As the largest wildfire recorded in European history raged in the Greek forests in August 2023, 10-year interest rates in the euro area soared to around 3.25 percent, a level not seen since 2011, and spiked at 3.5 percent in October 2023.
The end of ‘free money’ marked the demise of the sometimes-excessive financialization of real estate, when buildings were reduced to mere cashflow lines in Excel models and defects were erased by continually compressing cap rates. A lesson learned from this crisis is a building, before it is an investment product, derives its value from its occupants. For occupants, and consequently for investors, a building should be useful, efficient, comfortable, desirable and accessible.
With real estate accounting for 39 percent of global greenhouse gases emissions, another criterion has been added to this list: a building should fight global warming by having the lowest carbon footprint over its lifecycle, taking into account the embodied carbon of its construction and the operational carbon over its life. As such, 2024 will offer promising prospects for a new generation of user-centric and low-carbon real estate.
From a leasing perspective, 2024 marks the enforcement of the Corporate Sustainability Reporting Directive (CSRD) in Europe. In the commercial real estate sector, companies that rent out office and commercial real estate space will now have to produce and disclose audited carbon emissions (including Scope 3) and publish a decarbonization trajectory. Real estate will be a lever for many corporate tenants to reduce direct (operational carbon) and indirect (embodied carbon) emissions across Scope 1, 2 and 3. A low-carbon headquarters would also allow companies to showcase their commitment to climate change to their employees and their whole ecosystem.
In this context, environmentally obsolete commercial real estate will be increasingly difficult to lease. A study published in September 2023 by the French low-carbon building association, BBCA, involving 14 managers listed on French indices CAC40 and SBF120, revealed 93 percent attached particular importance to the carbon footprint of newly leased premises.
On the investment side, low-carbon real estate aligned with 2050 carbon neutrality goals is now a must-have for institutional capital. Most major investors have now adopted decarbonization trajectories based on scientific models such as the Science Based Targets initiative, aligning objectives for their real estate portfolios with the Paris Agreement.
In the same study published by BBCA, all of the 40 largest institutional investors in France, with combined asset value of around €888 billion, declared they had adopted a strategy to reduce their carbon footprint. Only 2.5 percent believed the carbon footprint of a building is of little importance in an acquisition decision.
Finally, from a financing perspective, banks and appraisers have equipped themselves with extra-financial analysis frameworks where carbon footprint is a key criterion.
As such, the value gap between prime, low-carbon and high-carbon buildings will widen in 2024. The latter are often functionally obsolete, with prison-like environments showcasing non-opening windows and low ceiling heights. The magnitude of capex required to reposition such ‘brown’ assets to align with 2050 carbon neutrality goals can exceed €1,500 per square meter. Repositioning also usually requires new administrative authorizations, in an increasingly complex administrative and political environment, and technical expertise to implement the use of bio-sourced materials such as wood and other low-carbon innovations.
2024 will be a new episode of Schumpeterian destructive innovation in the real estate sector, with the rise of low-carbon construction and redevelopment paving the way for new opportunities on the value-add investment side for operators with strong low-carbon expertise.
Laurence Desmazieres is managing partner of ICAWOOD, a Paris-based low-carbon real estate development and restructuring strategy managed by European manager ICAMAP.
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