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Episode 36 - Part 1: Understanding ESG and Its Impact on Property Valuation with Joël Scherrenberg
40 Plays1 year ago
In this episode, host Matt Nally of Survey Booker converses with Joël, an active RICS member and valuation expert, to explore the relevance of Environmental, Social, and Governance (ESG) criteria in property valuation.
The discussion sheds light on:
1. The definition and importance of ESG in the valuation process.
2. Factors affecting property valuation including environmental and social impacts.
3. The interaction between value drivers, risk drivers, and cashflow drivers in property valuation.
4. The role of legislation and financial sector pressures in driving ESG compliance.
5. The anticipated increase in ESG-related regulations impacting the property market.
00:00 Introduction to the Podcast
00:15 Guest Introduction: Yoel and His Background
00:31 Understanding ESG in Valuation
03:06 Factors Affecting Property Valuation
06:57 Value, Risk, and Cashflow Drivers
13:17 Regulatory and Social Drivers of ESG
18:23 Future of ESG and Real Estate
25:47 Resources for Learning About ESG
28:15 Conclusion and Next Topic Preview
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Transcript
Podcast Introduction
00:00:02
Speaker
Tune in to hear from people working in a range of industries and roles to provide you ideas that you can take away and use in your own
Guest Introduction: Yoel
00:00:08
Speaker
business. I'm your host, Matt Nalley, the founder and director of SurveyBooker, which is the leading CRM and survey management system for survey surveyors. On this week's episode, we have Yoel, who's an active RCS member and his background sort of day-to-day in evaluation.
What is ESG Evaluation?
00:00:21
Speaker
So thank you for coming on today. Thank you for inviting me and lovely to be here to tell something about what's happening on ESG evaluation.
00:00:30
Speaker
Awesome. Yeah. So that leads us in nicely. We're actually going to be covering on this episode everything around ESG and valuation and we'll split it into two topics. We'll look at ah what is ESG and why is it important in valuation? And then later on we'll look at the process of moving towards ESG in valuation. So should be a couple of interesting topics I think. Before we dive into everything, do you want to give a bit of background as to I suppose who you are and what you do day to day with this side of things?
Day-to-Day in Real Estate Valuation
00:00:54
Speaker
In my day-to-day missions, my primary activities are a failure aware of public real estate in the Netherlands. And you have to think about most of it is healthcare, care but also things like museums, sporting facilities, educational facilities, and all those kinds of things all over the country. Partially for financial institutes, partially for and the the balance sheet, and sometimes for decisions on political decisions where they have to make a choice between one or the other. Interesting. Okay. so i So a good but good background in valuation. I suppose in terms of, look we'll before we start moving on to sort of ESG evaluations, should we touch on what do we mean
Understanding ESG and UN Goals
00:01:41
Speaker
by yeah ESG? So what does it stand for and what's it cover? Yeah, ESG is, of course, the latter stands for environmental, social and governance.
00:01:49
Speaker
and But as I see it as more a holistic approach of sustainability, where you look into, in this in my kind of business, the real estate, is it fit for purpose and fit for the future? And therefore you need a framework to assess that. And therefore somebody thought ESG might be a nice framework because we can link it then to the sustainable goals of the United Nations.
00:02:19
Speaker
And it looks in a broader way only then like energy consumption. and When we talked about sustainability in real estate, focus was in the past almost only on energy consumption.
How Does ESG Affect Property Valuation?
00:02:36
Speaker
And there's so much more to sustainability than only energy consumption and therefore we needed a new concept and people thought ESG might be one and that's embedded in all kinds of legislation on European level and also on a global level. And um then it needs to be translated into what does it mean for real estate. I suppose on that on that note then, so you've mentioned that it previously was based primarily on energy usage. So what are the factors now that are encompassed by ESG that would affect a property valuation? yeah
00:03:14
Speaker
um When we look to property valuation, then you have to make a distinction in two lines. What kind of real estate? Because for domestic real estate, things might be different than for industrial real estate. And also you have to look to the geographical location of a real estate because the risk of earthquakes for the UK, I cannot imagine that there has ever been an earthquake not in um some parts of Greek or Italy it is a real risk and that's also for flooding and etc. When we look to ESG then most of the risks related to real estate are and driven by environmental
00:04:06
Speaker
climate change, um too much rain, too little rain, drought, pollution, all all the things you you see now in in all over the press in the business. And of course, also social and governance are important for real estate, but they are a little less easy to identify.
Social and Governance in Real Estate
00:04:32
Speaker
When we talk about social, then you have to think about how is your position as owner? In your relationship to the tenants? Are you contributing anything which you're building to the surrounding neighborhood? Those are examples of social aspects. And governance is all about are you compliant with legislation?
