What is the issue?
Buildings, by their nature, are energy intensive. From the carbon used in bricks, concrete and steel, to the running costs, they have a direct impact on the environment. According to an assessment [i] made by the engineering faculty at the University of Cambridge, buildings account for “50% of all extracted materials, 42% of final energy consumption, 35% of greenhouse gas (GHGs) emissions, and 32% of waste flows” in the EU. Figures for the United States are likely higher.
Recently, the World Green Building Council updated its Net Zero Carbon Buildings Commitment to include new requirements for addressing “embodied carbon emissions”, the materials and construction processes required to build and renovate buildings, that represent 10% of total carbon emissions. It is estimated that between 2020 and 2050, more than half of total carbon emissions from all new global construction will be due to embodied carbon.
As a result, post COP26, there are many factors for the real estate industry to consider, now that 95% of global GHG emissions are covered by government-led net zero targets to be reached between 2050 and 2070.
Context
Buildings are primarily in cities, and a growing number of cities will be impacted by a 1.5ºC temperature increase scenario in Europe, but also Asia and Africa where climate scientists analysts predict outcomes from flooding and disrupted weather patterns could be severe and widespread.
Coupled with this, social change may worsen the situation. The UN estimates that 70% of the global population will live in urban spaces by 2050, but many of those are in informal settlements and slums, with related issues including excessive housing density.
The sector will need to undergo significant transformation
Data from the Global Real Estate Sustainability Benchmark (GRESB) for the last three years shows a consistent 75% of property investor and manager respondents adopting some form of climate related targets. However, the proportion making specific net zero CO2 commitments is small, albeit rising: 3.7% in 2019, 7.9% in 2020 and 15.1% in 2021. This is below the level of net zero targets being set in the public equity space. A challenge for real estate market participants and valuers is the size of capital expenditure required to retrofit existing buildings. The conundrum is similar for businesses and households, i.e. weighing up the value enhancement v cost in terms of investment [ii].
As a result, the business case for action seems to be foundering on high barriers of expenditure required alongside the timing in making changes which require significant commitment. An answer could lie in a combination of government intervention and feasible technological solutions. Enabling the market to support the cost of retrofitting buildings is key to encouraging large scale investment and mitigating the physical effects of climate change on buildings.
The risk of stranded assets
Sector stakeholders model their assets’ climate-change resilience against a 1.5 or 2ºC increase in global temperature to assess the risk of stranded assets or related impacts on portfolio management strategies. Identifying and articulating key risks to value to determine where assets could become stranded through being uninsurable, unlettable or unsellable is becoming common practice.
Evaluating the cost of improving resilience and the efficiency of vulnerable buildings against climate scenarios stretching out to 15, 20 years and beyond can serve as a mitigation strategy.
But the question is how much governments will step in and regulate and incentivize change?
The EU recently unveiled its “Fit for 55” package of 13 policy proposals as part of efforts to achieve the European Green Deal. It includes plans to establish a new carbon market for buildings, a strengthening of the Energy Efficiency Directive (EED) and a promised revision to the Energy Performance of Buildings Directive (EPBD) [iii].
Investor action is growing
The Norwegian pension fund KLP is one of nine asset owners to participate in a €270m funding round for a sustainable housing strategy that links management fees to impact targets. Eight unnamed pension schemes and insurers in Germany also recently invested in the €750m European Residential III Fund from Berlin-headquartered Catella Residential Investment Management [iv], which describes itself as the first ‘dark green’ pan-European residential ESG impact fund. Launched two years ago, it includes a penalty clause for management if they don’t meet its financial or societal targets – which include cutting carbon and offering affordable housing and decent living conditions.
New value horizons for real estate operators?
Last year, JLL, the real estate advisor, identified a “green premium” in central London real estate. It compared BREEAM (Building Research Establishment Environmental Assessment Method) certified A-grade buildings to uncertified and found that between 2017 and 2020 “the average premium of all rated buildings above non-rated buildings is approximately eight per cent.” The new implications for property valuations extend conversely to investors who also may be subject to “brown discounts” [v].
Investors are pricing in ESG factors and green loans are offering cheaper access to finance when KPIs are met. It may be that the plans to achieve net zero in the building industry are now on the table.
related webinars
Post COP26 reflections from the Real Estate industry
Nov. 2021 | This webinar will explore the challenges to upgrade buildings and retrofit, deliver and fund greener buildings while also meeting net zero targets.