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How ESG, Sustainability and Climate Risk Enter Value Under the International Valuation Standards

Why ESG affects value only through market evidence — and how valuers should evidence it.

By José Covas, FRICS
Member, IVSC Standards Review Board · Chair, IVSC ESG/Sustainability Working Group · Chair, RICS Standards Committee

The short answer. ESG does not create value by decree. A building is not worth more because it is sustainable; it is worth more only to the extent that the people who rent, buy and finance it demonstrably pay more, pay sooner, stay longer, or lend more cheaply because of its sustainability characteristics. Under the International Valuation Standards (IVS), the valuer’s duty is not to assume a “green premium” or a “brown discount” — it is to find the market evidence, weigh it, and disclose it. Where the evidence is thin, that too must be stated, not papered over.

This is the distinction that most published answers miss. Consultancy notes and surveys often report that “green buildings command a premium,” and then stop — as if the premium were a property of the certificate rather than a behaviour of the market. The standards take the opposite starting point: the impact of ESG is an empirical question, answered market by market, from observable transactions and cash flows, not from a white paper.

1. The principle: value is evidenced, not asserted

The IVS are built on bases of value — and the most common, Market Value, is defined as the price that would be agreed between a willing buyer and a willing seller in an arm’s-length transaction after proper marketing, where both parties act knowledgeably and without compulsion. Everything in that definition points to one thing: what the market does, not what the valuer, the owner, or a sustainability framework wishes it would do.

That forces three well-established distinctions to the front:

  • Price is not value, and cost is not value. The cost of a retrofit can be calculated to the euro; it does not follow that the retrofit adds that amount to value. The market decides how much of the cost it will pay for. For ESG, the cost approach is therefore the weakest tool — it answers a different question.
  • ESG is a value driver, not a value add-on. It does not sit beside the valuation as a separate line. It works through the ordinary mechanisms of value — rent, occupancy, costs, risk, liquidity — and must be captured there, which also means it must not be double-counted.
  • The evidence lives in the market, not in the rating. A certification or an EPC band is useful information about a building. It is not, in itself, a value. It becomes value only where market participants act on it.

As the IVSC’s own perspective puts it, the impact of ESG “is not to be found in any white paper or think tank study; it is to be measured from the market.” That sentence is the spine of this entire note.

2. The mechanisms: how ESG actually reaches value

If ESG works through the normal drivers of value, then the practical question is: which drivers, and how do you evidence each? Six channels matter most.

Income — rent, incentives and void. Where occupiers prefer sustainable space, that preference can show up as higher rents, shorter void periods, lower incentives and more resilient demand. The evidence is in leasing: comparable rents, letting times, tenant retention and the selection criteria occupiers actually apply. The valuer’s job is to establish whether that preference is present in this market, for this asset type — not to import it from elsewhere.

Operating costs. Lower energy and water consumption reduces running costs. Where the tenant bears those costs, efficiency can support rent and net effective income; where the landlord bears them, it supports net operating income directly. This is one of the more measurable channels.

Capital expenditure and the cost of inaction. Non-compliant or inefficient buildings carry a future bill — retrofit capital expenditure to meet tightening regulation and occupier expectations. A credible valuation reflects that bill where the market would, and also the cost of delay: lost income if the asset becomes less lettable to ESG-sensitive occupiers before it is upgraded.

Risk — capitalisation and discount rates. Market participants price risk. Where less sustainable assets are seen as more exposed — to regulation, to obsolescence, to weaker future demand — that can be reflected in the yield or discount rate. The influence of ESG on the capitalisation rate can be significant, but it must be grounded in how investors actually price comparable assets, not asserted as a blanket adjustment.

Terminal value and obsolescence. This is where climate and transition risk bite hardest. A building that is acceptable today may face a smaller buyer pool and a higher exit yield in ten years if it no longer meets expectations — a lower residual value. Reflecting this honestly is central to valuing long-hold assets.

Liquidity and finance. Green finance (lower-cost debt for qualifying assets) can enhance returns; conversely, assets that fall outside lenders’ or investors’ ESG criteria can face a narrower, more expensive capital market. Liquidity is itself a value factor.

The point of listing them this way is disciplined: each channel is a place to look for evidence, and each is a place where an assumption, once made, must be stated and must not be counted twice.

3. The evidence problem — and why transparency is the answer

The honest difficulty is that ESG-comparable evidence is still thin and inconsistently disclosed. Two buildings rarely differ only in their sustainability characteristics, and ESG attributes are not yet recorded consistently across transactions. That is precisely why the sales-comparison approach, used naïvely, tends to overclaim.

