Macquarie Asset Management: Tackling embodied carbon emissions

This article is sponsored by Macquarie Asset Management.

The built environment is a major contributor to greenhouse gas emissions, which has put the sector under pressure from regulators, investors and occupiers to improve its performance. To accelerate the transition, asset owners, among other strategies, are going to need to embrace retrofitting and adopting new technologies.

Owners and operators will also have to take a fresh look at property and facilities management, say Coen van Oostrom, chief executive of sustainable real estate developer Edge, and Brendan Jones, head of opportunistic real estate in EMEA at Macquarie Asset Management (MAM), which, on behalf of one of its managed funds, is a strategic investor in Edge.

How is the real estate industry progressing on the path to net zero?

Coen van Oostrom: We believe the leading companies are well progressed, while on the tenant side, we see a huge push from professional international companies, such as the big consultants or the big accounting companies, as they want to be in net-zero buildings. For example, last year Edge committed to all our new redevelopments and developments being net-zero carbon, with the ultimate goal to reduce all Scope 1, 2 and 3 emissions, including both embodied and operational emissions of our buildings, to absolute zero by 2050.

However, that depends on the whole industry and we also know cities are full of buildings which are not at that level. There are institutional and sophisticated investors who are improving that bit by bit, but it is too slow.

What is missing is that, while tenants and some leading real estate companies are significantly leading the pack, cities and municipalities are behind. I believe they could take a more aggressive approach, perhaps by putting a carbon tax on energy consumption in commercial real estate and then using the revenue generated to subsidize retrofitting of buildings to make them more efficient.

Brendan Jones: MAM is committed to investing and managing our portfolio in line with global net-zero Scope 1 and Scope 2 greenhouse gas emissions by 2040, where we have control or significant influence, and are actively working with our portfolio companies around the world to achieve that.

Out of the primary real estate sectors, we see the most innovation in the office sector, and I think tenants have been driving a lot of that change by demanding more from their existing landlords and seeking new space that meets their sustainability targets.

However, a huge challenge is that roughly 80 percent of Europe’s office stock is still outdated. Driving change across the existing stock, particularly in Europe and the US to make it ‘Paris proof’ will be a massive challenge in the coming years.

How much is the industry focusing on embodied carbon?

CvO: In many cities, when you talk to tenants or municipalities about embodied carbon, they have no clue what you are talking about; it really is a new part of the equation. Even for Edge, two years ago we had such low operational carbon emissions that it didn’t really make sense to invest more money in reducing it any further, but we hadn’t begun to think at all about embodied carbon.

However, embodied carbon is now on the agenda in major global centers like London, and I think it will come into focus in other European markets, too – especially as the big international brokers are increasingly focused on this. For the next few years, the falling price of existing stock will also make retrofitting more attractive than ground-up development in most cases, which is good from an embodied carbon point of view.

How are investors approaching sustainability and what are the challenges for those seeking to make their portfolios more sustainable?

BJ: In the past five to 10 years, there has been a focus from investment committees on delivering sustainable outcomes for new buildings. Now we are starting to see investors, particularly in Europe, focusing on what they can do with their existing portfolio, too. This has been accelerated by the recent challenging market conditions which are creating an opportunity to upgrade outdated, obsolete stock into modern, sustainable offices.

We have seen a major shift in approach over the past year and expect to see this become a focus for more investors over the next 12-24 months.

Just making sure your next development meets sustainability targets is not enough. What you do with your existing portfolio is also key to making a meaningful change.

CvO: The market is very confused at the moment because the rapid increase in interest rates has created uncertainty about valuations. This has made it more difficult for some investors to justify capex on energy efficiency.

For example, if you own real estate in North America, you might be looking at investing in upgrading older office buildings – assets with single-pane glass and old boilers which have not been upgraded since the 1950s. However, with the market in its current state, you might well fear that approach is throwing good money after bad.

Any trend is always accelerated by a crisis, and that is what we are seeing in office tenant markets where people are asking themselves, ‘How much space and what sort of space do I really need?’. This is driving bifurcation in the office market. We believe some large investors are going to see a big part of their portfolio shifting slowly in the wrong direction and they have to make an action plan.

That action plan today is very difficult, because of the need for capex. I think that we will see more creative joint ventures, perhaps with new money from the Middle East or Asia, to partner with investors and bring these buildings up to standard.

How can technology help asset owners?

CvO: In many cases, installing a few basic sensors and having someone monitoring the building management system, tasked with reducing energy use, can reduce energy consumption by up to 25 percent, for minimal cost. It seems crazy that a significant proportion of buildings are monitored by people who have no incentive to reduce energy use.

High quality, sustainable buildings are like a Ferrari, in that they need to be used and maintained properly to ensure top performance. So, in the facilities management space, people need to get used to working with new technologies and be incentivized for the right things. This means investors need to get away from the assumption that the lowest price is the best option.

There is a lot which can be done by using technology from the start of the design process. We build a digital model of each project and work with the architect to look at how we can reduce energy use through design and technology. We have found that a lot of progress can be made in reducing embodied carbon by using different materials or making a building lighter, without losing strength.

In the future, artificial intelligence will help us with all of this. We already see AI playing a role in the management of buildings, using its learning capacity to tell us what is wrong and what can be done better. In the future, even building design could be optimized by AI.

For example, AI could have data on all the available building materials in the world. You could then request a design which is very sustainable, efficient to build and safe. We are definitely not there yet, but we could see huge changes over the next 10 years in this space.

BJ: The technology is there to measure the data, but we don’t think it is used enough and the data that is collected is not always used properly. That is why you need specialist operational capabilities to best utilize available technology.

There has been a lot of new ESG regulation in major jurisdictions, is this the right way forward? 

CvO: There is too much talk about sustainability, rather than action, and there is a risk policymakers could stifle innovation through over-regulation. Even within Edge, there are more people working on reporting than there are on innovation. We need to get the balance right, otherwise we may end up delaying progress.

A few years ago, at the World Economic Forum, Al Gore advised the real estate sector not to get bogged down in standards and to focus on what is really important: embodied and operational carbon. These are two simple numbers that can be applied to anything.

Our industry is very fragmented. We have a host of different bodies and representatives, which can be problematic when it comes to being influential. We need a way to come together as an industry – not just the developers and investors, but also the architects and the other parts of the real estate ecosystem.

We are the biggest industry group in the world and should use our voice more effectively to drive positive change.

Has pricing moved enough to make sustainability-boosting retrofits an easy win?

Brendan Jones: In liquid markets, such as London and Amsterdam, we are starting to see the economics stack up, making the retrofit of existing stock a better option than ground-up development. Much of this comes from the bifurcation we are seeing from a tenant perspective. 

We often talk about the rental premium for the best buildings, which we think is 15 percent or more, however it is actually becoming binary. Occupiers want tech-enabled, healthy and sustainable buildings, but there isn’t enough stock to meet their needs.