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¹ JLL, The impact of sustainability on value, 2020.
Operational carbon
Whole life carbon
Stranded assets
GRESB
EPC rating
Embodied carbon
Discounted cash flow (DCF) model
CRREM
BREEAM
Defining the terms
Targeting whole-life net zero
Pricing in the realities of decarbonisation
Changing the real estate landscape
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Where past performance is shown, please note that this is not a guide to future performance. Information is subject to change and is not a guarantee of future results.
But the case for decarbonisation is getting stronger and the imperative to accelerate it more urgent. Industry experts have been able to demonstrate a green premium for office buildings in the form of higher rental values.¹ Regulation is stepping up, and the value at risk from the physical effects of climate change is becoming better understood. It seems increasingly clear that decarbonising real estate portfolios is not a matter of choice for investors; rather, it is a journey they must undertake to seek the best possible risk-adjusted returns for their stakeholders.
Lacking both the full range of necessary data and cohesion among policymakers globally, some investors remain sceptical about the relationship between greener buildings and increased value – and the need to accelerate decarbonisation.
For the past decade, real estate investors, with increasing intensity, have debated the impact of climate change on returns.
Rising to the climate challenge: Perspectives on accelerating decarbonisation in real estate
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For investors to pursue net zero more effectively, however, they – alongside the rest of the real estate industry – must rethink the old ways of doing things. Conventional approaches to assessing risks and valuing assets are not fit for purpose – and they are shackling investors’ ability to decarbonise portfolios. This report draws on insights from asset owners, consultants and M&G’s own real estate experts, to highlight the need for new approaches in key areas below.
Why investors need to think in terms of ‘whole-life carbon’, and why that will be difficult to achieve.
How to deal with the complexity of pricing climate-related physical and transition risks into valuations, and the implications for investment decision making.
How regulation, accounting standards and valuation practices must evolve to secure climate outcomes and financial returns.
The path to net zero in real estate
Interview with Nina Reid Head of Sustainability, Private & Alternative Assets, M&G Investments
Don't get lost on the road to Paris
Read how to avoid the unintended consequences of a net-zero portfolio.
READ MORE
Considers embodied carbon in materials and construction processes, the emissions generated through operational use of a building, and its maintenance and demolition.
Whole-life carbon
Assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities.
Emissions generated across the operational lifetime of a building, consisting of the energy required to light, heat and cool it.
A valuation method used to estimate the value of an investment based on its future cash flows, often used in evaluating real estate investments. Initial cost, annual cost, estimated income, and holding period of a property are some of the variables used in a DCF analysis.
A publicly available tool that assists in assessing decarbonisation strategies for real estate assets. The tool can evaluate the progress of a portfolio’s carbon-reduction performance against specific targets.
A third-party certification system assessing an asset’s environmental, social and economic sustainability performance, using a set of standards developed by the Building Research Establishment (BRE).
An ESG benchmarking system for real assets. Collected data is also used to create and present ESG analytics.
A measure of the energy efficiency of a building, using an A+ to G rating scale (or in the case of a building that is a dwelling, A to G), where A+ is the most efficient and G is the least efficient.
The total greenhouse gas (GHG) emissions (often simplified to ‘carbon’) generated during a building’s construction or renovation, including emissions caused by extraction, manufacture/processing, transportation and assembly of every product and element in the building.
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Key area insights
Buildings’ greenhouse gas emissions breakdown
M&G Real Estate, Global Alliance for Buildings and Construction, 2018 Global Status Report.
2020 global status report for buildings and construction, Global Alliance for Buildings and Construction and UN Environment Programme, December 2020
Embodied carbon will represent a larger proportion of emissions as buildings become more operationally efficient
Defining net zero in real estate
BBP announces three new signatories to its groundbreaking climate commitment, Better Buildings Partnership, June 2022
Net zero investment framework, IIGCC, March 2021
Net Zero Whole Life Carbon Roadmap, UK Green Building Council, November 2021
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Illustrative CRREM pathways for a UK office building
Source: CRREM Introduction, 2020.
