The EU’s new taxonomy for sustainable finance and associated legislation is a complicated concept to get your head around. To make matters trickier, it seems likely to evolve over the coming years, with the ramifications unknown for some time. To break down the impact of the new EU taxonomy, at least briefly, and how it impacts real estate investors and decisions around building a new property, Marina invited Theodor Kubak, the Managing Partner at Arbireo Hospitality Invest & Value One Hotel Operations, for the sixth episode of the IDEEA podcast.

As he breaks down the impact of the new regulations, Theo stresses that one of the main challenges in complying with them is the lack of data. While it may pose some challenges, he believes one of the key benefits that these changes are that all stakeholders will need to work together as a team to ensure that the project or properties are compliant. Before this, goals and priorities were too fragmented by project phase and group.

When you have questions about sustainability and hospitality, Theo is someone whose insights will be valuable to the conversation. For example, did you know greenwashing was coined in the hospitality industry? Watch or listen to the 20-min episode as Theodor Kubak teases a few insights ahead of his sustainability panel session on day two of IDEEA.

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TRANSCRIPT

Intro 00:00

Welcome to the IDEEA Podcast, a channel for the IDEEA Hospitality Investment Forum, which is an annual gathering for the Hospitality Investment Community in Eastern Europe. Tune in to insightful conversations between the IDEEA team and hospitality investment leaders and innovators across Europe. And now let's dive right into today's episode.

Marina Franolic: Hello everyone! Welcome once again to IDEEA Hospitality Investment Podcast. We're getting close to IDEEA forum that's going to be in Athens on September 26th and 27th, and this is just the introduction to the topics that we will be discussing at the event. So today with me, we have Theodor Kubak is also one of the speakers at IDEEA. He's managing partner at Arbireo Hospitality Invest and Value One Hospitality. Theodor welcome.

Theodor Kubak: Thank you for having me.

Marina Franolic: Theodor you have been working in the sustainability aspect of investments for a really long time. So you're one of the persons that whenever I have a question regarding sustainability, I actually first think of you and when I also talk to people, everyone thinks about you first. But there's one thing that has significantly changed in 2022. The ESG EU taxonomy regulation has been introduced and implemented from January 2022, so this year. And the updated document has been released in July, so just a month ago. This new regulation at this moment has only E from ESG regulated, so environmental, and also just first two environmental goals and 94 economic activities defined, but as well, it already has 24,000 pages. Theo, can you please share with us, what has changed for real estate investor when developing the new property?

Theodor Kubak: Well, you quite rightly refer to the first dedicated act on sustainable activities for climate change adaptation and mitigation objectives that was published on December 9th and came into effect as of January 22 as you said. The publication of the first dedicated Act was accompanied by the adaptation of commission communication on EU taxonomy, corporate sustainability reporting, sustainability preferences and fiduciary duties. So the objective of this initiative was and probably still is, clearly the directing of finance and investment towards European Green Deal. However, and that's the issue here, it has become apparent that EU taxonomy dedicated act is to be seen rather as a living document that has and that most probably will evolve further over time, as new developments and technological progresses occur. To me, it also seems that these criteria’s will be reviewed on a regular basis. This will ensure, however, that the new sectors and activities including the transitional and other enabling activities can be added to the scope of a time. And as such, the adopted document from July that you're referring to, from this year, is yet such another step in this direction. But now coming back to your actual question, what has changed of a real estate investor when developing a new property? This is a very complex question. It's the new or perhaps extended toolkit for successful real estate investor, especially in the hospitality industry is a result of various phenomena that have emerged over the last two years basically. Besides the emerging changes in relation to the first efforts to comply with the Green Deal, you remember December 2019 and the EU Taxonomy requirements, COVID-19 triggered economic challenges that first only manifest itself in a dramatic deterioration of business and elevated uncertainty, I would think, across most sectors and not only in hospitality sector. You recall in the beginning, we were all glued to webinars trying to guess by when and in which form and shape the travel industry would be recovering. Besides the question of recovery, the duration of how long the elevated inflation would [inaudible 05:05] us, is now answered differently by different central bankers. We in the EU in Berlin, the central bank, so in Frankfurt the central bank has probably the most laid-back definition of it. A few months ago, not long into the just recent recovery, we realized an additional challenge labor. So trained staff that had either been asked to leave or found better paid, more secure alternatives had been difficult to replace.