00:04:56
Speaker
um And not only strictly by the rules, but also by what is meant by it. And that's one of the main assets, I think, of RCS. It's always principle-based. You can say, okay, I'm following the rule, but I'm contradicting the purpose, so it's still wrong. okay And governance looks as well to the purpose as to the rules.
00:05:27
Speaker
And of course, when you own a building or you exploit the building, you have to be compliant with legislation. um And when I combine it with ESG, and for example, the Netherlands, then I have a quite simple example. In the Netherlands, if you want to use an office building, you need to have an energy rating of at least C.
00:05:55
Speaker
Yes. It's lower than C. You're not longer allowed to use the building. Now, there is where governance directly interacts with environmental and directly impacts the real estate. Interesting. Okay. So ah there's there's a number of different factors, um yeah, impacting, I suppose, valuation generally then. ah Absolutely. And um what we have determined during our investigation when we were writing this paper with a group of European followers and some RCS staff members.
Framework for ESG in Real Estate
00:06:28
Speaker
And also ah with the collaboration of a ah group of European leaders, we created the European Leaders Forum to help us to make sure that we had the connection with the market. And then you have to think about those where people from investors, banks, like the European Mortgage Federation, Urban Lanterns, ULI, APRA, INREV,
00:06:53
Speaker
those kind of organizations all contributed to this paper and we determined that when you look to ESG evaluation that you can divide it in three possible ways how it can affect the real estate. We determined value drivers if you have or if you don't have a specific asset or and then it might lower or higher your value, correctly.
00:07:26
Speaker
um For example, in this case, had the energy label C for an office building, if you don't have it, your building will be valued lower than with a label C. And then it's an easy connection. Then we determine the risk drivers. um And then you can say, OK, for example, flooding.
00:07:53
Speaker
But something and where you can say the building has certain, a yeah how do you say it, aspects which, how it's built doesn't affect whether it could flow a flood or not, because flooding is caused at a different place. But it might affect your real estate when flooding does happen. And you can add that risk in your valuation.
Impact of ESG on Value and Cash Flow
00:08:23
Speaker
If there's a low risk, you say it has hardly any impact on the valuation. If it has a low high risk, it might impact your valuation. That's a risk drive. And the last one is the cash flow driver, where you see that specific measures related to ESG might change your cash flow. I have a higher rent because I have a more energy-sufficient building. I have lower maintenance costs because I have taken certain the measures etc. So when we determine the 11 possible ESG factors in real estate, and I must say we have determined a little bit more, but we say there are about 11 factors we can now and somehow determine and certainly measure them.
00:09:22
Speaker
and From each of those factors we determined are the most influential value, the risk for the cash flow. And of course, they all eventually end up changing the value. And that's the risk immediately, because if you say, hey, um I have taken certain measurements measures, and then you say, okay, and it will lower my maintenance cost, so my cash flow improves,
00:09:52
Speaker
I have less risk because I have improved the building. I lower my yield and hey, I have certain assets added to the building. So I add it to my value directly. Then the same measure will take three times into account in the evaluation. Yeah. Okay. An investment of a thousand euros might end up in a value of 5,000 euros. That won't be the reality.
00:10:21
Speaker
Yes, yeah, yeah, yeah. Careful as you're fairly aware. Those drivers interact with each other and cannot be seen separately. Okay, interesting. And so so between those three drivers, the value drivers, the risk drivers and the cashflow drivers, and that is the way in which they're weighted, sort of built into a framework, or or is it just very dependent on the the individual asset that's being reviewed? It depends on the individual asset.
00:10:51
Speaker
And it's also dependent on the different factors because, and for example, the flooding risk is measured differently than whether you do have solar panels or not. Because those are there every day and they have their contribution every day. Flooding risk is there sometimes. yeah The potential risk is imminent, but the The period where what where it might flood, yeah for example, i'm I'm living in the Netherlands, and we have heard that the big rivers here, they only flood when there's coming a lot of melting water from the Alps and the other mountains in spring after the winter. So in in in autumn,
00:11:44
Speaker
there's no there's no risk at all at flooding because the rivers won't rise because there won't be any melting water. So that's time dependent. Well, it could happen or not. And so theconration what we also determined when we are making the framework as a conceptual way of thinking about ESG, we realized that a lot of the factors you we have determined are not specifically on E, S, or G.
00:12:20
Speaker
Often they are related to at least two and sometimes even three of them. and and The big energy label for example is directly related to environmental but is also directly related to governance. So at the end we said we have determined the 11 factors which are relevant for ESG evaluation without telling This is E, that is S, and that is G, because we said there's too much interaction, that not always clear to define. Let's just say those are relevant for ESD. At the end, as a failure, you determine one market value, you and you don't say this is the environmental or the social or the governance value. It's the market value at the end. It doesn't matter where you put them also.
