Brown-to-green funds offer a much-needed narrative for adding value

When markets are as uncertain as they are today, investors can do one of three things: panic and cut their losses, wait and hope things will improve, or focus energies on a trend that gives them a modicum of confidence of finding – or protecting – value.

In the real estate world, the latter is increasingly playing out with the rise of the sustainability agenda, which manifests in its most basic form in more stringent due diligence around an individual investment’s environmental impact, and in its most extreme form in the so-called ‘brown-to-green’ real estate fund.

These vehicles are used to acquire assets where there is potential to significantly improve energy efficiency and carbon emissions before they are sold again. In so doing, a narrative for adding value is materializing and, critically, it is garnering capital.

PERE now counts six dedicated brown-to-green vehicles launched in 2023 – five of which are focused on Europe, one on Asia-Pacific. The most recent came this week in the form of Milan-based manager Coima’s Coima Opportunity Fund III. As reported by PERE, the fund will be used to invest exclusively in redevelopment and retrofit projects in the office and residential sectors across Italian cities, with the firm targeting LEED certification for all its investments. The fund’s anchor investor is GIC, the Singaporean sovereign wealth fund, which has committed €200 million toward the fund’s €500 million target.

These specialist vehicles are not alone in their purpose to decarbonize assets. Some value-add funds have also now carved out dedicated allocations to turn standing ‘brown’ buildings ‘green.’ One such vehicle is Houston-based manager Hines’ European Value Fund 3, for which the manager takes this approach to its office investments. As of July, the firm had raised €1.45 billion for the fund against a €1.5 billion target, per PERE data.

At a roundtable event at Hines’ offices in London this week, Paul White, the fund’s manager and senior managing director at the firm, said decarbonizing assets is an important value creation lever that should be pulled as a way to retain control over a property’s value, “even if the market does not recover in the way we hope.”

Indeed, in a dislocated market where debt costs can no longer be relied upon to compress yield over time, more managers will jump aboard the brown-to-green train and attract capital to acquire assets with high-quality conversion potential at attractive prices. It is a strategy that affords less risk than developing high-quality sustainable properties from the ground up, and also ticks the box for addressing embodied carbon in standing assets.

There is regional nuance when it comes to engagement with the concept. While the idea of a ‘brown discount’ has overtaken the concept of the ‘green premium’ in a slow-moving market in Europe, managers in the US have less conviction generally in the power of value-creation strategies to protect value.

In his keynote address at the PERE Network America Forum in New York last week, PIMCO’s global private real estate portfolio manager, John Murray, told members that capital dislocation in commercial real estate is “crushing” sentiment. As a result, decision-making is not about how to add value anymore, he said, but about managing relationships with lenders, protecting reputations and coming to terms with “extremely difficult” valuations.

Opinions may differ on the viability of active value creation given today’s highly dislocated capital market – whether there is a green agenda involved or not. But for buyers with capital to deploy, a brown discount is now being positioned as an attractive investment point of entry in some quarters – and some investors are agreeing.