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Guest Blog: UK Property Can Shine, But Sustainability Is Essential

By Simon Durkin, head of EMEA real assets research and strategy, BlackRock 

The resilience of UK real estate has been severely tested by the pandemic; all sectors faced a multitude of challenges, from enforced lockdowns and closures to occupiers re-evaluating their real estate requirements. Simultaneously, as businesses and communities were plunged into crisis, the pandemic caused us to confront the realities of the broader threats we face long term. We have seen efforts to address climate change, perhaps at risk of being put on the back burner as was observed during the GFC, accelerating over the last year, with the pandemic serving as a tangible reminder that the biggest crises still lie ahead – and demand an ambitious and decisive response.

In the past year, the physical toll of climate change has become ever more apparent, and there is now a recognition that there will be direct financial consequences of failing to prepare for it. There has also been widespread and growing impetus behind the push to more sustainable investments, as the significant economic opportunity that the transition to a green economy presents becomes more evident. For our investors, climate change and sustainability are at the top of their list of priorities.

Considering sustainability is no longer optional for UK property managers. However, UK real estate remains one the most attractive markets globally, offering resilience across the cycle due to its high transparency, liquidity, market size and fair value. Vaccine programs in the UK are the most advanced in Europe, facilitating an earlier reopening of the economy and the UK economic outlook is the strongest in Europe. Yet, the effects of climate change must remain front of mind for investors and tenants, given that real estate is one of the asset classes where climate change poses physical and transitional risks to assets.

A framework published by the UK Green Building Council in April 2019 reported that buildings account for up to 40 per cent of the UK’s carbon emissions, the majority of this through heating, cooling and electricity use. Furthermore, the embodied emissions from the construction process can account for a staggering 50 per cent of the carbon impact of a building over its lifetime.

As the UK industry adapts to ensuring new and existing buildings are aligned with net-zero carbon by 2050, in line with the goals of the Paris Agreement, delaying action on decarbonisation is not an option. Sustainability as it relates to individual buildings translates directly into the sustainability of value and performance. As occupiers seek to understand the long-term implications of a more flexible approach to working, so too are they assessing the sustainability of the assets they occupy. This not only impacts the operating costs associated with their estate, but importantly the assets they occupy will become extensions of their corporate net-zero commitments.

Physical real estate will become increasingly vital in attracting and retaining the talent so critical to business growth. We expect a greater emphasis on employee health and wellbeing and landlords to create more spaces to facilitate innovation, creativity and teamwork. The space that corporations choose to occupy will also act as a beacon for their own sustainability commitments.

Moreover, the population at large have become more conscious of their own carbon footprint and with it, the net-zero commitments of their employers. As individuals makes personal commitments to tackling climate change, this will also extend to their working life. As such, businesses will have to offer a work/home balance that is cognisant of personal carbon footprints, and places of work that have clear net-zero strategies. Add to this dynamic an increase in the war for talent, the sustainability of buildings will become an ever more important performance differentiator and determinant of value.

The office space was already evolving pre Covid and occupiers are likely some way ahead of investors in their understanding of what a different work/home balance actually means to their ongoing space requirements. Nevertheless, offices will remain the beating heart of UK central business districts with real estate therefore becoming a key strategic tool for CEOs to attract and retain top talent, rather than simply a cost for CFOs to minimise.

We are quickly moving from a world where we are incorporating sustainability data into investment analysis, to one where portfolios must have exposures to positive characteristics, aligning capital with changes in the marketplace.

Private investors can manufacture this exposure by improving assets, for example, upgrading to LED lighting and optimizing building controls to reduce energy consumption. For asset managers this shift presents an exciting opportunity. The nimblest investors recognised that communication and continuous dialogue with tenants was more critical during the pandemic than ever before.

However, the managers most successful at delivering long-term resilience, manifesting in higher rent collection rates, were those who already had strong engagement with their tenants. This dialogue – between all stakeholders across the value chain – will only continue to grow in importance as the transition to a net-zero economy accelerates.