The CRREM tool allows investors to directly assess decarbonisation and energy reduction pathways
Going nowhere without the data
Scope 3 reporting profile for first building owner
Source: UK GBC guide to Scope 3 reporting in commercial real estate, July 2019.
The first owner of a new building accounts for upfront (embodied) carbon in the year of purchase. These emissions are not transferred to the second owner if the building is sold on in future.
Getting to grips with embodied carbon
Calls to action
Transfer embodied-carbon debt
Towards whole-life carbon
The push for data
“The message to the tenants is we need the data; they need it, investors need it. And that's Scope 1, Scope 2 and in due course, Scope 3 emissions data principally. Investment managers need this data in order to demonstrate compliance with the Paris Agreement and for completing tools such as CRREM to illustrate the net zero journey.”
Douglas Crawshaw
Global Head of Real Estate Manager Research, Willis Towers Watson
“Longer term, I think we all have to provide our data, and maybe in an anonymous way.”
Guido Verhoef
Head of Private Real Estate, PGGM
“At the moment, if you’re following CRREM, and focusing on operational carbon pathways, you might decide to bring forward works to retrofit an existing building. But you might find that from a whole life carbon perspective, it's not the best decision for you to do a retrofit at that point in time—or even at all.”
Nina Reid
Head of Sustainability, Private & Alternative Assets, M&G Investments.
Accounting treatment of embodied carbon needs to be updated to include the transfer of embodied carbon debt to secondary purchasers. This will enable investors to make a fairer assessment of both individual assets and real estate funds from a carbon-footprint perspective.
Even in the absence of mandatory disclosure, investors can make strides in collecting operational carbon data by promoting the roll-out of smart meters and other property technology to tenants, implementing green leases, and constructive engagement around data sharing. Requirements on the measurement of embodied carbon emissions should also be set for new development projects.
The industry needs to move towards a whole-life carbon approach to mapping emissions within real estate portfolios and setting net-zero pathways. In practice, this means addressing both operational and embodied carbon to the extent currently possible, and continuing to evolve the definition of net zero – and your decarbonisation strategy – as better data becomes available.
With the built environment contributing approximately 40% of global carbon emissions,² the real estate industry is acutely aware of its vital role in the attempt to achieve net zero by 2050. A growing number of investors are stepping up. For instance, since the launch of its climate commitment in 2019, the UK’s Better Buildings Partnership has amassed 33 signatories, managing more than £380bn of assets worldwide; each signatory has pledged to publish a net-zero carbon pathway for their portfolio, together with a delivery plan.³ Momentum behind decarbonisation is growing. But, for the industry to achieve net zero, all of its stakeholders must work towards the same goal. This requires a clear definition of net zero for the sector, something that is lacking today. Building emissions can be broadly categorised as either ‘operational carbon’ or ‘embodied carbon’. Operational carbon accounts for a bigger share of emissions today and, to date, has garnered more attention from regulators and investors. However, there are still inconsistencies in how it is defined, and problems obtaining data on energy use and associated emissions from building tenants. Embodied carbon accounts for a smaller share of emissions and has been less of a focus to date in regulations and net-zero investor frameworks. For instance, the Institutional Investors Group on Climate Change’s (IIGCC) Net Zero Investment Framework does not yet include embodied carbon in its emissions scope for real estate assets.⁴ For the industry to target whole-life net zero, this must change. Moreover, it has important implications for investors’ decisions about where and when to incur refurbishment costs within their business plans for property assets. The UK Green Building Council (UK GBC) is already calling for the mandatory measurement and reporting of buildings’ whole-life carbon, as part of its Net Zero Whole Life Carbon Roadmap for the Built Environment.⁵ This approach is also being advocated by the World Green Building Council.
