The world of investments has been undergoing a real transformation in recent years. Investors no longer focus solely on the bottom line (profits), but are also paying close attention to how their investments are affecting ESG issues. The ESG trend is gaining momentum in the alternative real estate market, which has become one of the leading channels for implementing principles of sustainability and responsible investments.
Alternative real estate investments refer to a variety of properties outside of the traditional categories of commercial and residential real estate and include categories such as data centers, logistics centers, long-term rental housing, student housing, assisted living housing for the elderly and real estate for renewable energy facilities. Incorporating ESG principles into these investments has become a significant factor for institutional investors and large investment funds.
According to data from the Global Sustainable Investment Alliance, the volume of global investments defined as “responsible investments” in 2023 totalled about USD 35 trillion, with average annual growth of about 15% over the last five years. Green real estate investments account for a growing share of this volume, particularly investments in properties offering higher energy efficiency, reduced carbon emissions and climate resilience.
Green properties may offer a higher premium, since they are benefitting from increasing demands from end-users opposite relatively limited supply, which drives up prices. Energy-efficient properties also enable significant reductions in current operating and maintenance expenses, and sometimes receive preferential access to financing from financial institutions. Furthermore, these types of properties have better risk profiles, since they are less exposed to future regulatory costs, such as carbon taxes. Green properties are also more resilient to extreme weather events and are less exposed to regulatory risks and usage restrictions as is currently the case for properties with low energy-efficiency ratings.
However, it is important to keep in mind that since the construction and development of green properties entail relatively high initial costs, it takes longer to receive a return on the investment. Regulatory amendments and government support or nonsupport can also have a dramatic impact on the activities of companies in this sector. It is also important to keep in mind that green investments are still developing and some technologies have not yet been absolutely proven.
Differences in approach towards ESG in alternative real estate between Europe and the United States
The European approach
Europe is leading the global trend in implementing ESG principles in real estate investments. The European Union has adopted binding regulatory frameworks, such as the SFDR (Sustainable Finance Disclosure Regulation), which obligates institutional investors to report on their sustainability considerations in their investments.
The European approach also clearly defines which economic activities are considered “green” and sets ambitious targets for energy efficiency in buildings. In Europe, about 70% of the new alternative real estate funds are defined as fulfilling Article 8 or Article 9 of the SFDR, which indicates a high commitment to sustainability principles. Large European pension funds, particularly in the Netherlands, Sweden and France, have stipulated that ESG policies are preconditions for considering investments.
The American approach
The United States’ approach towards ESG is more voluntary and is driven primarily by market forces and investor pressure, with considerable variation between states. California, New York and Massachusetts, for example, are leaders in legislation supporting ESG and in incentivizing green building. In the US as a whole, only about 40% of new alternative real estate funds have declared structured ESG policies, but the number of such funds is growing at a rapid pace, especially due to pressure being exerted by institutional investors.
The Paris Agreement signed in 2015 led to the adoption of stricter regulations in Europe and to economic incentives in the United States. These developments are prompting an unprecedented volume of capital investments in the development of low-carbon construction solutions. Investors in alternative real estate must adapt their investment strategies to a reality in which achieving climate goals is a key factor in generating long-term value for their properties.
To summarize*, the green trend and ESG investments are transforming the alternative real estate market and are significantly impacting property values, capital requirements and investment strategies. This is not a passing phenomenon, but rather is a fundamental change in the investment paradigm. While the disparities between the European and American approaches are significant, the overarching trend is definitely in one direction – towards wider adoption of ESG principles. The impact on property values has been proven and includes significant value premiums and improved risk profiles for green properties.
The long-range returns, the competitive advantages and access to financing on preferential terms make investments that take ESG aspects into account quite attractive, notwithstanding the high initial costs. The Paris Agreement and the global emissions reduction targets constitute a significant catalyst that will continue to impact the alternative real estate market in the coming decades. This trend may create new opportunities for investors that embrace this shift towards ESG.
