Don’t let ESG gaps affect your asset’s value

The day when ‘brown discounts’ on property become a genuine concern for stakeholders is drawing nearer. A brown discount is an asset’s loss in value because it does not meet specific ESG standards. 

On 31 January 2025, changes to the International Valuation Standards will come into force, integrating ESG metrics into valuation reports.  

Current and upcoming regulatory requirements 

Property stakeholders in Hong Kong should be aware of several current and upcoming regulatory requirements. Here are some key changes: 

ESG Metric Integration: Valuation standards now often include specific ESG metrics, such as energy efficiency, carbon footprint, and social impact. These metrics help assess the sustainability and ethical impact of properties.

Regulatory Requirements: Hong Kong is pursuing more stringent ESG disclosure requirements for listed companies. The Hong Kong Stock Exchange (HKEX) has introduced new climate-related disclosure requirements that will come into effect in phases starting from 1 January 2025. These requirements align with the International Sustainability Standards Board (ISSB) standards and will mandate disclosures on various ESG aspects, including greenhouse gas emissions. The move puts increasing pressure on property valuers to consider ESG factors. This ensures that stakeholders know their investment’s environmental and social implications, including their property acquisitions or rentals.

Market Demand: There is increasing demand from investors and tenants for properties that meet high ESG standards. This has pushed valuation professionals to consider ESG factors more seriously to reflect market preferences accurately.

Risk Assessment: ESG factors are now critical to assessing long-term risks and opportunities. Properties with poor ESG performance may face higher risks, such as regulatory penalties, higher insurance costs, or decreased marketability, which are now factored into valuations.

Standardisation and Guidelines: Organisations like the International Valuation Standards Council (IVSC) and the Royal Institution of Chartered Surveyors (RICS) have updated their guidelines to include ESG considerations, providing a more standardised approach to incorporating these factors into valuations.

These changes will ensure that property valuations reflect the growing importance of sustainability and ethical considerations, making ESG a crucial aspect for stakeholders to consider. 

Valuers left between a rock and a hard place 

Despite valuers advocating to clients at every turn that they should take note of their ESG rating, Hong Kong lags behind other markets, including the mainland, since there is no legislation to force compliance on property assets. Given economic conditions and geopolitical uncertainty, this is unlikely to happen in the foreseeable future, and few valuers would force the issue, given how detrimental it could be to clients. 

However, the argument could be made that wantonly ignoring ESG remits is hurting our clients. Several tangible benefits can be gained by actively improving an asset’s ESG score – enhanced asset value, cheaper financing, access to other incentives, lower operating costs, reduced risk, enhanced tenant satisfaction and increased rental value. Yet, many local developers and investors still do not see the point of adding to their CAPEX, especially if it means retrofitting a mature asset. This kick-the-can-down-the-road attitude has not directly impacted the asset’s sale value, yet.  

However, as banks demand more ESG information about the companies that want to borrow their money – who they lend to affect their own ESG ratings – they require more transparency in valuations. 

The brown discount 

Quantifying how much Hong Kong’s property market has been affected because it is not as ESG-forward as other markets – the mainland, Singapore, the UK – would be even more unlikely given the cluster of factors at play: a lack of data from which to make the calculations needed; a lack of legislative requirements applicable to Hong Kong; and reticent owners who feel they can still hang on long enough to sell the asset at a profit quickly enough to avoid the crunch. 

When the new standards come into force, professional valuers will have no choice but to find a way to make ESG count in an asset’s value.  

Stakeholders who have neglected their ESG issues will, among other things, find that borrowing money is not easy and more expensive. Valuation is about quantifying risk; if an asset is likely to be affected by extreme weather, it is more of a risk.  

Hong Kong has already experienced the results of climate change – super typhoons, black rainstorms, flooding, extreme heat and cold weather. All these phenomena cause significant damage to assets and endanger people’s lives and livelihoods, so much so that they are a relevant factor in any property asset’s value. As we have seen in other countries, they can also lead to companies refusing to assure assets. 

However, ESG valuation is more nuanced than just looking at location. 

Market trends favour properties with strong ESG credentials. Investors and tenants prioritise sustainable and socially responsible buildings, directly affecting their sales value. Properties that fail to meet ESG standards will incur ever-increasing operational costs that will factor into investors’ calculations. When the government decides to crack down on carbon emissions, non-compliance can result in fines, legal issues, and increased oversight by regulators. 

While those factors are easy to spot, investors and tenants would also consider a property’s effect on its reputation and brand value. They have an image to maintain. Stakeholders expect properties to adhere to ESG principles because their reputations are also affected. 

Hong Kong has a notoriously swift property turnover rate – aided by the removal of the spicy taxes, lowering the loan-to-valuation ratio and lowering interest rates – which encourages speculators not to look too far into the future. But there will come a point when asset owners could struggle to dispose of assets which are not green clean, losing a large chunk of their anticipated profit.

And that future is approaching far faster than many Hong Kong stakeholders imagine. 

Concrete steps to protecting your asset’s value 

Here is how stakeholders can proactively protect their assets from the inevitable ESG regulations: select the ESG board; speak to your valuer about an ESG gap analysis to understand what needs to be remedied for each asset; devise a plan to move your asset onto the right track. Your valuer can help you to do this too. 

By taking these steps, stakeholders can protect their assets from potential brown discounts and unlock numerous benefits such as enhanced asset value, cheaper financing, and increased tenant satisfaction. The future of property valuation is rapidly evolving, and those who adapt will be best positioned to thrive in this new landscape.