements on landlords with regard to differentiated consumption measurement:(Heizkostenverordnung), which places new requirements on landlords with regard to differentiated consumption measurement; the obligation of the building owner to replace and retrofit (insulation, consumption and gas/oil boilers) on the basis of the regulations of the Building Energy Act (Gebäudeenergiegesetz, GEG); the requirements of the Photovoltaic Obligation Ordinance (Photovoltaik-Pflicht-Verordnung, PVPF-VO), which has already been issued in Baden-Württemberg and requires the installation of photovoltaic systems in new buildings, and the right of the tenant to demand the installation of air-conditioning systems. tenant to demand the installation of charging stations for electric cars, combined with a corresponding obligation on the part of the building owner.

6. what are the effects of the regulations on the leasing of real estate?

The sustainable, ecological use of a property is also becoming increasingly important for tenants and their reputation. If a landlord:in creates ESG-compliant conditions, he or she enables the tenant to externally vouch for and implement the achievement of ecological goals. This attracts strong and high-quality tenants and thus also secures rental income and usability of the respective property. So-called “green lease clauses” are increasingly being included in leases, which document and make verifiable ESG compliance for the tenant. These contractual arrangements may relate to two aspects: (a) to ensure ESG-compliant substance of the building (as part of landlord/tenant fit-out, construction of the building); and (b) to ensure sustainable, resource-conserving use of the building (through intelligent measuring devices, data collection and evaluation, etc.).

7. the “social” is also relevant for the real estate industry

It is not only sustainability criteria that need to be considered in the life cycle of real estate. The Supply Chain Due Diligence Act (Lieferkettensorgfaltspflichtengesetz, LKSG), which will affect large companies with at least 3,000 employees in Germany from January 1, 2023, and extend its scope to companies with at least 1,000 employees from 2024, takes measures to ensure compliance with human rights along supply chains. Violations could result in fines of up to eight million euros or two percent of annual sales. The term supply chain extends from the company’s own business unit to direct suppliers and indirect suppliers (with substantiated knowledge). Companies that fall within the scope of the LKSG must also conduct a human rights and environmental risk analysis of their suppliers in their risk management system. Thus, preventive and remedial measures are to be taken in individual cases, which are to be documented and regularly reviewed.

8. conclusion

In the future, ESG criteria will become relevant throughout the entire life cycle of real estate – from the planning of new buildings, the refurbishment of existing properties, and real estate transactions to the renting and leasing of properties. The European Union’s regulatory process with regard to the implementation of sustainable ESG concepts and the financial sector’s commitment to climate-friendly business practices has long since begun. In the coming months, numerous other Union requirements relating to sustainable business will come into force. We therefore expect that an increasing number of market participants from the real estate sector will be directly affected by EU regulations in the future – and all others will be indirectly affected by requirements formulated by financing banks. At present, the existing regulations are still very detailed, legal formulations are sometimes imprecise, and there is still a lack of empirical values in four cases. Nevertheless, it is already possible today to make the ESG compliance of real estate visible in a value-creating way by means of legal appraisals – in particular as part of a legal due diligence review – in cooperation with technical experts.