ESG and its Impact On Real Estate

October 31, 2023

Written By Michael Chow, Michelle Yung, Natalia Iamundo, Jessica Munro, Rebecca Taylor and Celina Glabus

Environmental. All sectors of the Canadian economy are adopting increasingly sustainable and environmentally-friendly practices to help the transition to a net-zero economy. In particular, as the Government of Canada stated in its Emissions Reduction Plan, "Decarbonizing the buildings sector is critical to Canada's pathway to 2030 and 2050."¹ In 2019, commercial and residential buildings accounted for 12 percent of Canada's greenhouse gas (GHG) emissions.² Clearly, the real estate industry has a pivotal role to play in achieving the federal government's emissions reduction goal by 2030 and achieving net-zero emissions by 2050.

Social. Real estate also has a social impact. Developers are constructing new affordable housing residential projects or converting existing commercial buildings into affordable housing supply. Retail outlets are activating open space for charitable and community events, including offering vaccination stations during the height of the COVID-19 pandemic. Developers of multi-unit residential buildings (MURB) are incorporating affordable housing strategies into their mainstream developments.

Governance. Real estate companies, including investors, developers and owner-operators, are focusing on corporate leadership to comply with governance-related standards. These companies must adopt fair decision-making methodologies and board selection procedures while providing clear and transparent communications to stakeholders.

Environmental, social and governance (ESG) considerations can affect key aspects of real estate projects, including investment and financing, government legislation, leasing and development, renovation and retrofitting, and construction.

Investment and Financing

Investors, especially institutional investors and financial institutions, are increasingly factoring ESG considerations into investment decisions. Environmental factors, including GHG emissions reduction and climate resilience, are key aspects of commercial real estate investment decisions. As investors and lenders begin to place greater emphasis on a project's ESG performance, ESG information is expected to be based on measurements and outcomes, rather than aspirations. Financial statement disclosure requirements evidence this shift, alongside industry-led benchmark frameworks.

The lack of standardized and streamlined data presents a challenge for commercial real estate investors when considering ESG factors in investment decisions. However, many commercial real estate investors, asset managers, and real estate investment trusts now rely on the Global Real Estate Sustainability Benchmark (GRESB) assessments to make investment decisions. GRESB is an organization that collects, validates, scores and benchmarks ESG data, mainly for investors and asset managers.³ The GRESB is a standardized framework that engages with industry-accepted investment and reporting guidelines like the Principles for Responsible Investment, the Global Reporting Initiative (GRI) and the Task Force on Climate-related Financial Disclosures (TCFD).

With investors and lenders placing an increased emphasis on ESG factors related to sustainability, emissions reductions and the transition to net-zero, commercial real estate projects must implement ESG mechanisms to attract suitable financing and investment. Commercial real estate projects with demonstrated commitments to ESG principles are best positioned to capitalize on relatively new financing mechanisms including: green bonds and green loans (to finance "Green Projects"⁴); social bonds (to finance things like basic infrastructure, housing and essential services); sustainability bonds (to finance both green and social projects); and other sustainability-based finance instruments. Over the course of the past year, we have seen Canadian financial institutions begin to use products like Export Development Canada's Sustainable Finance Guarantee program, which increases the financing available to businesses that are working to transition to a low-carbon economy.

Government Legislation

a) Municipal

While ESG-related building certifications such as Leadership in Energy and Environmental Design (LEED) are not broadly legislatively mandated in the Canadian commercial real estate context, recent trends suggest that municipal governments are increasingly requiring new buildings to meet prescribed ESG standards.

For example, the City of Calgary's Calgary Sustainable Building Policy (Sustainable Building Policy), last updated in 2019, requires all new buildings owned by the City, or for which the City provides a specified financial contribution, to meet minimum sustainability requirements.⁵ The Sustainable Building Policy's guidance document outlines 11 categories of minimum sustainability requirements including green power and carbon offset, multimodal accessibility requirements, responsible landscaping and water use reduction.⁶

Similarly, the City of Toronto has mandated ESG initiatives on a municipal level through the implementation of the Toronto Green Standard (TGS).⁷ The TGS applies to both private and city-owned developments and is structured in four tiers of performance.⁸ The sustainable design and performance requirements set out in Tier 1 are mandatory and apply throughout the planning approval process.⁹ Tier 1 requirements for mid- to high-rise residential and non-residential buildings include greenhouse gas emission limits, building energy performance standards, electric bike infrastructure and waste collection requirements. The more stringent standards prescribed by Tier 2 through Tier 4 are not mandatory. However, compliance is encouraged through access to partial development charge refunds for projects that achieve these higher standards of sustainable design.¹⁰

Municipal policies and requirements, such as those outlined above, demonstrate a shift from ESG considerations being optional and encouraged to becoming mandatory aspects of the building process.

b) Provincial

Provincial environmental and sustainability-focused legislation also illustrates the shift towards enhanced ESG consideration. One example is the provincial enactment of the National Energy Code of Canada for Buildings (NECB), a model code developed by the Canadian Commission on Building and Fire Codes in collaboration with industry stakeholders.¹¹ Today, the Canadian Board for Harmonized Construction Codes (CBHCC) is responsible for developing Canada's national model codes, and is made up of representatives from several jurisdictions across Canada.¹²

