Property sector will face increased UK and EU regulatory pressure to decarbonise.
The “minimal impact” of climate resilience on today’s real estate valuations is set to change, according to a report by UK real estate stock exchange IPSX and Carbon Intelligence. Investors are now asking for increased transparency in order to avoid stranded assets as the sector transitions to net zero greenhouse gas emissions, the report said.
Continuing to invest in real estate that won’t be able to achieve net zero by 2050 would prove to be “a major pitfall” for investors, warned David Delaney, IPSX Group CEO.
“Around 80% of the buildings that will need to be net carbon zero by 2050 have already been built. Chances are they won’t all make it to net zero. Some will almost definitely either become stranded assets or, at the very least, trade with a substantial brown discount,” he told ESG Investor.
Investors wanting to better understand the connection between asset value and climate-related physical and transitional risks will be looking at their real estate assets more closely, Delaney added, which will have an impact on future valuations.
The report noted that there is growing evidence linking a building’s green credentials to improved property values. For example, offices in central London with high sustainability credentials benefit from 6-11% higher rental premiums, the report said.
In comparison, assets without net zero plans “will depreciate significantly over the next five years”, the report warned, as investors seek to avoid assets at risk of stranding or incurring penalties associated with non-compliance.
The built environment is currently responsible for 40% of energy consumption in the EU and UK. This means that there will be increased scrutiny from policymakers through the EU Taxonomy or the UK’s Energy Savings Opportunity Scheme (ESOS), Delaney warned. ESOS is a mandatory energy assessment scheme carried out every four years, auditing the energy used by buildings in order to identify cost-effective energy saving measures.
The draft technical screening criteria for the EU Taxonomy outlines sustainable activities for the real estate sector, including: the reduction of primary energy demand; the use of sustainable technologies; waste management; and the use of construction and hazardous materials. The Taxonomy will serve as a guide for asset managers looking to assess the sustainability-related performance of their investments.
The EU’s Emissions Trading Scheme (ETS) has also been further extended to ensure the EU target of a 55% reduction in overall emissions by 2030 compared to 1990 levels. It will now put a bigger price on emissions from real estate and transportation.
This is supported by the European Commission’s ‘renovation wave’, which will provide financial incentives to double the prevailing rate of energy-related building renovations by 2030.
The climate resilience of existing infrastructure was highlighted as a key concern in the Intergovernmental Panel on Climate Change’s (IPCC) latest report on climate change. Cities, in particular, are more at risk from the effects of a changing climate – such as heatwaves and severe flooding.
A recent report co-published by the UN Environment Programme Finance Initiative highlighted the current status of the real estate market’s progress in pricing in risk from the physical impacts of climate change.
Ensuring net zero
Investors need to ensure that real estate firms have a “pragmatic plan” to become net zero by 2050 and how “capital intensive” that process may be, Delaney said.
“A simple analysis of Energy Performance Certificate (EPC) ratings and BREEAM will be a good start,” he noted.
EPC ratings must be conducted in the UK whenever a property is built, sold or rented, outlining the property’s energy use and costs, as well as recommendations for reducing them. BREAAM is a global sustainability assessment method used by the real estate sector to determine an asset’s environmental, social and economic performance. Both of these will give a clear indication of the current levels of energy emitted by a property, as well as whether a real estate firm is following recommendations to reduce reliance of unsustainable energy, Delaney said.
“Property owners will be pushed by regulation to move to net zero, but they also need to consider other aspects of how climate change may affect their building. Flood risk, for example, makes it worth considering a climate change risk report. As asset owners become more aware of these issues, they will be looking for greater transparency from the property owners,” he said.
Investors cannot afford to “do nothing” about climate risks to their real estate investments, said Kristina Foster, Fund Manager for Real Estate Debt at Schroders in a recent blog post.
“The value of your asset – no matter where it is or what type – will be impacted by increased obsolescence or stranding of properties that do not meet occupational, investor and legislative sustainability standards,” she said.