Net zero commitments are all well and good, but without complete emissions and energy consumption data, investors will be stuck in the starting blocks. Many investors embarking on portfolio decarbonisation are initially focusing on operational carbon emissions and using the EU-backed Carbon Risk Real Estate Monitor (CRREM) tool to help them set emissions and energy reduction pathways,and to monitor the performance of their assets and assess stranding risk. CRREM is proving a valuable tool for investors, but it still has limitations. For instance, it cannot yet be applied to all types of assets or the model is too generic (for example, supermarkets are categorised as retail warehouses but their energy profile is substaintally different than a retail warehouse used for fashion for example). Its model currently only provides pathways for operational carbon and not embodied carbon. Crucially, its efficacy is reliant on having the necessary data to input. “The message to the tenants is we need the data; they need it, investors need it. And that's Scope 1, Scope 2 and in due course, Scope 3 emissions data principally. Investment managers need this data in order to demonstrate compliance with the Paris Agreement and for completing tools such as CRREM to illustrate the net zero journey,” says Douglas Crawshaw, Global Head of Real Estate Manager Research, Willis Towers Watson. One big challenge is that investors and asset owners are still reliant on voluntary disclosure of emissions and energy consumption data by tenants in many cases, across commercial and residential properties. To use the residential sector as an example: an investors’ portfolio may encompass thousands of homes, not all of which are fitted with smart meters, and EU GDPR rules dictate that permission must be obtained from individual owners or occupiers to access waste, water and utility usage data. Then there is the challenge of aggregating the data. “Longer term, I think we all have to provide our data, and maybe in an anonymous way,” says Guido Verhoef, Head of Private Real Estate, PGGM. “If we have a building with 100 residential units, we’re not interested in the energy use of each individual unit, but we need to understand what the sum of the hundred looks like.” The roll out of smart metering systems and greater engagement with tenants is essential to start to plug existing data gaps. Green leases are also an important tool to ensure better access to data going forward. Louise Warden, Head of Real Estate at Local Pensions Partnership Investments (LPPI), says LPPI is now including green lease clauses as standard practice when renewals fall due. It is sometimes more difficult to insert addendums into existing lease agreements, however. GRESB is another tool that is helping investors to make progress on operational data gaps. The ‘performance’ component of its assessments includes information on energy consumption, GHG emissions, water consumption and waste. It continues to expand its reach and coverage. Last year, its real estate assessment covered nearly 117,000 assets across 66 countries⁶.
If we are to limit global warming to less than 1.5ºC above pre-industrial temperatures, addressing the issue of whole-life carbon will be essential. Embodied carbon will represent a larger proportion of emissions as buildings become more operationally efficient and, over the next few years, investors will need to move embodied carbon up their agendas. It follows, therefore, that regulators will demand disclosure of the carbon footprint associated with construction and renovation. This has important implications for investors’ decision making. “At the moment, if you’re following CRREM, and focusing on operational carbon pathways, you might decide to bring forwards work to retrofit an existing building. But you might find that, from a whole-life carbon perspective, it's not the best decision for you to do a retrofit at that point in time – or even at all,” warns Nina Reid, Head of Sustainability, Private & Alternative Assets, M&G Investments. In the absence of mandatory disclosure, obtaining embodied carbon data from across the construction supply chain is a tough task, however. For now, the industry needs to take the lead on this. At M&G, for instance, we are updating our Sustainable Development and Refurbishment Framework to set requirements on the measurement of embodied carbon emissions for all new projects. Another challenge is the current accounting treatment of embodied carbon debt. Taking the UK GBC’s Scope 3 reporting methodology⁷ as an example, the first purchaser of a newly constructed building must add the entirety of the upfront embodied carbon to its Scope 3 emissions in the year of purchase. However, when the building is sold for the second time, none of that embodied carbon debt is transferred to the new buyer, as the second owner of the property. Unless this is changed, from an embodied-carbon perspective, real estate investors will be unfairly disadvantaged as the first buyers, with no responsibility for embodied carbon passed on to secondary buyers.
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Guide to Scope 3 Reporting in Commercial Real Estate, UK GBC, July 2019
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GRESB Real Estate Assessment, 2021
Source +
CRREM Introduction, 2020.