The response is not to stop valuing ESG; it is to make the reasoning explicit. In practice that means:

  • Favouring approaches that expose assumptions. A discounted cash flow can carry ESG explicitly — in rents, incentives, voids, operating costs, capex timing and exit yield, year by year — and show scenarios side by side. Transparency of assumption is worth more than a single opaque adjustment.
  • Scenario testing over formulaic adjustment. Where the market has not yet priced a factor clearly, the valuer’s value-add is to test outcomes under different paths (early retrofit vs. delay; tightening vs. stable regulation), not to invent a point estimate and present it as certainty.
  • Stating what is assumed and why. Special assumptions and the limits of the evidence belong in the report. “The market does not yet show X” is a finding, not a failure.
  • Reading the market’s own barometer. The IVSC runs an annual ESG/Sustainability survey of valuers and users worldwide — the 2025–26 edition is open for participation now — which tracks, year on year, where practitioners actually see ESG affecting value and where they do not. It is one of the few public, repeated, cross-market reads on how far the evidence has actually moved.

4. Physical risk vs transition risk — a distinction worth keeping straight

Climate risk reaches value along two different paths, and conflating them produces bad valuations.

  • Physical risk is the exposure of the asset itself — flood, heat, storm, subsidence, water stress — and it bears on insurance cost and availability, capital expenditure, resilience and, ultimately, liquidity and yield.
  • Transition risk is the exposure to the response to climate change — tightening regulation, carbon pricing, energy-performance minimums, and shifting occupier and investor preference. This is the path that turns an acceptable asset into a stranded one.

Both can affect value; they do so through different channels and over different horizons, and the evidence for each is found in different places.

5. What is changing — the public direction of travel

Two public developments make this the moment for the profession to get the method right.

First, the standards themselves are moving. The IVS Exposure Draft — the next edition, effective 31 January 2028 — has been through public consultation, and sustainability is now squarely on the standard-setter’s agenda. Notably, the forthcoming edition introduces the term “sustainability” into the standards’ own vocabulary: a signal that the profession’s central rulebook is absorbing these considerations into its language, rather than treating them as a side topic.

Second, regulation is already pulling. In the EU, the architecture that turns sustainability into cash-flow consequences is in place or arriving — corporate sustainability reporting (CSRD), the EU Taxonomy’s technical screening criteria for real estate, and tightening energy-performance requirements for buildings (EPBD). These do not change what value is; they change what the market prices, which is exactly why they reach valuation through the channels in Section 2.

The direction is clear, but the discipline does not change with it: new regulation is one more thing to evidence in the market, not a licence to assume.

Frequently asked questions

Does a “green” building automatically command a premium?

No. A premium exists only where market participants actually pay it, and it varies by market, sector and time. Surveys suggest many practitioners observe green premiums and brown discounts, but the valuer’s task is to establish whether one is present in the relevant market — and to say so plainly when it is not.

How should an EPC or energy rating affect a valuation?

The rating is evidence about the building, not a value in itself. It affects value to the extent it drives rent, running costs, lettability, capex exposure and buyer demand in that market. Treat it as an input to the channels above, not as a direct adjustment.

What is the difference between physical and transition risk for value?

Physical risk is the asset’s exposure to climate hazards (flood, heat); transition risk is its exposure to the response — regulation, carbon costs, changing preference. Both reach value, through different channels and horizons.

What are “stranded assets” and how do I reflect them?

A stranded asset is one that loses value early because it no longer meets future regulatory or market expectations. It is captured through a smaller future buyer pool, higher exit yield, lower residual value and the capex needed to avoid stranding — usually most transparently in a DCF.

Which valuation approach best captures ESG?

Usually the income approach, and often a discounted cash flow, because it lets ESG assumptions be stated explicitly and tested as scenarios. The sales-comparison approach is harder to apply while ESG-comparable evidence remains thin; the cost approach is weakest, because cost is not value.

Do the International Valuation Standards require me to consider ESG?

The standards require that investigations and advice be appropriate to the purpose of the valuation. Where ESG factors are capable of affecting value, considering them — and evidencing or ruling them out — is part of doing the job to standard, not an optional extra.

About the author

José Covas, FRICSJosé Covas (FRICS) is a real estate valuation specialist and the founder of José Covas Real Estate in Lisbon. He is a member of the IVSC Standards Review Board, which oversees the development of the International Valuation Standards used in more than 100 countries, and Chair of the IVSC’s ESG/Sustainability Working Group. He also chairs the RICS Standards Committee. He has close to three decades of experience across international markets and teaches valuation, including professional ethics and conduct.

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