Forces Driving ESG Adoption
00:13:13
Speaker
he but we'll We'll come on to um yeah the process of moving towards the issue in a bit, but ah one one thing I wanted to touch on first, just related related to what you said is, these changes that are coming into the valuation process, what what is driving it most? is it Obviously, there's the regulatory changes that you mentioned in terms of yeah certain things you'll have to do because of that, but ah but is it driven mostly by that or is it social pressures? Is it the financial sector? It's it's a combination and and they enforce each other.
00:13:42
Speaker
Of course there is social pressure because luckily more and more people are aware of the risk of the changing climate, the risk of how we are, yeah some say abuse, others say use our resources.
00:13:58
Speaker
um I don't want to make it it into a political discussion today. set's So but but but that's the social impact which you see and and and where it's driving change in also evaluation. And of course, there's a change in legislation and coming from EU, but also on national levels. And and in the paper we wrote about EUC evaluation, we made a brief overview of all the legislation which is already in place or about to come in place
00:14:36
Speaker
ah around ESG evaluation, which might impact real estate. And that's quite a long list already. And then you see that's on the EU level, but there's also on the national level. And the third one is, and that's, of course, driven by the first two social changes and legal changes, is that Financial Institute investors are saying, okay, we see what's happening in society.
00:15:04
Speaker
We take our responsibility and no matter what the social demand is or what the legal demand is, we'll set this level for our portfolio or for our investment or whatever. And effectively, that's the biggest driver in the change. Because when the banks say, you won't get a loan unless this, this and this, people say, OK, I will do it because I mean i will need the loan.
00:15:36
Speaker
um And that's what you now see in, for example, there's not a description about Ferris-proof 2050. A lot of people are thinking, okay, Ferris-proof 2050. Yeah, it's important. Okay, but hey, it's 25 years from now. and so its perceives a long way away We can wait till tomorrow and even the day after that. So there's No legislation but yet. Yes, there is social pressure. But what we now see is that a lot of banks say, OK, Paris proof, 2030. If you are not proof by 2030, and if you don't show me now today what you're going to do in the next five years to become Paris proof in 2030, I'll cancel your loan. Right, OK. And that's driving market change because investors say, OK,
00:16:30
Speaker
um I'll need those loans to get my portfolio in order. So I have to be compliant with those needs. And also on the investor side, like what we have a lot of disc discussion with in Reverend Ephra for the listed and non-listed investors. And they say, our members just say, these are our goals for 2025, 2030, 2035, whatever.
00:16:58
Speaker
And they want their portfolio to be compliant with those demands. And they say to the market, if you don't become compliant, we'll sell it, or we won't buy it, or we won't rent it, or whatever. And also, the user said that the the people who rent the places, are especially the large companies but organizations, say, we only want to rent a building which is compliant with it.
00:17:26
Speaker
and And then is where other legislation comes in place, the CSID, for example, Corporate Social Responsibility Director.
Future ESG Regulations
00:17:35
Speaker
Organizations have to report whether they are compliant or not with their CSID. And therefore, they need their real estate to be compliant. Yes, yeah. So whether or not there's legislation for the real estate itself,
00:17:53
Speaker
The occupier has legislation where he has to fulfill his needs. And that drives the real estate to change. Yeah, it's a very interesting one, actually. The more we're discussing it, the more you can see the way so many different factors interrelate. Absolutely. And um yeah, it must be quite a complex one to put a framework together on, or at least, as you say, there's 11 points. I can see why they would have taken time to come up with.
00:18:23
Speaker
um I suppose my my the final question I got for this topic I think are um in terms of the regulatory aspects or whether that's from sort of governmental level or EU level or or from say governing bodies like the RICS for example, ah is there more regulation that you ah think think is on the way? um Absolutely, yeah and for example whole life carbon assessment is directly related to ESG. It's now compliant for our CS members since July 1st to at least report about it. and There will be more legislation ah around carbon assessment and carbon pricing in the next couple of years. That will definitely impact real estate markets.
00:19:14
Speaker
2027, for example, we have the, and I don't know what the European worth is for. We have a legislation about water quality. ah Yes, the speak topic. Yeah. Yeah. and And I know exactly in the Netherlands what what how the legislation in the Netherlands called, but I don't know what the name is of the European law for that. But in 2027, you have to be compliant. If not,
00:19:41
Speaker
Permits which have been granted can be ah taken away. That will definitely impact real estate. and um We see changes in CSRD legislation as mentioned. For 2025 only the listed companies on the on stock market have CSRD responsibilities.
00:20:07
Speaker
but they have to be transparent about all the people who are in their chain of operation. So that already impacts other organizations and within a few years, also the the mid cap and the small entrepreneurs will have to be ah following CSID. So um it's it's there's a lot of legislation already in place, but not effective yet.