UK GBC guide to Scope 3 reporting in commercial real estate, July 2019.
Net zero commitments are all well and good, but without complete emissions and energy consumption data, investors will be stuck in the starting blocks. Many investors embarking on portfolio decarbonisation are initially focusing on operational carbon emissions and using the EU-backed Carbon Risk Real Estate Monitor (CRREM) tool to help them set emissions and energy reduction pathways,and to monitor the performance of their assets and assess stranding risk. CRREM is proving a valuable tool for investors, but it still has limitations. For instance, it cannot yet be applied to all types of assets or the model is too generic (for example, supermarkets are categorised as retail warehouses but their energy profile is substaintally different than a retail warehouse used for fashion for example). Its model currently only provides pathways for operational carbon and not embodied carbon. Crucially, its efficacy is reliant on having the necessary data to input. “The message to the tenants is we need the data; they need it, investors need it. And that's Scope 1, Scope 2 and in due course, Scope 3 emissions data principally. You need that to fill in your CRREM, in order to get the outputs you need to know where you are on your journey,” says Douglas Crawshaw, Global Head of Real Estate Manager Research, Willis Towers Watson. One big challenge is that investors and asset owners are still reliant on voluntary disclosure of emissions and energy consumption data by tenants in many cases, across commercial and residential properties. To use the residential sector as an example: an investors’ portfolio may encompass thousands of homes, not all of which are fitted with smart meters, and EU GDPR rules dictate that permission must be obtained from individual owners or occupiers to access waste, water and utility usage data. Then there is the challenge of aggregating the data. “Longer term, I think we all have to provide our data, and maybe in an anonymous way,” says Guido Verhoef, Head of Private Real Estate, PGGM. “If we have a building with 100 residential units, we’re not interested in the energy use of each individual unit, but we need to understand what the sum of the hundred looks like.” The roll out of smart metering systems and greater engagement with tenants is essential to start to plug existing data gaps. Green leases are also an important tool to ensure better access to data going forward. Louise Warden, Head of Real Estate at Local Pensions Partnership (LPP), says LPP is now including green lease clauses as standard practice when renewals fall due. It is often more difficult to insert addendums into existing lease agreements, however. GRESB is another tool that is helping investors to make progress on operational data gaps. The ‘performance’ component of its assessments includes information on energy consumption, GHG emissions, water consumption and waste. It continues to expand its reach and coverage. Last year, its real estate assessment covered nearly 117,000 assets across 66 countries⁶.
Put simply, institutional investors need to generate the best possible risk-adjusted returns in the long term. If they are not pricing in climate risks – both physical and transition-related – then they could be perceived as not doing the job properly. “If temperatures rise and weather patterns change, then assets are going to be put at greater risk. And if that risk hasn’t been adequately priced in, then the implication is that investors may have paid too much for them and future performance will be adversely affected,” says Willis Towers Watson’s Douglas Crawshaw. In general, the impact of climate risks is not yet feeding through into real estate valuations in a meaningful way. But, even today, there are clear signs that these risks will move the valuation dial much more in the near future. Looking at transition risks, European countries are already setting out how minimum energy efficiency standards (MEES) for buildings will become more stringent over the next decade. The Netherlands will require office buildings to have a minimum EPC rating of C by 2023⁸, and the UK government has proposed legislation requiring the same for new residential tenancies by 2025, and for non-domestic properties to achieve EPC B by 2030.⁹
Why it matters
Fix problem assets
CapEx trade-offs
A new way to value
As decarbonisation is better priced in by the market, investors should have far greater opportunities to benefit from green premiums and brown discounts. The latter will be essential to facilitating the widespread purchase of lower-quality building stock at prices that accurately reflect the risks, with sufficient margins available to fix those assets from a climate perspective.
Valuation models that account for the climate transition – and its implications for real estate – are urgently needed. We are a long way off from having a set of standardised metrics for every facet of these ‘new models’, but it should be possible to agree on best practices that integrate CapEx requirements and rental growth assumptions.
