Key themes from COP26 for commercial real estate investment

Given the oft-cited statistic that building and operating real estate accounts for around 40% of global greenhouse gas emissions, it’s not surprising that the real estate investment industry was actively involved in the discussions and events at COP26 in Glasgow this month.

COP26 highlighted the growing desire of the real estate investment community to achieve environmental and social returns in addition to purely financial returns, and the recognition by many investment managers that this is both their fiduciary duty and a broader moral duty, as an influential factor influencing our built environment to do . As Neil Slater, Global Head of Real Assets at abrdn plc noted in the COP26 Green Zone Seminar, while the real estate industry has always focused on asset performance in order to create value while taking an appropriate level of risk into considering assets to create that work for the occupiers and also for society in general.

So is there a clear consensus in the industry on key challenges and key steps that need to be taken to make meaningful progress on the climate challenge?

A varied picture across all industries

See our diagram on the climate change challenge in the sectors.

The scale of the challenge varies widely between real estate sectors, with the logistics sector offering some of the best ways to achieve energy neutrality through the use of solar panels on the roof. A recent report from Savills states that, on average, about 40% of a warehouse roof could be suitable for installing solar panels, and based on that, the additional 250,000,000 m² of storage space to be delivered over the next decade could provide enough energy 97% to cover the energy demand of the new building. However, retrofitting existing stocks with a solar roof on the roof can be more difficult due to the load-bearing capacity of older units. Rainwater harvesting and the charging of electric vehicles offer further possibilities for green logistics systems.

The change in the office sector has been driven by the desire of investors to protect their assets from obsolescence and to keep them attractive to potential tenants who, in turn, are demanding greener buildings up to space rated BREEAM Excellent or better. The current challenge is an undersupply of green office space, which drives rents for green spaces and further illustrates the existence of a “green premium”.

The residential investment landscape is a complex picture: With “beds, meds and sheds” as the focus for real estate investors due to the sustained outperformance of alternative real estate sectors in recent years and structural tailwind, the numerous new construction and rental developments that are currently underway offer real estate investors the opportunity to To develop green buildings, which are also increasingly in demand by tenants. The broader UK housing sector is likely to be much more challenging, however, with Savills noting that the government’s goal of EPC-C for all homes that are “cost effective, affordable and practical” by 2035 without further policy action is high Interventions are unlikely, especially in the case of owner-occupiers.

The retail market presents a similar challenge, with a divergence in outlook between the larger and usually institutional shopping centers, specialty shopping centers and larger units and the typical smaller UK high street store. The latter make up the vast majority of retail space in the UK and are likely to prove far more difficult (and in many cases not economically viable).

The common theme across the various markets is the need for owners and investors to successfully manage the risk of asset stranding due to failure to address the climate challenge.

Go beyond operational carbon

As investors become more adept at reducing operational CO2 emissions and even making buildings carbon neutral, the role of embodied carbon is likely to be an increasing focus for the real estate market . The UK Green Building Council (UK GBC) has forecast that carbon will account for more than half of all emissions in the built environment by 2035. The UK GBC also recently launched a “Net-Zero Whole Life Carbon Roadmap”, which aims to develop a shared vision and agreed actions to achieve net zero in the construction, operation, demolition and reuse of buildings and infrastructure in the UK. It does this by establishing a carbon budget and path for the UK construction sector, as well as defining key policies and actions for central government, local authorities and relevant stakeholders. UK GBC recommendations include:

  • mandatory measurement of embedded carbon, followed by the gradual introduction of embedded carbon limits for new buildings to reduce demand;
  • Eliminate VAT on renovation works (ie 0% VAT) that maintain the structural framework of the building and meet energy performance targets in order to incentivize reuse versus demolition;
  • Development of a freely available national instrument for assessing embedded carbon;
  • Using existing industrial resources to embody a national database of assets and products, such as the Built Environment Carbon Database;
  • Publication of integrated carbon benchmarks and voluntary best practice standards by 2023;
  • Update national planning guidelines to require a carbon emission impact assessment of a new building before approval for demolition; and
  • This enables local planning authorities to set more ambitious pre-carbon limits for new developments than those introduced by building codes.

It is perfectly clear that the measurement and management of embodied carbon will be an essential feature of real estate investment and development processes in the decades to come.

If you can’t measure it, you can’t improve it

Real estate investment management increasingly includes the collection, processing and reporting of ESG data in several areas including:

  • Disclosure through laws such as the Task Force on Climate-related Financial Disclosures (TCFD) and in Europe the Sustainable Financial Disclosure Regulation (SFDR) and Taxonomy Regulations (with UK versions of such initiatives to be implemented);
  • Reporting against voluntary benchmarks and ratings at portfolio or company level, such as the Global Real Estate Benchmark (GRESB);
  • Reporting based on global frameworks and guidelines, such as the UN Sustainable Development Goals (SDGs) and the Global Reporting Initiative; and
  • Data that is collected and shared by a property manager himself in order to make investment and asset management decisions, at the company, portfolio and individual asset level and for reporting to investors.

Reliable data is therefore becoming a critical tool in enabling real estate investors to monitor and increase the contribution of their wealth to social and environmental goals. Innovations like smart metering, automated data collection, and WiFi-enabled building sensors, as well as Internet of Things (IoT) devices are all becoming useful tools for embedding the collection and transmission of data on various aspects of a building’s ESG performance.

A high degree of transparency and data exchange on climate-related KPIs (e.g. energy consumption by tenants) are likely required and supported by environmentally friendly rental contracts. With some commentators predicting that green finance products will become mainstream, it is important to ensure that the KPIs that such products revolve around have integrity and are properly structured to both add value and meet sustainability goals. Stakeholders are also struggling to include climate-related risks in assessments, with owners and appraisers often coming to different conclusions on how this should be considered, with some owners performing “net zero audits” at the time of acquisition and adjusting the price based on theirs own views on ESG risks.

It is clear that the digital transformation of real estate is in full swing and investment managers are spending increasing amounts of time and resources on ESG data analysis.

Radical collaboration

Real estate is a very idiosyncratic, negotiated asset class with a huge network of diverse stakeholders involved in the typical life cycle of an asset, from architects, development teams and brokers to asset managers, tenants and investors, to name a few. The diverse, interactive and collaborative nature of the sector attracts many people to work in it, but in the context of climate change this poses additional challenges. In the COP26 Green Zone seminar, Shuen Chan, Head of ESG Real Assets at LGIM, called on the challenge of involving all stakeholders along this value chain for “radical cooperation” within the real estate industry. This includes working with all stakeholders to ensure they understand their role in the process and the interventions required, which in many cases requires simultaneous training of these parties.

diploma

COP26 demonstrated that there is a strong desire in the real estate investment industry to address the climate challenge and an increasing understanding of the steps that need to be taken to achieve net zero carbon emissions in the built environment. However, real estate investors are likely to need to adjust their mindsets to take into account the lifetime carbon impact of their real estate assets and are becoming increasingly sophisticated consumers of data. Perhaps the clearest message is the need for radical collaboration between everyone involved in an asset’s lifecycle to achieve a greener real estate market.