Now, when we saw that COVID was nearing an end, the war in Ukraine triggered a new set of challenges. There's one more issue last but not least, is the sentiment of being green becoming more and more invoke capital structures that have not lived up to this claim have come under intense scrutiny by regulatory measures. You remember the term greenwashing? And the term greenwashing, if I just put it in is actually a term that originated in the hospitality industry funnily enough. It was first used in 1986 already by an American environmentalist and researcher. Greenwashing was initially used to describe a practice adopted by a beach resort in Samoa, where they provided with reusable towels as a way to help the environment. Now meanwhile, the same resort was expanding further and further into local land. So answering your question of what has changed for real estate investors when developing a new property, you first need to remember that more often than not, the developer on one hand, and the real estate investor, on the other hand, are often two different parties. The core interest of the developer is to create a new product and sell; whereby the investor most often wants to acquire a sustainable cash flow producing product. Now, empirically, especially pre-COVID, their interests have not always been aligned. This misalignment is particularly also to be blamed for the present consultation in operating platforms that is seen in the market. Now, this event has brought about the biggest change. Developers and investors are moving closer to find common solutions to questions such as, and now it comes, ensuring ESG and EU taxonomy compliance are traced in the development process already, despite the moving targets and varying interpretations in different countries. So working together from the very beginning, rather than just looking at the product at the end of the development, and agreeing on the implementation of digital transformation to enhance services, and experienced delivery, as well as efficiency and profitability. There's now often a common understanding that the compliance of the sustainable finance regulations, or you probably refer to it as the SFTR, is essential for an investable, great product. On this note, the EU SFTR requires capital structures to disclose how sustainability risks are considered in their investment process. What metrics they use to assess ESG factors and there we have a long way to go because there's so many initiatives out there on the market; and how they consider investments decisions that might result in negative effects on sustainability factors.

Now in a hotel asset, these are aspects that are relevant during the development process as well as during the operational process. One takeaway for many hotel operators is the challenge to comply with requests from potential corporate clients during the annual RFP, the request for proposal process to report and show how the hotels report co2 footprint for the stay of a guest, which is impossible. Simply the infrastructure is not available; most often the infrastructure is not available in the property simply because the hotels or the legacy design guidelines have not implemented or considered such infrastructure.

Further considerations including how to achieve development cost, certainly in this volatile environment. Password, maximum garden prices; you may be aware that right now new developments have become a lot harder simply because of this exploding development costs of steel, concrete and what have you. And last but not least, when addressing changes for investors it's the [inaudible 10:29] in contractual changes to answering questions such as what kind of provisions need to be incorporated in operating contracts to ensure ESG requirements and learnings from the pandemic are successfully covered, buzzword Green Lease. And other topics that need to be discussed in this context are ESG clauses and the distribution of co2 costs and any higher property taxes. In these times of hyperinflation, the topic of preservation will also be hotly debated in negotiations on modern hotel operator contracts. So you see, the real estate investor has to really adopt to a completely new strategy and attitude when it comes to developments.

Marina Franolic: Theodor, I think that everyone can understand what they what I said, when I was doing the introduction, what an expert you are in this field, because you know each of these aspects in such a depth. I wanted to go back a little bit to one part of your answer, is talking about developer and investor. So as you said, it's the developer that develops the property, and then it's the investor that actually buys the operating property. So when I was asking you what changed for the hotel investor, I also meant what changed to hotel developer. So when we know that about 30% of co2 emission that comes from the real estate and from the construction industry. On the side of the developer, what do they need to change within their operations and on type of development in the construction, now calling this to this new law that has been implemented from beginning of the year and then now also additionally from July this year. So what new regulations are there that they need to implement? What do they need to do in terms of the construction?

Theodor Kubak: That's again a very, very complex question, depending on the requirements of the capital. Because essentially, the EU taxonomy and the Green Deal is targeting the capital to comply as you have said, essentially, co2 free asset. Now, it was just on this aspect., various capitals are structured differently. And in March last year, 2021, new fund structures have been applied and have been introduced. They are called the Article Six, Article Eight, and Article Nine funds, and they have different objectives. Now, us ourselves in Arbireo Capital right now, we are transforming some of these funds into article eight funds, as these are required under this new scheme. A brief explanation - all managed products are essentially referred to as Article Six funds. Article eight funds, however, refer to financial products that promote environmental or social characteristics provided that companies in which the investments are made, follow good governance practices. You see, this is very, very loose. And then Article Nine funds refers to products that have sustainable investment objectives, and all holdings that invest in this must be sustainable investments that meet the standard of -- and I'm sure you're also familiar with this, is the Do not significant harm concept under the EU taxonomy objectives. Now, you may recall also that with identifying co2 emissions, we have scope one, scope two and scope three emissions. And it is the scope three emissions that make it so difficult to measure. So therefore, what changes must be introduced to the construction is not only a matter of material, but it's also a matter of knowing your supplier, similar knowing to the KYC process, knowing your customer process, knowing your supplier in terms of where do the materials come from, how have the product being produced, which kind of distance have they traveled in order to get to the site. Give a basic example, we have been thinking for a long time to use [inaudible 16:06] Developments. Now, we had thought that's a brilliant idea until we found out in order to get this module development from where developed, we need run about 246 trucks to get them from Germany to Italy for example. This is not very sustainable. So therefore, depending on the situation there are various different aspects on how the construction will be affected. But to give you one hint with regards to the cabinet structure, and to provide some insights on the dynamic of these vehicles, assets in Article Eight and Article Nine funds reached in excess of 4 trillion euros at the end of December 2021, representing around about 42.4% of all funds sold in the EU. So there is an incredible dynamic and yet it is there's so much room for further interpretation.