The NECB sets out technical requirements for energy efficiency in relation to the construction and design of new buildings and additions to existing buildings. Whereas New Brunswick, Nova Scotia, Manitoba and Saskatchewan have adopted or adapted the national model codes, Alberta, British Columbia, Manitoba, Nova Scotia, Quebec and Saskatchewan have each adopted regulations based on iterations of the NECB.¹³ Conversely, Ontario typically initiates its own energy requirements, incorporating these requirements into the Building Code.¹⁴ Provinces and territories may adopt the NECB as is, adapt the NECB to account for regional differences, or adopt a more strict energy code.¹⁵ In provinces where the NECB has been adopted, consideration of the environmental ESG factor (at minimum) is mandatory. Additionally, the Reconciliation Agreement on Construction Codes, which all provinces and territories are party to, stipulates that the parties agree to identify, reduce and eliminate differences between their construction codes and the model national codes by 2025 as well as to minimize variations between codes in the future.¹⁶ Provincial adoption of codes such as the NECB illustrates a shift from voluntary to required ESG consideration.

c) Federal

Currently, there is no comprehensive federal legislation scheme mandating ESG consideration in the commercial real estate context; however, it is possible that future federal legislation concerning ESG considerations may apply to commercial real estate projects. For example and despite the Supreme Court of Canada's recent finding that key aspects of the legislation are unconstitutional, the Impact Assessment Act (IAA) may apply in the future to commercial real estate projects that fall within its purview. Although the Supreme Court of Canada's ruling currently acts to negate or limit the IAA’s application, it does not strike down the IAA in its entirety. In response to the Supreme Court of Canada decision, Parliament is expected to revise federal impact assessment legislation to comply with Canada's constitutional framework.

To read more about this decision, a Bennett Jones update is available here.

Leasing

Many commercial tenants, especially those that are consumer-facing, are in a similar position as investors and investment funds. As a result of reporting requirements and increased attention to ESG factors, it is now common-place for companies to make ESG commitments. Importantly, these commitments include obtaining energy from sustainable sources, reducing waste and water consumption, committing to pay equity, and supporting charitable causes. Tenants must be able to summarize how their leased space contributes to their ESG commitments or fulfills reporting requirements.

The leased space a company occupies has the potential to impact each of these commitments either directly or indirectly. As a result, commercial landlords offering such rental space and helping tenants achieve or enhance ESG commitments are increasingly more successful at attracting and retaining commercial tenants conscious of ESG factors.

Green Leases

Green leases incorporate sustainability into key provisions of the lease and are designed to encourage collaboration between tenants and landlords to achieve sustainability-focused outcomes. For tenants, a green lease can provide greater control over energy usage and costs which results in greater cost-savings and oversight. For landlords, a green lease enhances the ability to market a building, increase tenant retention, and even charge a premium rental rate.

The Real Property Association of Canada recently released an updated example of a green lease, intended for office buildings. Although intended primarily for office developments, the lease provides a useful template for all commercial property sectors. Building Owners and Managers Association (BOMA)'s a green lease guide also provides a variety of clauses and amendments related to sustainability that parties may seek during lease negotiations.

For example, landlords may establish the building's certification standard and reserve the right to upgrade the building's certification standard. Landlords may also require tenants to pay for the costs of installing green improvements like solar panels or green roofs or reserve a certain number of stalls for low emissions vehicles, carpool vehicles and electric vehicle charging stations. For tenants, a green lease can provide assurances of sustainability commitments, especially in relation to certification standards. However, tenants should proceed with caution as a green lease may place onerous and unrealistic obligations on the tenant to maintain building certification in practice. Tenants should ensure that landlords are, for instance, seeking all available tax relief, credits and grants to offset against the tenants' increased operating costs.

Construction and Development

ESG considerations have also significantly influenced the construction and development landscape. As mentioned above, demonstrating the implementation of ESG factors in a project during the development and construction phases is increasingly important for obtaining financing and stakeholder approval. As such, it is vital that all parties involved on the project have established ESG strategies.¹⁷ This may involve ensuring that suppliers selected for a project have internal ESG policies in place and source the raw materials required in an ethically and environmentally-conscious manner.¹⁸ Further, contractors must be mindful of ensuring that subcontractors also have comprehensive ESG strategies in place, diverse teams (including the involvement of nearby Indigenous communities) and act ethically.¹⁹ Contractors must also ensure ESG considerations are prioritized throughout the project supply chain. A contractor's failure to demonstrate the strength and consistency of their ESG strategies may cause reputational harm and business risk, potentially negatively impacting the success of the project and future projects.

In March 2022, the Canada Green Building Council (CAGBC) announced that it would assume direct oversight over LEED certification in Canada.²⁰ As a result, contractors and other professionals who use LEED or Investor Ready Energy Efficiency (IREE) certification may now work directly with the CAGBC.²¹ This in turn facilitates and streamlines the certification process which ultimately allows contractors and other stakeholder to better affirm their ESG strategies through acquiring certification.