Investors and fund managers should hold transparent discussions about the impacts of retrofitting interventions on short- and long-term returns. The use of CRREM and increasing clarity of regulatory timelines for EPC thresholds can help with an evidence-based approach to these decisions.
“If temperatures rise and weather patterns change, then assets are going to be put at greater risk. And if that risk hasn’t been adequately priced in, then the implication is that investors may have paid too much for them and future performance will be adversely affected.”
Source: CBRE.
Corporate tenants are also driving change as they face up to the pressure of meeting their own net-zero targets. A study by CDP and Oliver Wyman found that the number of European companies with approved science-based climate targets grew 85% in 2021, to cover businesses responsible for a third of reported emissions.¹⁰ There are early signs this is impacting rents and valuations in some market segments. For instance, JLL’s analysis of rents for grade A office space in central London shows that buildings with an ‘outstanding/excellent’ BREEAM rating typically achieved 14% higher rents than the average grade A rent in the three years to 2019.¹¹ M&G’s own analysis of London office buildings found that, while lower-quality, higher-yielding properties had better capital growth than higher-quality properties during the city’s booming market in the 2010s, the tables have turned since 2019, implying rising tenant demand for higher-quality properties.
Savills, “What investors need to know about the upcoming Dutch building regulations,” February 2019.
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House of Commons, Minimum Energy Performance of Buildings (No. 2) Bill, July 2021.
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CDP and Oliver Wyman, Now for nature: The decade of delivery, March 2022.
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JLL, The impact of sustainability on value, 2020.
Source: MSCI (UK Quarterly Index to Q2 2021).
Growing value divergence according to quality of assets
When it comes to physical risks, the impact on value is more difficult to determine but evidence of their link to pricing is slowly emerging as better data becomes available. A study by the University of Colorado at Boulder and Pennsylvania State University, found that properties exposed to sea-level rises in the US were selling at a 7% discount relative to comparable properties that were less exposed to this risk.¹² “We have seen non-sustainable assets as a big risk for a long time, but that has been difficult to prove. Now that more and more data is becoming available, we fully expect to see brown discounts and green premiums arising across the market,” says PGGM’s Guido Verhoef. The immediate problem for the industry is that neither transition nor physical risks are being adequately factored into real estate valuers’ pricing models. Nevertheless, it is a matter of ‘when’, not ‘if’, and investors need to build these considerations in now to avoid jeopardising future returns.
Illustrative stranding timeline with and without a retrofit
As legislation advances and tenants demand greener buildings, investors are having to factor the capital expenditure (CapEx) required to transition buildings into their business plans and portfolio return models. Now that some governments have mapped out how EPC thresholds are set to change, it is possible to calculate the spend required to bring buildings in the portfolio up to the required energy-efficiency level over time. This gives clarity on the investment required - but it only addresses one aspect of transition risk. The CRREM tool can be used to estimate the CapEx required to keep assets aligned with net-zero pathways. “Plotting the portfolio on the CRREM line is very useful for making those decisions, because, if an asset is below the line, then we should spend enough CapEx to stay below the line for the next 10 to 15 years or so,” says PGGM’s Guido Verhoef. “We feel we should always be able to sell an asset after we have held it and we expect future buyers will be looking at its pathway, too. If it’s not aligned, then you risk having a brown discount.” The CRREM pathways can help to inform investor decisions about when to incur costs to retrofit their assets, and how this will extend the lifespan of their buildings.
Solving the CapEx conundrum
Given their varied nature, and that there is no single accepted approach to modelling their projected impacts, assessing physical risks poses one of the biggest challenges to developing accurate valuation models. However, there are some factors that can be integrated sooner than others. For instance, UK investors are increasingly incorporating Environment Agency flood-risk ratings into their decision making, and such ratings could form the basis for standardisation of the flood-risk metric.
Bernstein, Asaf, Matthew Gustafson & Ryan Lewis, Disaster on the Horizon: The Price Effect of Sea Level Rise, 2018.
