The European Union has undertaken to reduce greenhouse gas emissions by 55% by 2030. What are the implications for the real estate and construction industry? Buildings will have to be greener and comply with new legal requirements that the EU is adopting on its journey towards carbon neutrality. Here is our overview of the requirements.
Buildings account for two-fifths of energy consumption in the EU. Hence, they have a significant share in greenhouse gas emissions associated with energy consumption – 36% in total. Logically, therefore, many of the legislative measures designed to ensure carbon neutrality in the future affect the real estate sector.
Requirements for energy sustainability in buildings, emission reductions, and conditions for sustainable investments are becoming stricter. Prepare for the new reality in time.
The year 2023 has seen the adoption of important legislative measures, such as regulations on energy performance of buildings and energy efficiency. The legislation also tightens taxation on the activities and assets of producers of greenhouse gas emissions, again including in the real estate and construction sectors, and the regulation is also generally aimed at redirecting private capital into sustainable assets and activities.
No emissions in five years
While EU legislation has so far only addressed the operational emissions of buildings, the new regulation will address the sustainability of real estate throughout its life cycle. The construction and operation of new buildings and the renovation of older ones will be fundamentally affected by the draft Energy Performance of Buildings Directive, which is expected to receive its final EU approval this year.
According to the current draft of the directive, all new buildings should be emission-free from 2028; public sector buildings as early as from 2026. If technically and economically feasible, new buildings should also be equipped with solar technologies from 2028, while refurbished buildings have an extra four years to meet this requirement. Existing buildings will have to gradually become more energy efficient and reach at least Class E within seven years and Class D within 10 years. For some types of buildings, such as public sector buildings, shorter time limits have been set.
There will also be tighter requirements for heating systems within buildings. Currently, natural gas has the largest share, accounting for approximately 42% of the energy consumed to heat residential areas. Oil (14%) and coal (approximately 3%) are the second and third most important fossil fuels for heating, respectively.
Member States, however, will have to ensure that new or renovated buildings are no longer heated with fossil fuels. Fossil fuels should be phased out completely by 2035 unless the European Commission allows their use until 2040. On the other hand, the EU is also counting on subsidy programmes to encourage investments in reducing the energy performance of buildings.
The directive is now being discussed by other EU institutions, so the details may still change, but the trend is very clear, namely a significant tightening of the rules that should be taken seriously by developers, construction companies and private property owners alike. We therefore advise you to start preparing for these changes as soon as possible.
Tighten your belts
The Energy Efficiency Directive, passed by the European Council at the end of July, will also have a dramatic impact on real estate. Under the directive, Member States will be obliged to ensure that final energy consumption is reduced by at least 11.7% by 2030 compared to the energy consumption forecasts for 2030 made in 2020. This will also step up the pressure to make buildings more energy efficient.
Sustainability should also bring more tax benefits in the future. Draft regulations and amendments to directives governing the Emissions Trading Scheme (the EU ETS) propose higher taxation of unsustainable assets and activities and redistribution of the money thus raised towards sustainable projects.
The EU Emissions Trading Scheme has been in place since 2005. However, it originally only covered greenhouse gas emissions from stationary industrial sources of pollution. However, it is gradually expanding to cover other activities. According to the draft directive from this May, in addition to air and sea transport, it will also cover buildings and building-related emissions.
Emission allowances will not apply directly to building owners, but to fuel suppliers. They can only supply fuel to buildings on the basis of greenhouse gas emission permits. They will thus have to buy the number of allowances corresponding to the amount of greenhouse gas emissions from these fuels. The suppliers, needless to say, will then reflect the costs in the price ultimately paid by the property owner or tenant. The method and sources of energy supply (heating or cooling) to the buildings and their energy performance have been gaining importance.
In this context, it is interesting to note that, for example, the incineration of municipal waste to supply heat to a large part of Prague and Brno, will not be covered by the emission allowance system. Buildings heated from these sources will thus have a competitive advantage at least for the term of the directive.
However, energy sources and energy performance will determine the value of real estate investment and potential returns in the future. This will be true even more so since many tenants and building owners will have to start tracking and reporting their own carbon footprint, which will include the carbon footprint of the buildings they occupy.
The (carbon) footprint
Under the CSRD, the Corporate Sustainability Reporting Directive, many companies will be required to publish a so-called sustainability report, or ESG reporting, alongside their annual financial reports. This should include information, data and risk assessments of the company in the environmental (E), social (S) and corporate governance (G) areas. To prepare these sustainability reports, companies will need to start tracking a range of data, including information relating to their own carbon footprint. And this is linked to monitoring the carbon footprint of the buildings themselves.
From 2025 at the latest, companies will be required to monitor and report such data if they meet at least two of the three criteria: total assets of over CZK 500,000,000; net annual turnover of over CZK 1,000,000,000; or more than 250 employees. In addition, after a certain period of time, these companies may start to require carbon footprint information from their suppliers, even if they themselves are not legally obliged to track their carbon footprint.
Thus, companies might be expected to have an incentive to reduce their carbon footprint and might want to cooperate with other low-carbon-footprint companies. In real estate, this will translate into companies being interested in properties that are as energy efficient as possible, not to mention that given the emission allowances imposed on fuel supplies, these assets will be more cost-efficient for owners as well as tenants. The companies will also be motivated by banks and investors who will also be keen on having environmentally sustainable investments in their portfolios.
What is and what is not sustainable?
Investments and activities in construction and real estate that comply with the EU taxonomy will be considered environmentally sustainable. The taxonomy was introduced by the EU Regulation on the establishment of a framework to facilitate sustainable investment in 2020. This Regulation contains principles and objectives for the classification of environmentally sustainable economic activities. The specific criteria for determining sustainability of an activity are then contained in the so-called technical screening criteria, which also include specific requirements for the construction and real estate sectors. These cover, e.g., the acquisition and ownership of real estate, construction or renovation of buildings and many others.
Therefore, in order to qualify as sustainable according to the taxonomy, buildings must make a significant contribution to one of the six environmental objectives – for example, mitigating climate change by reducing CO₂ emissions by meeting even more stringent energy efficiency requirements than the minimum requirements set by legislation. At the same time, they must not significantly harm the environment. According to the taxonomy, buildings should minimise their environmental impact, engage in sustainable waste management and promote recycling. Projects should also comply with strict biodiversity protection requirements and promote economical water management. Meeting these requirements can be challenging, even financially. This is why investors should ideally already consider these criteria at the project preparation stage.
They can then be rewarded for meeting these criteria with higher interest in such properties and thus higher profits. Projects that have already set out on this road will have a competitive advantage.
Preparing and implementing buildings to comply with the EU taxonomy also makes sense because of the possibility to obtain more favourable financing. Banks will provide more favourable bank financing for sustainable investments than for investments that will not be sustainable.
In this context, in addition to bank financing, we can also mention the possibility of financing investments in sustainable real estate through green bonds. The European Commission is drafting a regulation as its own standard for this type of bond. To be green, for example, all the proceeds of the bonds will have to go into investments that are again in line with the EU taxonomy.