Occupiers' ESG in commercial real estate

There is a gap in the existing environment, social and governance (ESG) literature in the real estate sector, where occupier characteristics with respect to ESG are overlooked. The paper investigates the relationship between the characteristics of occupiers of commercial real estate and their choice over sustainable labelled buildings, evaluates the bargaining power of tenants with different ESG agendas; and examines the potential impacts of regulation on minimum energy performance and the Covid pandemic on the relationships between occupiers’ characteristics, choice of building and rent determination.This project focuses on the London office and use lease transactions from CoStar (www.CoStar.co.uk) and occupiers’ ESG scores from Refinitiv (www.refinitive.com) from 2002 to 2022. Our empirical results show that publicly listed tenants, who are more likely to disclose their Corporate Social Responsibility (CSR) policies and therefore more likely to be ESG-conscious, are more likely to occupy a sustainable labelled (such as BREEAM certified) space. Tenants with stronger emphasis on governance (i.e., higher G pillar scores) are also more likely to choose a BREEAM certified office space. Our hedonic modelling results confirm a BREEAM related rental premium of around 9% on average in the London office market. However, this sustainable label related premium, is lower among listed firms. The introduction of minimum energy performance regulation seems to have increased listed firms bargaining power in rent negotiation due to the increased supply of more sustainable buildings. Listed firms’ bargaining power also is shown to be stronger during Covid period, as the demand for office spaces significantly reduced. Tenants’ overall ESG scores do not appear to affect effective rent they pay in the hedonic estimation, while separate scores on the ‘Social’ and ‘Governance’ pillars do seem to affect effective rent during the Covid period.This paper differs from previous ESG studies in real estate by providing further insights into occupier’s demand and covenant strength that are related to their ESG agenda, and thereby contributes to the sustainability and the ‘net zero’ debate by providing further insights from the occupiers’ perspective. It sheds light on landlord-tenant relationships and the changing occupier role in the context of ESG. The quantitative analysis and results will have direct implications to real estate investors, real estate managers, developers, occupiers, and policy makers who influence the supply and demand of commercial spaces.