Integrating Environmental Considerations in Real Estate Underwriting

Professional standards paper by INREV (2025) | Underwriting, Financing, Capital Stack

Curators: Asha Lad and Bill Bateman

London, UK

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Why we recommend it: This publication, the initial phase of a larger project, offers a promising step forward in advancing the integration of sustainability into underwriting and valuations. The document effectively recognizes the wide variation in approaches to environmental integration among investors and highlights the most quantifiable factors currently in use. It is encouraging that valuers are now beginning to incorporate environmental factors into their processes, a move that could significantly impact existing underwriting and valuation methodologies. The report interestingly highlights new techniques, such as shadow carbon pricing and green IRRs, are emerging, though not yet mainstream due to regulatory uncertainty and market inconsistency. It affirms that advancing this transition continues to require consistent valuation methodology between investors, occupiers and valuers, and clearer links between environmental performance and pricing as the market build confidence in increasing the volume of relevant transactions, which over time, will lead to better evidence-based data.

Key takeaways:

- The paper expands on prior studies to increase awareness of the diverse methodologies used by investors and lenders to evaluate environmental factors, aiming to build greater transparency and consistency in risk assessment and value creation. The next stage will be creating a test underwriting model and sensitize which factors have a material influence on value and returns.

- Approaches of applying environmental considerations vary significantly among interviewed investors. Interviews confirmed that indicators like energy efficiency, carbon intensity, and climate risk are the most quantifiable factors influencing underwriting inputs. These have both qualitative and quantitative multi-variable impacts to DCF models through inputs including capital expenditures (CapEx) and operating expenses (OpEx), discount rate and exit yields.

- Decarbonization pathways, including CRREM, along with proprietary tools developed by investment managers, are being used to assess downside risk exposure from transition risk, physical climate risk and environmental related capex planning.

- Efforts are also underway to link environmental CapEx to long-term OpEx savings and value creation, but establishing these links remains difficult. Separating environmental upgrades from other capital improvements adds complexity to financial modelling.

- Energy ratings, such as EPCs, and certifications, such as BREEAM, are useful benchmarks, but they only represent a single point in time. Real asset performance remains dependent on tenant behaviours and operational practices.

- New approaches are being tested in asset underwriting. These include shadow carbon pricing and green IRRs. They are used to better account for future carbon costs and potential return impacts. However, they are not yet widely used in transaction-based valuation models. This is due to regulatory uncertainty, the theoretical assumptions involved, and market inconsistency.

- In parallel, valuation standards such RICS and IVS, require valuers to identify, document and report significant environmental factors in valuation conclusions while being aware of changing legislation and regulation. As sustainability’s role in investment decisions grows, valuation frameworks may shift towards more forward-looking models rather current methodologies of using observable market information, transaction based, comparable evidence.

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