Retrofitting Existing Buildings

In 2019, the Final Report of the Expert Panel on Sustainable Finance concluded that "deep retrofits are one of the most economical means to improve Canada's carbon footprint and climate resiliency."²² According to some estimates, more than half of the buildings built today will still be in use by 2050. Many of these buildings were not built with sustainability in mind and must be renovated in order to become appropriately energy efficient. It is estimated that Canada will need to retrofit approximately 32 million m2 of commercial property, along with residential retrofits, every year until 2040 to meet the net-zero by 2050 commitments.²³ Those with an understanding and ability to navigate the complexities associated with retrofitting will be well positioned to gain massive strides, from government and private-sector investments.

a) What is retrofitting?

Most commercial building retrofits aim to upgrade the building's energy consumption technology or equipment. It usually involves replacing windows, light fixtures or adding insulation. A deep-retrofit, on the other hand, involves more extensive renovations to the building more generally and usually disrupts the building's tenants to some extent.²⁴ Because deep retrofits involve more substantial upgrades to energy consumption systems, it follows that while they require greater investment, they generally produce greater cost savings.

When planning the elements of a retrofit, it is important to consider the minimum building requirements under the NECB which have been adopted through regulation or otherwise, in a particular province.²⁵ The NECB's four-tier system evaluates energy efficiency. Under the tiered system, a building's annual energy consumption performance is measured against a building energy target, expressed as a percentage building energy target or as a percent improvement. At Tier 1, the building has the same annual energy consumption performance as the target; Tier 2 has a 25 percent improvement; Tier 3 a 50 percent improvement and Tier 4 a 60 percent improvement.²⁶ By 2030, it is expected that most buildings be constructed to the Net Zero Energy Ready tier.

b) Potential Economic Advantage

In addition to the environmental benefits stemming from retrofitting, there are also proposed economic benefits.²⁷ Specifically, the CAGBC suggests that new jobs will be created as a result of the demand for retrofits to render existing buildings more energy efficient.²⁸ Furthermore, the CAGBC posits that the jobs created as a result of the demand for retrofitting will be sustained in the long term as the movement towards sustainable low carbon buildings becomes standard practice, ultimately, stimulating the economy.²⁹ Building retrofits also mitigate against and support better recovery from extreme weather events like floods and wildfires—features as simple as higher efficiency windows and roofs and waterproofed sub-surfaces better withstand excess ice build-up, increased snowfall and water damage—and even from public health emergencies like the COVID-19 pandemic. Such measures help address operational risk, and the expectation is that a reduction in the number and severity of claims for losses of this nature should result in lower premiums for property owners. Although there is currently a lack of data in relation to the economic advantages relating to retrofitting, in time retrofitting will likely produce both environmental and economic benefits.

c) Incentives for Retrofitting

Funded in part by the federal government, Canada Infrastructure Bank's Building Retrofits Initiative provides funding for retrofits of privately owned commercial, industrial and multi-unit residential buildings. Among others, real estate investment trusts, retail chains and corporations are invited to participate in the initiative.³⁰ Similarly, the federal government's Budget 2022 dedicated $200 million to the City of Toronto's Deep Retrofit Accelerator Initiative as evidence of Canada's commitment to retrofitting buildings in order to reduce emissions and meet the net-zero by 2050 target, and in Budget 2023, the government highlighted grants for home retrofits and deep retrofits.³¹ At the municipal level, the City of Toronto has introduced a multitude of incentives for retrofit projects to encourage the transition to net zero, ranging from deep retrofit challenges, low interest loans and various grants and support services for residential, commercial, industrial and institutional buildings in the City. 

Given the volume and cost of retrofitting activities needed to meet Canada's net-zero targets, private and public investment into retrofitting projects will continue to increase with demand. Accordingly, understanding and navigating the costs and benefits associated with retrofits will be key to project success, and a critical assessment of which ESG factors will deliver the greatest value will be important for building owners and occupants on an ongoing basis.

Takeaway

Considering ESG factors is integral in the commercial real estate context. As Canada strives to reach its climate commitments, the real estate sector plays a pivotal role and ESG considerations are at the forefront.

Organizations involved in commercial real estate projects should prioritize ESG considerations from the outset of the project. Adopting a tailored ESG approach is imperative for various types of commercial real estate projects including construction and development of new builds, commercial leases and retrofits of existing structures. Organizations who appropriately address ESG considerations and successfully implement a tailored ESG approach are better positioned to be aligned with the expectations of investors and stakeholders and avoid reputational risk associated with inadequate ESG consideration.

Organizations in the commercial real estate sector face significant challenges to implementing a successful ESG strategy. These challenges include, among others, a lack of standardization in reporting of ESG data, variations between ESG regulations and standards between provinces and navigating the various types of ESG related certifications, among others.

The Bennett Jones Commercial Real Estate, Construction and Infrastructure and Project Development teams are available to provide expert advice and assistance on navigating ESG considerations in the commercial real estate context.  If you or your business require assistance in respect of issues relating to commercial real estate or construction/capital projects ESG strategy, or related matters, please contact us.

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