European real estate: red tape, rent controls complicate efforts to meet ESG investment challenge

European real estate: red tape, rent controls complicate efforts to meet ESG investment challenge

Red tape and regulatory controls over rent in the real estate sector are obstacles to upgrading Europe’s building stock to meet tougher environmental, social and governance standards, in part by discouraging green financing in the sector.

Scope Ratings says investment flows specifically dedicated to sustainable buildings and/or social housing so far represent only a small, albeit rising, fraction of overall investment. Only 20% (+10pp YoY) of European real estate companies’ bond issuances in 2020 were labelled as fundraising compliant with sustainable development goals (SDG).

Yet buildings of all sorts are inevitably at the centre of attempts to create more sustainable economies and improve human wellbeing. Real estate stock accounts for a major part of energy consumption and carbon emissions.

“Simplified regulatory requirements on how market players mitigate and adapt to the demands of combatting climate change and improving health and social equity are much needed,” says Philipp Wass, analyst at Scope Ratings.

“For now, administrative and regulatory procedures in Europe tend to be complicated and time-consuming and imply heavy investment,” Wass says. “If you also consider investment-unfriendly regulations, a headache particularly for smaller real estate firms and tenants, then regulatory-related credit risk in real estate starts to stack up,” he says.

The residential sector is one subsector where sustainability-related regulatory risk has long been apparent. The supply-demand imbalance in Europe’s housing markets, notably reflected in rising house prices and rents in metropolitan areas, is drawing increasing regulatory scrutiny as landlords have discovered: take the Berlin 2019 rent freeze, Lisbon’s secure rental income programme in 2020, Paris’s tightened control of rental caps in 2019, and similar measures in Catalonia in Spain. More controls are up for discussion in the European Parliament.

“The paradox is that rental caps and/or other limits on the ability of landlords to pass on sustainability-related and other costs to tenants can deter investment in the sector, with a knock-on effect on the construction industry, exacerbating the supply-demand imbalance in the residential sector,” says Wass.

Better alignment and interaction between local authorities and investors is important to maintain and improve the quality of the property stock and offer affordable housing for rent.

“At least it is reassuring that in absolute terms, Europe’s SDG financing for the sector has proved resilient in the past 18 months,” says Wass. European property companies raised nearly EUR 7bn in green bond finance in aggregate in the first quarter, including Spain’s Aedas Homes, Czech Republic’s Atrium European Real Estate, the UK’s Canary Wharf Group, Germany’s Deutsche Wohnen and Vonovia.

“We expect the segment to grow more this year, with green, social, sustainability and transition bonds supported by regulatory efforts to establish general applicable frameworks across different sectors in Europe, not just real estate,” he says. “Sustainability is increasingly embedded in the investment and financial market infrastructure.”