ESG: how technical due diligence can protect you from being left with a ‘stranded asset’

With ESG and net zero at the top of the business agenda, the environmental impact of the built environment has, rightly so, been a key focus. However, as part of this transition the value of real estate is likely to be impacted due to the growing potential for 'stranded assets' - the term used to describe a property which will not meet future energy efficiency standards or market expectations, and as a result will be increasingly exposed to the risk of early obsolescence.

Increasingly investors are relying on technical due diligence (TDD) to inform them on how an asset actually performs and identify potential risks. Often everything from the literal fabric of the building to the availability of energy performance data is accounted for to help avoid this outcome.

This is very likely to be impacted by the changing legislative landscape. For instance, as of April 2023 the Minimum Energy Efficiency Standards (MEES) requirements will apply to existing commercial leases. Landlords will not be permitted to let properties with an Energy Performance Certificate (EPC) of F or G, subject to certain exemptions. What's more, this minimum requirement will tighten as regulations change, capturing more assets and putting the future value of those buildings that don't comply at great risk.

The shift away from modelled energy use such as EPCs towards metered actual energy consumption and carbon emissions must also be factored in. If not, many businesses will have portfolios of properties that will not meet energy performance legislation.

This is where TDD has an important role to play by applying technical advice to a business's ESG strategy. For example, during a TDD exercise, the carbon emissions and energy use of an asset can be benchmarked against a client's carbon reduction ambitions, just one ESG factor that is increasingly impacting on asset value and investment decisions.

An asset may be performing badly now, but there are opportunities to make improvements and ultimately add value. The leasing structure of a building can drive the ability to influence this process. It can relate to both lease events and the type of occupier, which may make it easier, or possibly harder, to improve the ESG performance of a property.

At present, this is something that the industrial and logistics sector, in particular, is having to contend with. Due to considerable demand, both from investors and occupiers, secondary assets are becoming increasingly attractive as the competition for space intensifies. Consequently investors are looking at these older, more inefficient units, especially as values and returns improve. However, at present many remain unaware of the potential long term ESG pitfalls.

As always, to be forewarned is to be forearmed and this knowledge will enable an investor to influence their asset value in line with changing legislation, ensuring they don't become stranded when it comes to ESG.

Further information

Contact Chris Skinner

Contact Savills Technical Due Dilligence