Many in the commercial real estate industry have already embraced voluntary ESG reporting. Although the final language is far from being finalized, it is clear that early adopters already factoring ESG considerations into their reporting (which includes virtually all U.S. publicly-traded REITs) could have a leg up in meeting the new rules from the SEC around mandatory climate-related disclosures, once those are finalized, potentially as early as 2024.
The SEC released its proposed “Enhancement and Standardization of Climate-Related Disclosures for Investors” rule for public comment on March 21st. If finalized, it would become the first rule requiring all companies registered with the SEC to report, measure and quantify material risks related to climate change in their registration statements and periodic filings. Specifically, the rule addresses reporting on Scope 1, Scope 2 and Scope 3 emissions, as well as physical risk related to climate-related events and transition risk related to compliance of federal, state and local climate laws.
The rule would have a dramatic effect on the commercial real estate industry, and it is drawing a mixed response from industry participants. On one hand, investors would welcome more consistent reporting of climate risk information. On the other hand, commercial real estate companies affected by the rule are concerned about the added cost and strain on resources in additional reporting.
“I would be very surprised if we didn’t see some moderate pushback from some commercial real estate folks as it is a very broad-scoped rule,” says Josh Richards, corporate director of ESG at Transwestern. “It is going to be valuable to the industry, but I believe there is going to be a lot of investment that goes along with this,” he says. People are going to be paying close attention to what that price tag is and understanding over the short- and long-term exactly what the impact is going to be, he adds.
ESG requirements have already become a big focus for institutional fund managers and companies raising money from institutions such as insurance companies, pension funds and sovereign wealth funds. “That demand for data from an investor’s standpoint has been there for years now, and it has really hit a critical time in commercial real estate. This rule just broadens the market of companies that need to address these issues,” says Tony Liou, president at Partner Energy, a division of Los Angeles-based consulting firm Partner Engineering and Science Inc.
The main intent of the SEC rule is to provide transparency and consistency for investors around information related to emissions and climate-related risks. Current reporting is voluntary and lack of standards means it varies from company to company. Some firms publish information in annual reports or separate ESG or sustainability reports. “I have read a lot of these reports. There’s no standardization of reporting, and everyone tries to make themselves out in the best light possible,” says Liou. “So, any standardization would allow for better transparency and understanding of performance to make decisions, and that’s the key from the investor’s standpoint.”
Demand for apples-to-apples information
Real estate investors have been frustrated by the lack of standards around ESG. Current reporting is a little bit of an “alphabet soup,” notes Uma Pattarkine, senior investment strategy analyst and global ESG lead at Center Square Investment Management. There are several different voluntary reporting disclosure and guidance frameworks, such as the Global Reporting Initiative (GRI), Global Real Estate Sustainability Benchmark (GRESB) and Task Force on Climate-related Financial Disclosures (TCFD) among others. “What that means for investors is that you effectively have a little bit of information overload, while at the same time not being able to get the information that you need consistently across your entire investment universe,” she says.
More companies are voluntarily reporting on ESG metrics, including data on energy consumption and Scope 1, Scope 2 and, on a more limited basis, even Scope 3 emissions. However, companies are at very different stages in measuring and reporting. Some companies are ahead of the curve, while others are further behind in their ability to put the data together to meet the proposed disclosure requirements. There are some companies that don’t yet measure emissions, and it will take time for them to build out infrastructure at the property level to measure emissions and then compile information for the portfolio, notes Pattarkine. “For those that are leaders in the space, it will be a continuation of what they have been doing, while it will really impact the laggards and hopefully push them along this decarbonization journey that we all need to go on,” she says.
Having an SEC rule that aims to create standardized reporting and allows investors to compare information on more of an “apples-to-apples” basis across companies will be tremendously helpful for investors, says Pattarkine. That being said, the rule that is currently proposed focuses on things that are material to certain companies. “So, you are still going to have a little bit of an apples and oranges comparison as you think about what types of disclosures might be coming out of different sectors and different markets,” she says. For example, a green building certification would not be relevant for a cell tower company, whereas it would be very material for an office company. “We’re definitely moving in the right direction as it relates to creating some sort of a standard or minimum framework,” she says. At the same time, companies are still trying to decipher some of the qualitative aspects and gray areas within the rule itself, especially as it relates to materiality, she adds.
