Making a positive climate impact

Logistics provides an opportunity that may have been overlooked, says Fidelity International’s senior real estate analyst.

Cian O’Sullivan

Guest comment by Cian O’Sullivan

Much of the focus of climate impact investing in real estate, both theoretically and practically, has focused on office and residential sectors. However, we see a strong case for a new era in brown to green logistics strategies.

This opportunity has arisen due to a confluence of factors, some foreseen, and others unanticipated. They include the acute repricing of logistics assets since H2 2022 induced by surging interest rates, the energy crisis in Europe, which has brought the additional costs of brown buildings into sharp relief, and the pace of rental growth in the sector, particularly over the past two years.

Most of the warehousing stock we have today is fit for purpose and will be for many years to come. However, it needs to become more operationally efficient. You could do more harm than good to efforts to decarbonize if you decided to demolish warehouses and start again from scratch.

Refurbishments emit 50-75 percent less embodied carbon – the carbon dioxide emitted from building materials like steel and concrete – than a new build. This embodied carbon makes up roughly one third of the life cycle emissions of a building on average.

The benefits of refurbishing warehouses accrue to the asset owners who will profit from the attractive IRRs that can be generated. They also flow through to occupiers who have lower operating costs. And, ultimately, this benefits future generations who will have incrementally fewer greenhouse gas emissions heating the earth.

Window of opportunity

There is little conclusive evidence on the extent of green premiums for rents and yields in the logistics sector, but we believe this has been distorted by the unique supply and demand imbalance that we have seen over the last cycle. This imbalance led to space availability being the single biggest determinant of its attractiveness to occupiers.

“Improving energy efficiency… will translate into major energy cost savings”

Now, as demand and supply normalize against a backdrop of increasing regulation, more forward-thinking net-zero aligned occupiers and energy cost pressures, we expect green warehouses to benefit more than ever before.

We estimate that around 25 percent of occupancy costs within a logistics building come from energy costs. Significantly improving energy efficiency and utilizing the vast potential for on-site power generation that many logistics assets have will translate into major energy cost savings for occupiers, while delivering double digit IRRs for investors.

Refurbishment does not come without challenges, and certainly debt and construction costs are now much higher than before the economic downturn. However, we expect this to be offset by better value entry prices that can be achieved today, with prime yields in some markets having moved out by 200 basis points already.

This has led to rapid capital value corrections of 30 percent or more – in record time. The necessary efforts to fully decarbonize our logistics building stock will likely take decades, but this window of opportunity could be a once in a lifetime chance to do it so profitably.