Given the oft-cited statistics that building and operating real estate contributes around 40% of global greenhouse gas emissions, it is no surprise that the real estate investment industry has been actively engaged. in the discussions and events of COP26 that took place in Glasgow this month.
COP26 highlighted a growing desire among the real estate investment community to generate environmental and social returns alongside purely financial returns and a recognition by many investment managers that this is both their fiduciary and moral duty more wide to do so as powerful influencers of our built environment.. As noted by Neil Slater, Global Head of Real Assets for abrdn plc in the COP26 Green Zone Seminar, while the real estate industry has always focused on asset performance, generating value while assuming appropriate levels of risk, the concept of performance is evolving to consider creating assets that work for occupants and that also work for society at large.
So, is there a clear consensus emerging in the industry as to the main challenges ahead and the key actions that need to be taken to make meaningful progress on the climate challenge?
A varied image depending on the sector
See our diagram of challenge of climate transition in all sectors.
The magnitude of the challenge varies widely across real estate sectors, with the logistics sector providing some of the best opportunities to achieve energy neutrality through the use of solar panels on rooftops. A recent Savills report states that on average about 40% of a warehouse roof can be suitable for solar panel installation and based on that, the additional 250,000,000 square feet of warehouse that need to be delivered over the next decade could provide enough energy to meet 97% of the energy needs of the new development. However, retrofitting of the existing fleet with rooftop solar installations may prove more difficult due to the load capacity of older units. Rainwater harvesting and recharging of electric vehicles offer further opportunities for green logistics assets.
The evolution of the office sector has been driven by investors’ desire to protect their assets from obsolescence and keep them attractive to potential tenants, who in turn have also demanded greener buildings, with 45% of all office rentals in central London since 2018 occurring in relation to the space classified BREEAM Excellent or better. The current challenge is seen as an insufficient supply of green office space, leading to rents for green spaces and further illustrating the existence of a “green premium”.
The residential investment landscape is a complex picture: with ‘beds, drugs and sheds’ a key target for real estate investors due to the consistent outperformance of alternative real estate sectors in recent years and structural favorable winds, Many new build for rent developments currently underway offer real estate investors the opportunity to develop green buildings, which are increasingly in demand by residential tenants. The wider UK residential sector is likely to pose a much more difficult challenge, however, with Savills noting that the government’s goal of upgrading all homes where ‘cost-effective, affordable and practical’ to EPC C by 2035 appears very strong. unlikely to be achieved without further policy. intervention, in particular vis-à-vis owner-occupiers.
The retail market presents a similar challenge, with a divergence of outlook between larger scale and typically institutionally owned malls, retail parks and larger units and the typical UK small high street store. These make up the vast majority of retail space in the UK and are likely to prove much more difficult to modernize (and in many cases it is not economically viable to do so).
The unifying theme across the different markets is the need for owners and investors to successfully overcome the threat of stranded assets due to their inability to meet the climate challenge.
Beyond operational carbon
As investors become increasingly adept at reducing operational carbon emissions and even operating buildings on a carbon neutral basis, the role of embedded carbon (carbon attributable to the extraction of raw materials and the process of construction) is likely to become a growing concern for the real estate market. The UK Green Building Council (UK GBC) has predicted that by 2035, embodied carbon will account for more than half of all emissions from the built environment. The UK GBC also recently launched a “Lifetime Net Zero Carbon Roadmap“which aims to build a common vision and agreed actions to achieve net zero in the construction, operation, demolition and reuse of buildings and infrastructure in the UK. It does so by setting a budget and a carbon trajectory for the UK built environment sector, as well as defining key policies and actions for central government, local authorities and relevant stakeholders. UK GBC recommendations include:
- mandatory measurement of incorporated carbon, followed by the gradual introduction of incorporated carbon limits for new buildings to reduce demand;
- elimination of VAT on renovation works (i.e. 0% VAT) which preserve the building’s framework and meet energy performance targets to encourage reuse rather than demolition;
- the development of a free national embedded carbon assessment tool;
- using existing industry resources to establish a national database on carbon embodied in assets and products, such as the Built Environment Carbon Database;
- publication of embedded carbon benchmarks and voluntary standards of good practice by 2023;
- update national planning policy frameworks to require assessment of the incorporated carbon impacts of new construction before authorizing demolition; and
- allowing local planning authorities to set more ambitious initial carbon limits for new developments than those introduced by building regulations.
It is quite clear that the measurement and management of embedded carbon will be an important feature of real estate investment and development processes over the coming decades.
If you can’t measure it, you can’t improve it
Managing real estate investments increasingly involves collecting, processing and reporting ESG data in multiple areas, including:
- disclosure guided by legislation, such as the Task Force on Climate-related Financial Disclosures (TCFD) and in Europe, the Sustainable Financial Disclosure Regulation (SFDR) and the Taxonomy Regulations (UK versions of these initiatives also to be implemented );
- reports against benchmarks and voluntary ratings at portfolio or company level, such as the Global Real Estate Benchmark (GRESB);
- reporting against global frameworks and guidelines, such as the United Nations Sustainable Development Goals (SDGs) and the Global Reporting Initiative; and
- data collected and reported by a property manager himself in order to make investment and asset management decisions, at company, portfolio and individual asset level and for reporting to investors.
Reliable data therefore becomes an essential tool for real estate investors to monitor and increase the contribution of their assets to social and environmental objectives. Innovations such as smart meters, automated data collection and Wi-Fi enabled building sensors as well as Internet of Things (IoT) devices are all becoming useful tools for integrating data capture and transmission on various aspects of the ESG performance of a building.
High levels of visibility and data sharing around climate-related KPIs (e.g. tenant energy consumption) are likely to be required and supported by green lease provisions. With some commentators predicting that green finance products will become mainstream, there is a need to ensure that the KPIs around which these products are centered are integrated and properly structured in order to both generate value and achieve sustainability goals. . Stakeholders are also wondering how to reflect climate-related risks in assessments, with owners and assessors often reaching different conclusions on how this should be reflected, with some owners performing ‘net zero audits’ at the time of assessment. ‘acquisition and adjusting the price according to their own view of ESG risks.
It is clear that a digital transformation of real estate is well underway and that investment managers are going to have to devote more and more time and resources to the analysis of ESG data.
Real estate is a highly idiosyncratic traded asset class, with a vast network of different stakeholders involved in the typical life cycle of an asset, from architects, development teams and agents to asset managers, occupants and investors. , to only cite a few. The highly varied, interactive and collaborative nature of the sector is what attracts many people to work in it, but in the context of climate change this poses additional challenges. In the COP26 Green Zone Seminar, the challenge of involving all stakeholders along this value chain led Shuen Chan, head of ESG real estate assets at LGIM, to call for “radical collaboration” within the real estate sector. This will involve working with all stakeholders to ensure that they understand their role in the process and the interventions that need to take place, which in many cases will involve educating these parties at the same time.
COP26 highlighted that there is a strong desire within the real estate investment industry to address the climate challenge and a growing understanding of the steps that need to be taken to achieve net zero carbon in the built environment. However, real estate investors will likely need to adapt their mindset to take into account the carbon impact over the lifespan of their real estate assets and become increasingly sophisticated data consumers. Perhaps the most resounding message is the need for radical collaboration between all stakeholders in an asset’s lifecycle in the pursuit of a greener real estate market.