We have been hearing a lot more about environmental, social and governance (ESG) standards in the real estate industry over the past few years, but the concepts that lie behind them have been germinating for decades. The origins of ESG lie in the rise of socially responsible investing in the 1980s, while the term itself was first coined in 2005 in a UN commissioned report from law firm Freshfields Bruckhaus Deringer. According to the United Nations Environment Programme, building operations accounted for about 31 per cent of global final energy consumption and 28 per cent of energy related carbon dioxide emissions in 2020. A growing appreciation of the important role that real estate can play in mitigating climate change has prompted the industry to take ESG much more seriously across the entire life cycle of a property. In our experience, in the region’s real estate markets, Australia, Hong Kong , Japan, New Zealand and Singapore are the front runners in the area of sustainability, with China and Vietnam making swift progress. Broadly though, Asia-Pacific lags Europe and the US and faces issues such as inertia, capital cost, insufficient policy impetus and inadequate access to green energy and construction materials, which are hindering the wider adoption of ESG standards. Hong Kong finance sector works with universities to plug green talent gap The importance of Asia-Pacific’s real estate markets to sustainability is underlined by the fact that the region now accounts for 20 out of the world’s 36 megacities with populations of more than 10 million. The region’s urban population is set to grow further from 2.3 billion in 2019 to nearly 3.5 billion by 2050, a 52 per cent increase. Rising urban populations mean more real estate and according to the International Energy Agency, Asia-Pacific will see the greatest rise in stock across all property sectors globally, with a 65 per cent increase by 2050 led by Asean, China and India. While the spike in supply implies a steep rise in embedded and operational carbon, on the plus side the region also has huge potential to promote sustainability and develop new technologies to combat climate change. Big Four firms boost hiring amid tough ESG compliance to beat climate change Here in Hong Kong, many industry participants have yet to set out their net-zero pathways and get to grips with the Science Based Targets initiative (SBTi). Quite reasonably, many are daunted by the prospect of a new regulatory burden and additional costs. The challenge is often to understand what is mandated, avoid the pitfalls of green washing and choose between a bewildering array of certifications and standards. The reality though is that it is too late to do nothing. Aside from growing public concern and government regulation, there is also sound financial justification for investors to improve the sustainability credentials of their portfolios, including risk management, transparency, cost savings and increased revenues. In commercial real estate markets, where transparent measurement criteria are often scarce, green building certification is one of the more structured indicators. While LEED is arguably the most widely adopted building standard in the region, many jurisdictions have developed their own to take into account local market characteristics. Water issues may be at the forefront in areas prone to drought, for example. Hongkongers show ESG awareness, but actions fall short of intent: survey Taking all green certifications into account, local and international, Singapore stands out with 95 per cent of the city state’s grade A stock certified, followed by 64 per cent in Kuala Lumpur and 47 per cent in Hong Kong. Meeting these standards has important implications for landlords, showing good corporate governance, and increasing the appeal of office portfolios to tenants whose own ESG commitments mean that they are not able to occupy non-compliant buildings. For landlords prepared to embrace social standards, there is also an opportunity to improve relationships with tenants and the wider community, while also addressing issues such as health and well-being. But if we look at ESG with a slightly colder eye, it also emerges as an important differentiator in competitive office markets such as Hong Kong, where a substantial supply pipeline at a time when companies are consolidating means that landlords need to work harder to improve tenant satisfaction. While data is hard to come by, we see a rental premium between green stock and uncertified buildings of between 8 per cent and 10 per cent under equilibrium market conditions. Asian companies lag behind US, Europe in climate impact disclosures In a falling market, that means green certification delivers welcome insulation from steeper rental falls while older, non-compliant stock can expect to face much higher vacancy levels. The challenges in our local market are evident as just more than 50 per cent of grade A stock lacks green certification and will require retrofitting or redevelopment over the next few years. For landlords, developers and asset managers, this is a call to action which cannot be ignored if Hong Kong’s office market is to maintain its competitive edge in the region and ensure that the city meets its own net-zero goals. Simon Smith is regional head of research and consultancy in Asia-Pacific at Savills