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Identifying the optimal timing of retrofitting interventions is not always straightforward, however, and can mean impacting short-term returns if carried out early on; equally, it can incur greater CapEx down the line if works are delayed. “We need to overcome short-term thinking when it comes to returns. That means valuing the reduction in risk that comes from incurring costs on retrofitting today. One way to do that is through the climate value at risk (CVaR) measure," says Willis Towers Watson’s Douglas Crawshaw. “If that can be baked into portfolio valuations, and you could see that CVaR number reduced over time, your future value take is improving – and you're not going to give that up.” Another conundrum for investors is that real real estate current pricing models are not yet factoring this inevitable CapEx spend into their pricing models. “It means properties are being misvalued. If you bought a car knowing it needed a new engine, you'd work out how much a new engine cost, and then you'd want to account for that in the price. The principles are exactly the same for this, and it's not being done, certainly not in residential,” says Alex Greaves, Head of UK and European Living, M&G Real Estate. This CapEx will need to be integrated into valuers’ DCF models – along with adjusted assumptions for rental growth – if the market is to facilitate decarbonisation by better reflecting brown discounts and green premiums. “When the brown discount does come in, it will create the opportunity to remedy [the problem of selling lower-quality] existing housing stock in the UK, which is the oldest in Europe. I see it as a double win, where properties are incredibly saleable, and the money can be spent to deliver better outcomes for the environment and society,” says M&G’s Alex Greaves. “I think we need to lead the market and find ways to make it attractive for housebuilders, tenants and other stakeholders to push this forwards.”
Fixing valuation models
In order for the market to offer a true reflection of climate risk, it is necessary for valuation models to evolve. Here are some of the ways in which DCF models can start to better reflect this in the short term:
3. Address physical risks.
Over time, more explicit CapEx requirements should be factored into DCF models in order to align buildings with net-zero pathways. In the short term, it should be possible to incorporate itemised CapEx related to improving EPC ratings in line with regulatory timelines. The UK’s Royal Institution of Chartered Surveyors (RICS)¹³ addresses this in its latest guidance note on valuations.
1. Integrate CapEx requirements.
As the industry achieves a more accurate picture of rental premiums for sustainable buildings, these assumptions should be built into models in a more standardised way.
2. Incorporate rental greenium.
“We have seen non-sustainable assets as a big risk for a long time, but that has been difficult to prove. Now that more and more data is becoming available, we fully expect to see brown discounts and green premiums arising across the market.”
“Plotting the portfolio on the CRREM line is very useful for making those decisions, because, if an asset is below the line, then we should spend enough CapEx to stay below the line for the next 10 to 15 years or so.”
Likely scaling up of EPC requirements for non-domestic buildings in the UK
UK government 2021 MEES consultation proposal
CBRE.
MSCI (UK Quarterly Index to Q2 2021).
RICS, Sustainability and ESG in commercial property valuation and strategic advice, January 2022.
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Put simply, institutional investors need to generate the best possible risk-adjusted returns in the long term. If they are not pricing in climate risks – both physical and transition-related – then they are not doing the job properly. “If temperatures rise and weather patterns change, then our assets are going to be at greater risk. And, if we haven't priced that risk in, then we've paid too much for the assets and performance will be hit,” says Willis Towers Watson’s Douglas Crawshaw. In general, the impact of climate risks is not yet feeding through into real estate valuations in a meaningful way. But, even today, there are clear signs that these risks will move the valuation dial much more in the near future. Looking at transition risks, European countries are already setting out how minimum energy efficiency standards (MEES) for buildings will become more stringent over the next decade. The Netherlands will require office buildings to have a minimum EPC rating of C by 2023⁸, and the UK government has proposed legislation requiring the same for new residential tenancies by 2025, and for non-domestic properties to achieve EPC B by 2030.⁹
The CRREM tool can be used to estimate the CapEx required to keep assets aligned with net-zero pathways. “We feel we should always be able to sell an asset after we have held it and we expect future buyers will be looking at its pathway, too. If it’s not aligned, then you risk having a brown discount.” The CRREM pathways can help to inform investor decisions about when to incur costs to retrofit their assets, and how this will extend the lifespan of their buildings.
