ESG real estate: Recovery with transformation risks

The real estate sector accounts for around 40% of energy consumption in the EU. Real estate investors must therefore prepare for growing transformation risks as the EU's Green Deal initiative enters its implementation phase. The new EU Energy Performance of Buildings Directive (EPBD) must be implemented in all EU member states by May 2026. This means that a large proportion of the building stock will require renovation. However, low renovation rates in the EU and the high complexity and costs of comprehensive renovations remain the main obstacles. Doubling the annual renovation rates in the EU would be necessary to achieve the decarbonization target by 2050. From 2030, all new buildings must be constructed as zero-emission buildings.

Transformation risks exist in the form of rising prices for CO2 certificates under the EU Emissions Trading System (ETS II), which is expected to come into force in 2027 and will make fossil fuels for building heating and hot water production more expensive. In addition, the decline in gas consumption and the dismantling of the gas network are increasingly reflected in rising network fees for end consumers.

With the high need for transformation and a disproportionately high supply of ESG bonds, the real estate sector offers investment opportunities, especially for sustainability-oriented investors. Green bonds have become the standard in the primary market for sustainability-related real estate bond issues.

Given the limited availability of comparable decarbonization plans from issuers, we use the EU taxonomy indicators. Here, the real estate sector performs well compared to other sectors in terms of taxonomy-compliant investments (CapEx). Nevertheless, real estate bonds continue to command above-average premiums. A continued high or rising green share in the real estate sector should have a slightly positive effect on spreads. However, a generally favorable financing environment remains essential.

From a cyclical perspective, the ECB's monetary policy easing since June 2024 has provided positive impetus for the interest-rate-sensitive real estate sector. As a result, refinancing pressure has eased and some of the sector's credit metrics (including leverage ratio and interest coverage ratio) have slowly recovered. According to S&P, the previously negative outlook for sector ratings has now returned to normal levels. Measured by their average ratings, real estate bonds offer attractive risk premiums compared to other sectors. If sentiment continues to improve, the IG real estate sector offers potential compared to other non-financial sectors.

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