Supply constraints have emerged as a dominant trend favouring Asian investors who are looking for opportunities in European real estate.

However, those interested in this asset class must have a high level of ESG compliance embedded in their investment processes; otherwise, they could face significant financial and strategic risks.

Keith Breslauer, founder and managing partner of Patron Capital, says ESG compliance is no longer optional but a critical factor for investing in, as well as operating and selling, European real estate.

London-based Patron Capital, which invests in pan-European real estate, recently secured a major investment from Japan-based Mitsubishi Estate Co., Ltd. ( MEC ), through its Mitsubishi Estate Global Partners ( MEGP ) investment management business. MEGP is acquiring a majority stake in Patron, as well as providing €600 million ( US$695.58 million ) in the form of equity commitments to Patron’s funds and financing for new subsector strategies, including real estate credit.

Mind your sustainability

“If you want to invest in European real estate, you need to have a high level of ESG capability,” Breslauer tells The Asset in an interview. “You need to have a high ESG standard, and you need to have that embedded in your operations; otherwise, you're going to have a big problem. Forget about the rental market. How are you going to exit ( sell ) the building?”

He explains that European regulators and investors increasingly prioritize sustainability and ESG compliance, and buildings that don’t meet ESG standards may find it hard to attract buyers or tenants.

Because of this trend, investors must ensure their properties adhere to environmental and social standards, such as energy efficiency, carbon footprint, tenant well-being, and good governance practices. This means that even if the rental market is strong, a property with poor ESG credentials will have a difficult time in the market.

Essentially, ESG isn’t just about operations; it affects the liquidity and long-term value of a property.

The slow pace of construction in the sector since the 2008 financial crisis, along with the Covid disruptions, has created a scarcity of supply in the market. ESG requirements have compounded the situation, rendering much of the existing real estate stock obsolete.

In the United Kingdom, for example, about 80% of commercial real estate falls below ESG standards, according to industry surveys, and this will force property owners and developers to upgrade existing buildings or build new ones.

Positive supply-demand imbalance

At present, there is a mismatch between current building standards and ESG regulatory requirements, creating a positive supply-demand imbalance. Meanwhile, tenants are increasingly seeking high-quality, sustainable spaces that align with ESG criteria. Consequently, properties that fail to meet these standards may face obsolescence, while those that comply can command premium rents and attract long-term tenants.

This dynamic opens avenues for redevelopment and retrofitting, presenting opportunities for investors to enhance asset value through ESG-focused upgrades, Breslauer says.

“There is opportunity for investors to basically fix things or build new ones, which will fill a natural demand because they cannot go into the weaker-quality buildings. So, the supply and demand dynamic is generally pretty positive. The ESG aspect helps,” he adds.