Understanding reporting requirements
As outlined in the Real Estate Roundtable’s fact sheet, the SEC rule would require more rigorous reporting of Scope 1, Scope 2 and, potentially, Scope 3 emissions. Scope 1 looks at everything within a company’s power to control, which is largely utility bills at a property. Scope 2 factors in costs associated with the production and distribution of that energy. Does that energy come from a coal-fired plant, a wind farm or a combination of sources? “By quantifying those things in Scope 2, it really tells you more about where your energy is coming from and the total footprint of that energy consumption,” says Richards.
Per the current rule, Scope 3 emissions reporting would only be required for something that would be “materially relevant” to a business. Although it is not clear how that materiality will be interpreted, for real estate owners, Scope 3 typically involves reporting on emissions for space not directly under their control, such as triple net lease spaces where the tenant is in charge of paying utilities. It also could relate to reporting on the carbon footprint of development projects, which would include digging into the embodied carbon, or carbon emissions associated with the manufacturing and transportation of an item, such as steel, timber and concrete.
“Scope 3 is going to be looking a lot more at the products you use, services, transportation of goods. All of that can be a lot more difficult to quantify. So, it’s definitely something that is going to be a heavy lift for certain industries,” says Richards.
Beyond emissions, the new rule would require additional reporting around material “physical risks” to buildings and other assets posed by climate change. Some of the smaller companies might be more challenged by this reporting requirement, because not everyone has a risk expert on staff, notes Richards. Companies also would be required to report on “transition risks” such as those that arise from regulatory compliance costs associated with federal, state and local climate laws.
Broadly, the rule will require disclosures about the governance for climate-related risks and the appropriate risk-management processes that companies have in place to deal with those risks. That reporting might relate to a property located in a flood zone, or perhaps a property location in a city such as New York or Washington D.C. that will need to make investments to comply with new climate laws. “It’s going to require a lot of qualitative description of how a company is really managing their sustainability and decarbonization journey,” says Pattarkine.
Laying the groundwork
The SEC has set a fairly aggressive timeline. Compliance would start in 2024 (covering FY 2023) for those very large companies, SEC registrants with a global value of $700 million or more, that will need to report Scope 1 and 2 emissions, and then phase-in for smaller companies. Reporting on Scope 3 emissions will phase-in starting in 2025 (covering FY 2024 emissions). “Especially for some of the laggards in the industry, hopefully this kickstarts developing some of the infrastructure, processes, resources and teams they need to start managing this in a more robust way,” says Pattarkine.
The steps companies need to take to prepare depends on their starting point. Those companies that are already following voluntary reporting frameworks, such as GRESB and TCFD, are already on the path to meet the new reporting requirements. Real estate companies affected by the proposed reporting rule will need to really understand the baseline measure of emissions at the asset level, as well as have the infrastructure and tools in place to collect and aggregate data. There will need to be a lot of materiality and life cycle assessments conducted at the asset level.
Many real estate companies are already reporting on Scope 1 emissions. Where a lot of the industry will focus over the next year or so is on Scope 2 emissions, notes Richards. It will take quite a bit of time to capture that Scope 2 emissions, particularly for the larger property owners, he says. Beyond that, another big focus for companies will be understanding what is and what isn’t material. That materiality will not only be an issue in understanding Scope 3 reporting, but also in understanding reporting requirements related to “physical risks” to assets posed by climate change.
Companies need to collect, understand and manage data, and they also need to be able to act on the data to drive change. “I think good fiduciaries and good managers of real estate are already doing this,” says Liou. However, there also are some unknowns that are concerning to the industry and creating some pushback. By bringing more data points to light on things such as exposure to climate-related weather events, how is the industry going to value that information? Could information on physical risks and transition risks negatively impact values and capital flows into some companies? “Do these data points impact real estate adversely or positively, those are the types of things that introduce some uncertainty to the way that real estate is going to be evaluated and managed,” he says.