The Canadian construction industry is making strides in adhering to ESG principles.CARLOS OSORIO/Reuters
Canada’s commercial real estate sector is striving to meet increasingly demanding environmental, social and governance standards, but the ESG is still greener on the other side of the world.
For example, experts say Canada is playing catch-up in the use of “green leases” – commercial tenancy agreements in which the landlord and the renter incorporate sustainability, socially responsible management and good governance into their property deals.
According to Tonya Lagrasta, head of ESG for Colliers Real Estate Management Services, in Toronto, “Canada is behind places such as the European Union. Many Canadian developers are moving ahead anyway – we’re seeing a shift – but the rules and regulations aren’t necessarily in place.”
“In North America we’re seeing more of a push toward stronger ESG standards coming from investors, while in Europe it comes more from regulation,” says Avis Devine, associate professor of real estate finance and sustainability at York University’s Schulich School of Business, in Toronto.
A study last year by Deloitte, Green Leases – in the ESG Context, found that the European Union Commission gave green leases and other ESG measures in the property sector a boost in December, 2019, when it adopted rules specifying what makes these measures green.
“In North America we’re seeing more of a push toward stronger ESG standards coming from investors, while in Europe it comes more from regulation.
— Avis Devine, associate professor, Schulich School of Business, York University
Lenders, developers and tenants can consider deals to be green if they include goals for climate change, protecting and conserving water and biodiversity (on the property), controlling and minimizing pollution and moving toward a circular economy that recycles and reuses materials.
According to the Deloitte report, research by Savills Investment Management found that 73 per cent of the world’s institutional investors expect green lease clauses to be incorporated universally between tenants and real estate investment managers by 2029.
In Canada, the experts say that major commercial developers, such as Oxford Properties, BentallGreenOak and Brookfield Asset Management, are typically ESG leaders. “These tend to be companies that have global assets, including those in places where the ESG rules are more developed than in Canada,” Ms. Lagrasta says.
Developers and institutional lenders in Canada were getting more serious about higher ESG standards before 2019, “but the pandemic set things back,” says Ryan Riordan, finance professor at Queen’s University’s Institute for Sustainable Finance, Smith School of Business, in Kingston.
On the other hand, COVID-19 gave real estate developers the opportunity to look more closely at environmental issues such as indoor air quality, Dr. Devine says.
There’s more interest than ever in commercial property ESG measures, but the challenge now is to make physical changes to buildings, Dr. Riordan says.
“We’re making strides on the construction side of ESG, but it takes a lot of time to retrofit and replace buildings with ones of higher standards,” he says.
Retrofitting is a daunting challenge but one that experts consider necessary because buildings contribute nearly 40 per cent of the world’s carbon emissions that are linked to the global climate emergency.
Canada and other countries are struggling to achieve net-zero emissions by mid-century amid concern that if we don’t succeed, damage to the Earth will be beyond repair.
“We need to retrofit nearly all the standing dwellings in Canada, but we’re doing this at 1 per cent of them per year. If we don’t go faster, it will take about 70 years – we should be going three times as fast every year,” Dr. Devine says.
There’s also a strong business case for retrofitting old office buildings to make them more eco-friendly, Dr. Devine adds. It’s partly good marketing – white-collar employees are still only trickling back to offices in major Canadian cities, and when they do, they want to go back to good quality workplaces, she says.
“There’s a premium earned by environmentally certified buildings,” she explains. It shows up in better occupancy rates, more likely lease renewal and lower costs to finish off rehab work for tenants once the basic environmental work is done, she says.
“And after we account for higher rents or lower water costs, is there a market premium for being a leader in sustainability? Evidence says yes,” Dr. Devine adds.
A study by Smith’s Institute for Sustainable Financing, released in April, shows investing in carbon reduction “more than pays for itself in terms of avoided physical damage alone.”
The Physical Costs of Climate Change: A Canadian Perspective suggests the savings come even before “taking into account the potential economic benefits of transitioning to a low-carbon economy” for Canada’s entire GDP.
But green leases are only a small part of how commercial real estate developers are boosting their ESG credentials, Ms. Lagrasta says. “There’s more attention being paid now to the S [social benefit] and the G [governance],” she says.
Institutional investors are looking more holistically these days at potential risks, for example, the cost of urban sprawl and the potential financial benefits of diversity on corporate boards.
“There is deep corporate finance literature showing that we end up with better risk-balanced outcomes in our real estate [investments] if the management isn’t all male,” Dr. Devine explains.