What the proposed SEC climate rule means (and doesn’t mean) for REITs
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On March 21, the US Securities and Exchange Commission (SEC) released its long-awaited proposed rule for mandatory climate disclosure for issuers. The 500+ page document outlines how the SEC intends to pull public markets into the modern age by requiring consistent, credible reporting that reflects the threat of the climate crisis. A final version is to be adopted, following a consultation period running to May 20th, by the end of the year.
The SEC rule is built in part around the recommendations of the Task Force on Climate-related Financial Disclosures, which focus on four key pillars: governance, risk management, strategy, and metrics and targets. The rule tells companies they need to disclose:
- Climate-related risks and the likely material impacts on their businesses, strategies, and future expectations;
- Climate-related governance and risk management processes;
- Greenhouse gas (GHG) emissions;
- Certain climate metrics and related information in their audited financial statements, and
- Information on their climate-related targets, goals, and any transitions plans
Given the real estate industry’s considerable exposure to climate risks, both physical (extreme weather events and changing long-term weather patterns) and transition (changing regulations, technology advances, market demands), the SEC rule will require REITs of all levels of climate maturity to put considerable effort into their SEC filings. In addition to the above, consider some of these proposed requirements from the SEC that are particularly relevant for REITs:
- The company needs to disclose the share of assets (book value or as a %) concentrated in areas exposed to certain material physical risks
- If properties are exposed to material climate risks, such as floods or forest fires, the company must disclose the ZIP code or geographic location
- The company “would have to report the financial impacts of extreme weather events, other natural conditions, transition activities, and other identified climate-related risks on their revenue, cost of revenue, selling, long-term debt and more if the aggregated impacts exceed 1% of the total line item for the relevant reporting period.”
The issue of GHG emissions reporting in the SEC rule garnered considerable attention. Under the proposal, a company would need to disclose Scope 1 emissions (direct) and Scope 2 (indirect), as well as Scope 3 (indirect, upstream and downstream) if material, or if it has set a decarbonization goal that includes Scope 3, for its most recent fiscal year.
There is no shortage of tools and platforms available for REITs to track the GHG emissions of their specific buildings and portfolio-wide. The SEC rule prompted a flurry of articles proclaiming how this new requirement for GHG disclosures will be a boon to climate tech platforms that track GHGs, especially those that focus on real estate.
We don’t disagree. There is a huge opportunity for service providers that can enable REITs to clearly and effectively track and report their Scope 1, 2 and 3 emissions. However, REITs should not be fooled into thinking that tracking their GHG emissions sets them up for success with the SEC’s new rule. It is just one piece of a much bigger climate puzzle.
GHG metrics and targets get a lot of attention, but in the climate reporting space, they are the tip of the iceberg. Consider some of the things, that from an investor standpoint, GHG emissions do not tell you:
- How well your company is identifying, assessing and managing climate risks
- Which climate risks are the most material to your business
- Who is responsible for overseeing climate risk at the Board and management level
- How your business strategy takes into account a changing climate and the transition risks posed by a low-carbon economy
- How credible your path is to getting to net zero
These are the majority of the topics that the SEC is asking companies to report on. GHG tracking covers one aspect; REITs that think that GHG emissions reporting should be the top priority in preparing for the SEC rules are missing the bigger picture.
Think of it this way. Consider two REITs, of identical size and assets, with comparable GHG footprints.
One REIT is planning to make a considerable investment in retrofitting their buildings to reduce their energy use. They intend to build on-site renewable energy. Their focus is on future markets where governments are investing in climate resiliency measures like flood protection. This REIT is running regular physical risk assessments using tools to project the risk of extreme weather damage, and using it to determine what buildings to prioritize for upgrades and which ones to divest.
Another REIT is planning for business as usual. They monitor and report their GHGs, but they don’t do physical risk assessments of their properties. The Board is not updated on climate risks and there is no one in management with responsibility for climate. The acquisitions team isn’t incorporating climate transition risks when evaluating investments, and intends to keep investing in jurisdictions where the electricity mix is still considerably weighted to carbon-intensive sources such as coal.
Same GHG emissions footprint, two very different companies..
GHG metrics are backward-looking. They don’t get at the internal practices and policies of how a company is preparing for climate risk — which is one of the fundamental aspects of the SEC’s new rule.
If you are preparing for the SEC rule, you need to move beyond just metrics and targets, and think through how you’re disclosing governance, risk management, and strategy.
The opportunity with the SEC rule is that as a sector, REITs present enormous potential for investors looking to support climate-positive investments. Unlike industries that are difficult to decarbonize, like oil production, aviation, or shipping, the technology exists to rapidly decarbonize real estate.
All aspects of the real estate value-chain, from using low-carbon cement and mass timber, to retrofitting existing buildings by improving energy efficiency and switching to renewable sources, allow for credible abatement possibilities. The technology opportunity that already exists in real estate means there is enormous potential for REITs to position themselves as drivers of climate solutions. With investors setting net zero targets for their portfolios, REITs that can demonstrate how they’re capitalizing on the pathway to net zero stand to benefit.
The SEC rule isn’t just about risk: it touches on opportunities too. There is a specific section outlining how companies should disclose how they’re positioning themselves for climate opportunities: potential positive impacts of climate-related conditions and events on a registrant’s consolidated financial statements, business operations, or value chains. While the disclosure of opportunities is proposed to be voluntary, the breadth of opportunities for real estate to improve energy efficiency, increase adoption of renewable energy, and reduce carbon throughout its value chain means that REITs should be identifying ways they can take advantage of the platform offered through the SEC rule.
The final SEC rule is set to be in place by the end of the year. While some aspects may still change, the overall focus on disclosing how climate risks are identified, managed and assessed, and the risk exposure companies have to climate, will remain. For REITs, GHG emissions reporting is necessary but not sufficient for credible climate disclosure to the SEC. When preparing for the new climate reporting requirements, REITs shouldn’t fixate on emissions at the expense of the other foundational elements in the SEC’s prop