00:20:40
Speaker
are becoming in place in the next few years. And they are still thinking about more and more. ah So it will only increase in importance. And what also helps, of course, I always talk about the homo economicus.
00:20:59
Speaker
and When energy prices are going up, people are more willing to lower the energy consumption. If prices of their basic products,
00:21:18
Speaker
yeah iron ore, e etc, if they go up, you want to use less.
ESG Compliance: Large vs. Small Organizations
00:21:25
Speaker
So when we are putting prices on all kinds of materials which are not so good for the environment, people will change and use other kinds of materials change their way of building, there will be more reuse of of materials, et cetera. So, we in my opinion, we're just at the beginning of the big change. Yeah, okay. And would one of those things potentially then, because because if we're downvaluing certain assets or properties because they are not as ESG compliant, would the answer to that to stop obviously more demand for cheaper
00:22:07
Speaker
properties in that respect, um be that they potentially start to get taxed in some way, that means that they're more favorable than, ah sorry, less favorable than any more ESG compliant property. or what What you see in the market is that um larger organizations are more open to be no more ESG compliant real estate where small entrepreneurs a
00:22:39
Speaker
are more driven by personal motives. Some find it very important and do as much as they can. Some think it's are not yet that and open to these changes or are not able to implement it in their business because they hardly survive at all at this moment.
00:23:03
Speaker
and have don't have the the space or the the the money or whatever to do the needed investments. um It's not always that people are not... and Not everybody who is not compliant with climate is a climate denier. No, very true. Yeah, it can just be lack of resource or... Yeah. yeah and and And what we see is that... the and and And therefore also evaluation. Yes, the failures are changing due to the more change in demand, change in social aspects, change in legislation. But it's coming from the big market dripping downwards into the rest of the market. And when I have a small part of commercial real estate in the Netherlands, which is just for a local entrepreneur, the ESG is only this relevant
00:24:01
Speaker
in the decision whether to buy or to rent this place or not. But that will change in time. And and of course, some people make it it already in this amount important, but overall, and then what you see is that, and and that's where we have to be aware of as a failure. If you assess a building, you can determine You are not
Market Value vs. Devaluation Risks
00:24:32
Speaker
compliant with ESG, that you see risks, that you see potential change negative change in your cash flow, etc. You have to mention them in your report. You have to make them clear in your valuation. But that doesn't mean that the value already has gone down today. There's a huge risk of devaluation in the near future.
00:25:01
Speaker
and And I have a lot of discussions with banks about it. They say, OK, if you see this and this, you have to devaluate the property. No. For me as a valuer, I always tell what the market value is today.
00:25:16
Speaker
and When I look to my opinion, for for example, Payfas, it's it's it's a nasty chemical stuff. But it's used in many ways.
00:25:30
Speaker
To my opinion, it should be forbidden, but it still has value today. It won't have a value in 10 or 20 years, because everybody then will be convinced we shouldn't have used it at all. But today, we do use it. um Yeah. Very interesting. but Before we move on to the topic too, my my final question, just if people want to learn more around ESG generally um and so potentially how it impacts valuation, are there good resources that you're you'd sort recommend to look at?
Resources for Learning About ESG
00:26:05
Speaker
They can start in several places because and it's more, do you want to know legislation, the practical implications
00:26:12
Speaker
applications or whatever because ESG is so broad topic and has so much angles you can look into it. um On the RCS website we have a lot of information about ESG but there are so much more resources. um I've seen in many countries also websites from sometimes commercial organizations, sometimes non-profit organizations about ESG where they can give links to all kinds of information. So depending what your background is and from what angle you want to look into it, go to your own overall organization, go to RCS, look on the internet. So yeah in in the paper we have written, we have made the list of some resources, but it's hardly a total overview.
00:27:11
Speaker
It's got so much information. Yeah, it's a good starting point. Yeah, it's a good starting point. and um Make sure that you make it practical to the things you are doing and you are assessing. Because I can fill a complete library with books and and papers about ESG. But for me as a valuer, only the things about which relate to valuation are relevant.
Discussion Wrap-Up
00:27:38
Speaker
Yeah, yeah.
00:27:39
Speaker
And therefore, as they say, there's a Dutch saying, you don't see the forest through the trees. Another one. And yeah but that's absolutely a risk in ESG that there are so much trees, you won't see the forest at all. And just try to lean backwards a bit. So then first look to the forest and then think, do I need the oak? The ash? Or whatever.
00:28:06
Speaker
Yeah, i like that I like that. You're right because there's a huge amount of information out there so you have to step step back, get an overview and then work out where you want to dive in. um That's been a really interesting first topic. I think we'll um we'll pause there and then join us for for topic two where we'll be discussing the the process of moving towards ESG in valuations.