ESG in action. How ESG is influencing the Hungarian office real estate submarket

ESG is a hot topic in Hungary. Despite the existence of ESG laws, it remains primarily a new approach towards sustainability rather than a set of legal provisions. The abbreviation implies the concept of the following areas: environment, social and corporate governance.

ESG has a major influence on the real estate market globally and in Hungary especially on the office subsector. Back in 2009, LEED, BREEAM and WELL certifications raised awareness of the importance of green solutions, although it was not followed by a real greening process. Since 2018 the green lease is being used more often in requests for proposals and lease negotiations even though almost no asset is currently being utilised with a green lease agreement. It is expected that ESG and sustainability will be catalysed to landlords and tenants with the energy crisis and that more and more ESG-friendly processes will be used resulting lower service charges, increased sustainability and greater adaptability to the changing needs of end users.

Around 44 % of the four million square metres of Hungarian office stock can be regarded as green, i.e. has either BREEAM, LEED or WELL certification. There are around 100 qualified office buildings, which corresponds to some 25 % of the assets currently used as office space in Hungary. The government has announced that from June 2024 only office buildings that qualified as so-called nearly zero energy buildings may receive an occupancy permit in Hungary.

A challenge for landlords?

Landlords are real estate investors utilising their assets to optimise profit. For them it is key to ensure sustainable asset operation, reduce vacancy, utilise the asset for a long time and encourage greening of tenant behaviour. Since the buildings exist for decades, landlords are also responsible for the built environment and should make decisions which are feasible for the long term.

Recently there are stricter public regulations and requirements. As construction costs and labour shortages increase, there is growing pressure from large corporate tenants. Even though newly constructed assets should be green and ESG compliant, landlords need to spend a considerable amount of capex on their brown portfolio. Otherwise, professional investors understand that whoever can secure ESG-compliant products in a central location will enjoy a huge market advantage.

An opportunity for tenants?

In Hungary the attitude and the education level of tenants depends on their size. Landlords educate smaller tenants but can achieve landlord-friendly lease terms. On the contrary, big corporations have more bargaining power and place ESG requirements in requests for proposals sent to the landlord. In Hungary an office area of 8,000 – 15,000 sqm for a single tenant is considered large and only the biggest multinationals rent them. For these companies, ESG conformity is becoming an internal corporate requirement, and they must spend extra costs to conform with it in order to continue to attract the most outstanding employees. For some, ESG is more than just a fine-sounding corporate principle, especially if they are subject to stricter regulation, for instance being listed on the stock exchange or registered by the Hungarian financial supervision authority.

For other tenants that are not sizable corporations the main driver in a lease negotiation is still the price of rent and service charges. These tenants are not yet making ESG demands to landlords. Nevertheless, the quality of the asset may determine the future level of service charges, as in case of inefficient buildings these may equal or even exceed the rent. Thus smaller tenants may also prefer more efficient buildings, pushing up rents on the office market.

ESG will tighten competition in the office subsector

While sustainability considerations are becoming more important in Hungary, so far ESG is only a priority for large corporate tenants, who are driving greening by their high internal standards and to secure the best workforce. For their part, landlords are seeing the benefits of implementing higher ESG standards in tackling operational risk and costs, complying with stricter public regulations and securing the best products so as to retain their market position.

authors: László Krüpl, Adrian Menczelesz, Viktória Magyar