Marina Franolic: Theodor, tell me what do you see as the greatest challenge for investors also for developers in the hospitality industry regarding this new taxonomy?

Theodor Kubak: Well, in order to comply to this regulation it requires data and reporting solution covering sustainable risks, principle adverse impacts that are often referred to as PAS, and Article Eight and Article Nine fund requirements that I've just alluded to. However, it is the missing data that is most often preventing various entities to report. Now, I remember a recent report by Bloomberg, with a somewhat provocative title, The Hotel Industry's Big Carbon Lie, that states that despite having made a pledge to considerably reduce carbon emission many of the global hotel chains that publish annual sustainability reports and follow environmental, social and governance criteria have failed to mention embodied carbon, even once, even once in its reports of data and pledges. So the challenge for real estate investors and developers [inaudible 18:44] really is that without any regulation, or agreed up on definition, through the EU taxonomy definitions or through by the hotel design guidelines of what it means to be net zero, complying is wide open to interpretation. As an example, as I mentioned before, while materials could be co2 free, the transportation of the production of the same may have had a serious impact on the co2 footprint. On this note, perhaps there's one issue that we need to think of. The fact remains that renovating or repurposing an already existing buildings will almost always be a more sustainable approach than a new development.

Marina Franolic: And another question that was interesting. So these laws will be implemented, but who will make sure that they're really working in practice; that hotel companies, investors, developers, whoever is part of this actually is implementing them on a daily basis.

Theodor Kubak: I would think that eventually it is the market that regulate the industry. The capital market, as well as the clients, the guests who have an increased awareness of such initiatives and to demand the implementation of those. Now, on the capital side, the increase of public investigated greenwashing or the spreading gap in financing costs will be main drivers. Recently, I've had the opportunity to moderate a panel on the impact of green finance, for example. And all the bankers agree that there is a spread. It's just a question how much the spread is. Some of the gap of 10 basis points other of up to 100 basis points. The financial impact coupled with the increased development costs, there is now an increased awareness that, considering the US economy, thus have a positive economic effect. So it is a market treatment. However, it is also true that the entire issue does remain highly complex and a moving target. Because despite 94 economic activities you've mentioned before, without any regulations, or agreed upon definition of what it means to be net zero, it leaves everything open to interpretation, and even sometimes obfuscation. So I would think there's lots to be done. But the market will take us to these objectives.

Marina Franolic: That's definitely something positive to hear. Because I wonder whether we're going to be as a society, overall be able to achieve the goals that we all kind of set. Theodor thank you so much. So Theodor will be joining, as I said, IDEEA on our panel discussion called Sustainable Real Estate Hotel Development Leading the Change. And as you can all hear, Theodore has been in this space for a really long time, that is a great expert has noticed all the details. And I'm really glad Theodore, that you accepted our invitation that you will be joining that you will be sharing your knowledge and your expertise with the audience and with the dominate. And I'm really very much looking forward to seeing you in Athens. Thank you so much for today.

Theodor Kubak: Thank you for having me. Thank you very much. Thank you. Bye bye.

Marina Franolic: Bye Theodor.

Outro: Thank you for listening to the IDEEA Podcast, the channel for the IDEEA Hospitality Investment Forum. You can find a full transcript of this conversation in the Content Library on ideaa-forum.com. With other reports and insights. We look forward to welcoming you and your colleagues in person at IDEEA in Athens, Greece on the 26th through 27th of September 2022. If you haven't registered yet, please go to ideaa-forum.com to purchase your pass today and save before ticket prices increase. Please feel free to email us with any questions at hello@thebench.com.

Until the next episode, stay safe and keep well. Bye-bye for now.