Last week, Danske Bank published a new report analysing the Swedish real estate sector from a sustainability perspective. In the publication ‘Beyond green – A primer on ESG risks’, the ESG risks for a selection of Swedish real estate companies are evaluated by Danske Bank DCM Credit Research.

Analytical model tailor-made for the corporate bond market
In order to do so, DCM Credit Research has developed a new analytical model for ESG risks, which is tailor-made for the corporate bond market.
 
“The purpose with our new analytical model is to clarify how we take sustainability issues into account in our risk assessments and investment recommendations in a more structured way”, says Louis Landeman, Head of Credit Research at Danske Bank DCM in Sweden, and one of the authors of the report. 

“Considering how important sustainability has become for investors in corporate bonds, both in Sweden and abroad, we think it is natural to put more emphasis on this area in our analyses.”

Low or medium risk for Swedish real estate companies
For the 14 Swedish real estate companies that have been analysed; the overall ESG risk is either assessed as ‘low’ or ‘medium’. The main ESG risk factors identified include direct physical climate-related risks, risks related to greenhouse gas emissions and rising energy costs, risks related to changes in society, risks facing the companies as employers, and credit-related governance and financial policy risks.

Sector makes up for 37% of total energy consumption
According to official statistics from the Swedish National Board of Housing, the Swedish building and property sector make up for some 21% of the total CO2 emissions in Sweden, and 37% of total energy consumption. Consequently, the property sector has a large impact on the environment and it will be virtually impossible for Sweden to reach its ambitious climate targets unless the sector can deliver on further energy efficiency improvements and reduced CO2 emissions in the years to come.
 
With regards to environmental risks, the Swedish real estate sector has been successful in reducing its direct CO2 emissions over the past years thanks to a better energy mix and energy savings. At the same time, the indirect emissions from new construction projects and renovations remain high and it will be a large challenge to reduce these emissions in the coming years. Also, further energy savings at existing buildings have to be achieved if Sweden’s long-term climate targets are to be reached.

Rapid growth of green bonds
A positive trend is the rapid growth of green bonds as a financing source for the Swedish real estate companies. In 2018, green bonds issued by real estate companies in Sweden amounted to SEK 24bn. This was a growth of more than 70% compared to 2017. So far in 2019, a further SEK 19bn of green bonds have been issued in SEK. In total, some 24 Swedish real estate companies have established green bond frameworks. The increased issuance of green bonds is positively perceived by DCM Credit Research, as it broadens the companies’ funding sources and increase the focus on their sustainability efforts.

DCM Credit Research: There’s scope for improvement
With regard to ESG reporting, DCM Credit Research see large scope for improvement. As an example, there is currently only one company in the report – Vasakronan - that provides full reporting disclosure of indirect greenhouse gas emissions (Scope 3) including emissions related to new construction projects. Another eight companies currently only report their direct Scope 1 and 2 emissions, while five companies do not report their direct or indirect emissions. That said, the level of reporting is improving rapidly, and most companies that DCM Credit Research has been in dialogue with, expect to improve their level of reporting going forward.

Another area where DCM Credit Research see scope for improvement relates to accounting transparency with regard to the treatment of maintenance costs, investments and reported market values. In order to preserve properties’ long-term market values, the amount spent on repairs and maintenance is of vital importance, as real rental income and market values will most likely decline over time for a building that has not been properly maintained. DCM Credit Research believes that the companies that increase their transparency related to maintenance costs and investments, which relates to their free operating cash flow capacity, will benefit long term in the form of lower and more stable financing costs.