When it comes to physical risks, the impact on value is more difficult to determine but evidence of their link to pricing is slowly emerging as better data becomes available. A study by the University of Colorado at Boulder and Pennsylvania State University, found that properties exposed to sea-level rises in the US were selling at a 7% discount relative to comparable properties that were less exposed to this risk.¹² The immediate problem for the industry is that neither transition nor physical risks are being adequately factored into real estate valuers’ pricing models. Nevertheless, it is a matter of ‘when’, not ‘if’, and investors need to build these considerations in now to avoid jeopardising future returns.
The real estate industry is steadily laying the foundations of net zero. But those foundations, from regulation to valuation methods to decarbonisation frameworks, require reinforcement. Investors, regulators, industry bodies and tenants all have important roles to play in changing the real estate landscape to make net zero achievable. “There’s an obligation for businesses like ours to make sure that we're pushing the rest of the industry to bring the whole standard up,” says Tony Brown, Head of M&G Real Estate. “Where we think we can improve on frameworks and benchmarks, let's do that collaboratively through a process of iteration. That’s the only way we're going to have really meaningful, positive outcomes.” As we have discussed, CRREM is already proving a valuable tool to help investors assess and plan their portfolios’ routes to net zero. Further refinement is required, however, for example by assessing stranding risk based on energy consumption as well as carbon intensity. “The bigger focus is on carbon with CRREM, but there's an energy pathway too, and those two things aren't always married up very well,” says M&G’s Nina Reid. “You can avoid being stranded on a carbon pathway, but still be stranded on an energy pathway, and that’s important to understand.” There is also the issue of coverage. Some building sectors, such as retail, cold storage and life sciences are not yet well catered for. And there is more work to do to adapt CRREM for use outside of Europe. “There are modifications that we need going forwards, but we'd rather focus on getting CRREM to cover additional markets and to have one unified approach, rather than more new initiatives popping up and creating more divergence in the industry,” says Stan Bertram, Associate Director ESG – Private Real Estate, PGGM. “By improving CRREM, and benchmarks like GRESB, we can get wider adoption and then, regardless of where you are on the globe, you can speak the same language and have a mutual understanding about all the aspects of decarbonisation.” GRESB saw its highest-ever increase in the number of participants in its real estate benchmark in 2021, rising by 24% to 1,520. But, again, there is room for improvement: in its annual member survey, investors cited net zero and whole-life carbon as areas they would like to see better addressed in future GRESB assessments.¹⁴
A unified approach
Break the valuation stalemate
Refine the tools
Harmonise regulation
Valuations are currently locked in a stalemate, as neither investors, lenders, tenants nor valuers can move as quickly as they might want in incorporating climate factors, unless all stakeholders move in unison. A more proactive approach on all sides is needed to break this stalemate and enable the market to price climate risk more efficiently.
Regulators in France and the Nordics are leading Europe in mandating the measurement of embodied carbon. It is critical that other countries follow suit. But unilateral action is leading to the adoption of different calculation methods being applied, which will create challenges for investors with international real estate portfolios.
Initiatives such as CRREM and GRESB have worked hard towards reaching a critical mass of adopters – and they have made significant progress. They still need to refine their methodologies to give investors more holistic insights to inform their decarbonisation journeys. But it is better to build on those foundations and harmonise the industry’s approach than to pour effort into divergent initiatives that will lead to fragmentation.
