ESG challenges in the care home and senior living sectors: Part 1

Several developments in environmental (and related) legislation are adding operational and investment pressures, including measures which:

• require developments to leave the natural environment in a measurably better state post-development by ensuring the enhancement of habitat and bio-diversity. The bio-diversity net gain requirements of the Environment Act 2021 are expected to come into force November 2023 and have already been incorporated into local planning policy frameworks;
• prevent buildings from being let, or continuing to be let, unless the property complies with minimum energy efficiency standards. The Minimum Energy Efficiency Standards Regulations (MEES) made it illegal to let a building with an Energy Performance Certificate (EPC) rating of less than 'E' from 1 April 2023 onwards with few exceptions, though it is thought likely that the Government will increase this target to EPC 'C' come 2027 and EPC 'B' by 2030; and
• imposes disclosure and reporting requirements on energy use and carbon output at an investor and/or corporate level. The FCA's proposed UK Sustainability Disclosure Standards (SDS) will apply at the investor level, with disclosure rules applying from 2024 and mandatory reporting from 2025. Energy use and carbon output disclosure and reporting requirements already apply at the corporate level for entities deemed 'large' (and their UK groups) under the Energy Savings Opportunity Scheme (ESOS) and Streamlined Energy and Carbon Reporting Scheme (SECR). In addition, Task Force on Climate-related Financial Disclosures (TCFD) aligned reporting requirements are being phased in for investment and larger corporate entities in coming years. Where funds are being raised outside the UK, overseas disclosure requirements may also be relevant (particularly in the EU).

The bio-diversity net gain ("BNG") requirements of the Environment Act 2021 will alter the financial equation when it comes to choosing sites for development, requiring developers to measure a minimum 10% increase in biodiversity after development through habitat creation and enhancement to hit 'net gain'. This will be automatically imposed in all planning permissions from (a to be confirmed date in) November 2023 (though individual planning authorities will have the discretion to impose a higher percentage BNG requirement) and will need to be demonstrated in concept pre-commencement of development. BNG is also an ongoing operational requirement for 30 years following development, with obligations potentially contained in section 106 agreements which run with the land and bind future purchasers.

The built environment sector is already reporting an adverse impact on timetables for construction in anticipation of the introduction of BNG. It is yet to be seen how great an impact it will have in slowing the delivery of new schemes, but further inertia at planning stages is a concern, particularly in the senior living sector. There is also a general unease about the capacity and technical expertise both within local authorities and on developer-side to navigate the significant complexities and challenges of the new BNG regime. Some pragmatic and creative solutions may be needed to avoid this becoming a major delay to consenting and execution of projects.

New care home or senior living developments face a number of challenges:

• They serve multiple occupants and can often not be high-rise, owing to accessibility and fire safety requirements.
• Schemes require dedicated community space and amenity space which needs to be available round the clock.
• Out of town schemes can present opportunities for gardens and landscaped areas but inner-city developments are harder pressed to find or develop green space.
• The location (and profitability) of developments are dictated by social factors – age, need and density of the local community – not just the state or cost of the land.
• It is possible under the legislation to purchase off-site land for habitat creation (although this also comes at a cost and developers across the real estate market are reporting a shortage in suitable available land, and involves complexities in securing the enhancement of the land). It will also be possible to rely on a new statutory biodiversity credits scheme, to in essence fund third party provision of biodiversity enhancement – but it is likely to take a number of years for this to become a liquid market.

Under MEES , a failure to achieve EPC 'E' now means it is not lawful for investor-owners to let developments to operators unless they are exempt. Banks and other financial institutions are also increasingly scrutinising EPCs.

The particular challenges for the care home and senior sectors include:

• Both care home and senior living assets are energy intensive, used and occupied on a 24/7 basis catering to complex care needs. Capital invested in improvements is put to task, with returns from energy reduction being harder to achieve than in other mainstream real estate investment classes.
• There is a substantial amount of older stock with poor ventilation systems, single glazing or poor insulation, and ageing fossil-fuel fired central heating and hot water systems. Systems can't be limited to 'out of hours' due to vulnerable occupies.
• Carrying out improvements can be challenging without a wholesale relocation of residents. For those with complex care needs such as dementia sufferers, the works, associated disruption and noise would be not merely inconvenient but confusing and distressing.

The resilience of buildings to deal with climate change and transition risk from environmental factors therefore has a greater impact in these sectors than in many others. These challenges are likely to intensify over the coming years as the legislative hurdles for reaching the required EPC ratings escalate to 2030.

Investors and operators are grappling with increased reporting and disclosure requirements, intended to increase accountability for those investing in and operating energy-intensive real estate businesses, and forming part of an ever-tightening framework of environmental requirements on operations that are likely to intensify as the 'Net Zero' deadline (2050) and interim targets draws near.

The care home and senior living sectors present unique opportunities to invest in business delivering genuine positive impact, both at a social and environmental level. The challenge for investors into the sector is how to measure that impact and accurately report green credentials to the market, without the "greenwashing" concern that has come to the fore.

Energy use and carbon output disclosure and reporting requirements apply at the corporate level for certain 'large' entities under the Energy Savings Opportunity Scheme (ESOS) and the Streamlined Energy and Carbon Reporting Scheme (SECR). Incoming Task Force on Climate-related Financial Disclosures (TCFD) obligations may require in-scope investors and corporates to report on their alignment with wider climate goals (and the risks that the climate poses to them). As the sectors have increasingly sought third party investment, even smaller operators are focused on capturing this data and putting in place improvements to attract the widest pool of capital investment. Whilst this comes with an additional administrative burden and potentially capital expenditure for businesses with pressured margins, management teams have already been identifying energy efficiencies which goes hand in hand with reducing their carbon footprint.

Notwithstanding the significant challenges in these areas facing the care home and senior living sectors, there is little evidence to suggest a max exodus from or crisis within the market as a result. On the contrary:

• the sector is taking steps to better exploit new technology to automate the data-collection process, with many operators now appointing a person within the organisation to deal with environmental and sustainability compliance;
• proactive and well-informed management teams are driving a new market of healthcare architecture and design, with operators and investors working together on increasingly innovative ways in which to fund improvements and improve resident experience as well driving energy efficiencies;
• operators and investors have, along with the rest of the built environment sector, called on the Government to stand behind its net zero targets with targeted tax breaks, grants and subsidies, to facilitate the much-needed investment into portfolios.

The care home and senior living sectors attract many motivated, innovative and caring individuals, with a genuine interest in improving the lived experience of our older people. Whilst the sector faces significant and particular challenges to keep up with the pace of change in the "E" space, it is also well placed to lead the way for sustainable development and investment into operational real estate assets as a whole.