How SEC’s Climate Rule Would Impact REITs

The federal government is codifying for REITs and other public companies what’s increasingly becoming conventional wisdom: Investors care about climate change and climate-related risk.

That’s the upshot of a proposed rule change announced this week by the U.S. Securities and Exchange Commission. The new regulation would require all U.S. public companies to report on their climate-related issues, their management of those issues, and the impact those issues have on their business strategies and consolidated financial statements.

Registrants will also be responsible for reporting on all greenhouse gas emissions, including Scope 1 emissions (direct emissions), Scope 2 emissions (those emitted by the energy they purchase), and Scope 3 emissions (those emitted upstream and downstream in the value chain).

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The announcement was unexpected but not “overly surprising,” according to Stephen Boyd, senior director, U.S. Real Estate and Leisure at Fitch Ratings. It is “additional evidence of the growing importance of investors’ focus on ESG risks.”

Many U.S. public companies, including REITs and other traded real estate companies, currently report on their climate-related risks, GHG emissions and other non-financial data, on a voluntary basis in their filings.

“The real estate industry is well ahead of regulation,” remarked Dan Winters, head of Americas at GRESB. “Leading REITs integrate a wide range of ESG best-practices into property operations.”

There are, however, a lot of inconsistencies in their reporting methodologies, even within the same industry, noted Green Street Senior Analyst Daniel Ismail. Standardizing reporting on climate-related factors will make it easier for analysts and investors to make apples-to-apples comparisons between companies.

“This is a material step forward in creating a national framework for tracking and reporting climate-related metrics,” he said.

The change is also significant because it changes how the SEC treats climate-related financial disclosures, according to Ameena Majid, a partner with Seyfarth Shaw in Chicago.

“They have typically taken a principles-based approach, which gives organizations an ability to assess the risk factors to the business that rise to a level of materiality for disclosure,” she said. “Here, with the prescriptive nature of these rules and a specific requirement to disclose Scope 1 and 2 emissions, the SEC has flipped that around and is effectively telling public companies that climate is a material financial risk factor.”

More Mandates

The SEC proposal reflects the growing involvement of government in U.S. climate-related issues and coincides with similar disclosure-related governmental actions underway in the United Kingdom and the European Union.

In January, President Biden announced the Building Performance Standards Coalition, a partnership of 33 state and local governments “dedicated to delivering cleaner, healthier and more affordable buildings.” One of the key goals is that legislation be passed in each of the represented jurisdictions by Earth Day 2024.

Green Street has calculated that about one-third of U.S. commercial real estate square footage is covered by some city or state regulations that already requires real estate owners to report greenhouse gas emissions and greenhouse gas reduction planning.

Challenges Ahead

The details of the SEC proposal have not yet been disclosed, so it is difficult to predict the challenges compliance could present for SEC registrants and commercial real estate registrants, in particular. One obvious challenge for all registrants will be tracking and reporting Scope 3 emissions, which emanate from assets not owned or controlled by the companies.

According to the U.S. Environmental Protection Agency: “The scope 3 emissions for one organization are the scope 1 and 2 emissions of another organization. Scope 3 emissions, also referred to as value chain emissions, often represent the majority of an organization’s total GHG emissions.”

The SEC has acknowledged that challenge by requiring Scope 3 emissions reporting to be implemented in 2025. Companies will need to begin reporting Scope 1 and Scope 2 emissions in standardized fashion by 2024.

Real estate companies also have a fair share of Scope 1 and 2 emissions, too, and their assets can be especially vulnerable to climate-related events depending on their location.

“Real estate is a notable contributor to greenhouse gas emissions,” said Ismail. “Forty percent of global greenhouse gas emissions emanate from real estate operations and construction, and, compared to other businesses, it is stationary.”

The proposal is subject to a comment period: 30 days after publication in the Federal Register or 60 days after the date of issuance on publication on sec.gov, whichever period is longer. As more details are released, however, there is a potential for legal challenges.

Nareit declined to comment for this article.