“There’s an obligation for businesses like ours to make sure that we're pushing the rest of the industry to bring the whole standard up”
Tony Brown
Head of M&G Real Estate
The direction of travel for regulation of embodied carbon is yet to be clarified but, unless disclosure and reporting in this area improves, there will continue to be an industry bias towards new, highly energy-efficient buildings, at the expense of whole-life carbon considerations. France and Denmark are two of the first movers in Europe. The Danish government has inserted targets for whole-life carbon into building regulations, which come into effect in 2023. France’s new RE2020 regulation, which applies to residential buildings from 2022, and will be expanded to other sectors next year, places a requirement on developers to account for embodied carbon emissions for the first time.¹⁵ Meanwhile, in the UK, the government’s net-zero strategy acknowledges the need to improve reporting on embodied carbon in buildings and infrastructure, with a view to exploring a maximum level for newbuilds. The UK GBC is pushing for mandatory measurement and reporting of whole-life carbon for large buildings to start as early as 2023.¹⁶ Regulators will need to look more closely at energy consumption measures too. “In reality, in markets where the carbon of the grid is quite low, what you find is that it's quite easy to decarbonise certain buildings, or to avoid their becoming stranded, but energy-efficiency wise, the buildings aren't actually performing as well as they should be,” says M&G’s Nina Reid.
A key role for regulation
GRESB, A shared vision: GRESB stakeholder survey report, Real estate standard, October 2021.
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Ministry for Ecological Transition and Territorial Cohesion, Ministry for Energy Transition, RE2020 environmental regulations, January 2022.
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Environmental issues not yet sufficiently covered by the GRESB assessment
Source: GRESB stakeholder survey report 2021.
Change in occupier demand for green buildings (2021) Europe has seen greater tenant demand than any other region
Source: RICS, Sustainability Report 2021.
Responsibility for changing valuation practices to better account for climate risk does not lie solely with property valuers. There are also important roles for investors, tenants and other stakeholders in driving this. For commercial buildings, LPPI’s Louise Warden says the global energy crisis may amplify the role tenants will play in better aligning rental prices with environmental performance.“ The spiralling energy costs tenants are currently facing should be an accelerator. As companies see those in greener buildings benefitting from lower energy bills, they’re going to want the same thing. And, as that impacts the rental prices they are willing to pay, it builds evidence that valuers can then start to rely on,” she says. Europe should be in a strong position when it comes to proactivity among corporate tenants. According to RICS’s latest global survey of commercial real estate professionals, two-thirds of respondents saw increased occupier demand for green/sustainable buildings in Europe during 2021, more than any other region globally.¹⁷
RICS, Sustainability Report 2021.
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Coalescing on a new approach to valuations
According to M&G’s Alex Greaves, in the residential market mortgage lenders need to exert a greater influence. “While we’ve got these parallel worlds of some buyers factoring in climate risk, and others not doing so, it's going to be a problem,” he explains. “One part of the solution is for mortgage companies to think about changing how they price debt on properties that have got different environmental-performance ratings.”
Head of UK and European Living, M&G Real Estate
Alex Greaves
"While we’ve got these parallel worlds of some buyers factoring in climate risk, and others not doing so, it's going to be a problem"
GRESB stakeholder survey report 2021.
For commercial buildings, LPPI’s Louise Warden says the global energy crisis may amplify the role tenants will play in better aligning rental prices with environmental performance. “The spiralling energy costs tenants are currently facing should be an accelerator. As companies see those in greener buildings benefitting from lower energy bills, they’re going to want the same thing. And, as that impacts the rental prices they are willing to pay, it builds evidence that valuers can then start to rely on,” she says. Europe should be in a strong position when it comes to proactivity among corporate tenants. According to RICS’s latest global survey of commercial real estate professionals, two-thirds of respondents saw increased occupier demand for green/sustainable buildings in Europe during 2021, more than any other region globally.¹⁷
For commercial buildings, LPPI’s Louise Warden says the global energy crisis may amplify the role tenants will play in better aligning rental prices with environmental performance.
The real estate industry is steadily laying the foundations of net zero. But those foundations, from regulation to valuation methods to decarbonisation frameworks, require reinforcement. Investors, regulators, industry bodies and tenants all have important roles to play in changing the real estate landscape to make net zero achievable. “Where we think we can improve on frameworks and benchmarks, let's do that collaboratively through a process of iteration. That’s the only way we're going to have really meaningful, positive outcomes.”
According to M&G’s Alex Greaves, in the residential market mortgage lenders need to exert a greater influence.