Nuveen Real Estate on keeping the ‘brown discount’ at bay

This article is sponsored by Nuveen Real Estate.

As real estate stakeholders increasingly embrace sustainability to combat climate change, managers’ commitment to attaining net-zero objectives serves as a strong defense against ‘brown discount’ worries, explain Nuveen Real Estate’s Carly Tripp, global chief investment officer and head of investments, and Abigail Dean, global head of strategic insights.

How does achieving net-zero carbon add value to a real estate portfolio and benefit investors?

Carly Tripp: When you think of net-zero carbon within a portfolio and why it is important, you think about an ecosystem comprising the regulatory environment as well as the investors we invest on behalf of. Investors’ sustainability requirements are more advanced in Europe than in the US, but there are many large state pensions in the US that have chosen to divest from fossil fuels – that is indicative of where the US is heading.

You also have the tenants, such as large corporate users, that will impose those requirements, and the insurers, which are starting to play a key role in the value of real estate. Major insurers like State Farm, for instance, are pulling out of states like California from a residential perspective because of natural disaster risk.

Lastly, the lender environment is imperative to values going forward. From a lender standpoint, it is assumed that there is a net-zero carbon and decarbonization policy in place when lending to an office building. That is a requirement of lenders currently in Europe and in the US that will become more prevalent.

So, because of this ecosystem, with all the different players impacting real estate’s value, it is going to be a requirement going forward that there is a decarbonization plan in place. If you are ignoring it, then you are putting your portfolio at risk for stranded assets. Because real estate is a very long-term investment asset class, you have to not only think of your value today, but also your buyer’s value.

Abigail Dean: The long-term nature of real estate investment is at the heart of it. If all real estate is going to be net-zero carbon by around 2050, that is 27 years away. Most buildings that we are going to have in 2050 are already here – probably well over 80 percent.

Those buildings are going to go through one or maybe two refurbishment cycles. That means that the cost of achieving that net-zero carbon efficiency has to be factored into underwriting now. We don’t want to buy anything where the cost to get there is going to be so significant that it is going to undermine our ability – or our next buyer’s ability – to deliver returns.

Where do you expect to see a value uplift for net-zero carbon buildings? 

CT: In the US, we see value uplifts in places like New York City that have taken policy measures like Local Law 97, which establishes carbon emission limits for the largest buildings. The requirement begins in 2024, but most real estate owners are now complying with that.

On the opposite side of the country, in California, where there are many more inquisitions around renewable energy uses, to eventually achieve a full transition to renewable energies, investing in a building that has the infrastructure to be able to be on the renewable grid becomes imperative.

AD: It is a brown discount, certainly, rather than a green premium. We might see small pockets of short-lived green premiums emerging where there is a real supply-demand imbalance, particularly if you have a lot of occupiers requiring space at the same time, who have very clear goals on this. That could create a short-term situation whereby green buildings outperform.

However, by and large, there is an assumption that prime buildings are sustainable, so they aren’t depreciated and subject to a brown discount. In the US and in certain parts of Europe, we have a bit of an oversupply of traditional office.

So, the net-zero carbon piece creates a bifurcation. We already see about 25 percent value differential opening up in London and Paris between green and brown offices.

What are the key challenges in decarbonizing portfolios? 

CT: Generally speaking, much of the built world wasn’t designed with this in mind, so being able to convert the infrastructure within a building is challenging. Access to renewable energy is another challenge.

It depends on the location, but there is not necessarily an efficient transmission grid for the built world to have direct access to renewable sources.

Further, as we have touched on, this ecosystem of what makes real estate value enhance is very disparate. There is a lack of data and transparency across the industry as a whole and a real lack of working together in a cohesive way to tackle this issue.

Policies right now at the corporate, investor, insurer, state or federal level are really unique and individualized. Beyond the Paris Agreement, there needs to be more influence holistically to really start to transition and decarbonize portfolios.

AD: As Carly just mentioned, one of the key challenges is a lack of data and transparency. It is very difficult to get access to complete energy consumption data for buildings, particularly where occupiers are procuring energy directly, and that can be a real problem when you are acquiring a building.

You have to make a lot of assumptions about how energy efficient it is, and you don’t always have access to that data. If occupiers aren’t giving permission for landlords to access it, that is very administratively burdensome.

If real estate managers don’t meet their carbon goals, what risks do they face and how could investors be affected?

CT: The overall risk is devaluation of your holdings. Going forward, it is also the risk of not being able to access investment capital and borrowing capital, which has greatly influenced the industry as a whole. You are at risk for stranded assets and, ultimately, devaluation of your portfolio if you are not supporting net-zero carbon efforts and, in some cases, the Paris Agreement objectives.

AD: There is also regulatory risk. Increasingly, there are regulated requirements on transparency related to sustainability and ESG. If managers have set goals related to this but then are unable to fulfill those, particularly if that is due to a lack of rigorous process rather than external factors, then there is also a potential for regulatory repercussions and reputational damage.

You have set a goal of achieving net zero by 2040. How do you plan to do this and what are you focusing on now?

AD: We set that goal back in 2020, so it is a 20-year program for us, which is broken down into five-year chunks with clear milestones as we go forward. We wanted to have very clear milestones for the first five-year period so that we were able to demonstrate tangible progress to our stakeholders.

The most important thing we are focusing on by 2025 is developing a good understanding of what the cost to achieve net-zero carbon looks like across our portfolio of existing buildings and incorporating an ability to assess that cost into our underwriting process for new acquisitions. That is work that is well underway now.

We also have a range of what we call ‘no regret actions’, which are things that make good sense to do. It just makes sense to ensure that all the lighting is efficient, the HVAC system is optimized correctly, and to take every opportunity when we are doing a refurbishment to incorporate a range of different net-zero carbon upgrades. We see the benefit of rolling out these good sense actions in our energy tracking.

‘Strong foundation’ to achieve net-zero carbon

Nuveen Real Estate set a 2030 goal to improve the energy efficiency of its portfolio by 30 percent, but it has been brought forward to 2025 thanks to the application of energy efficiency measures while replacing obsolete stock with more efficient buildings.

“That is really going to put a very strong foundation in place for us to move forward to achieve the net-zero goal over the longer term,” says Abigail Dean, Nuveen’s global head of strategic insights.

“In 2020, for instance, we acquired a logistics asset in Vienna whose development, expected to complete in Q1 2024, will provide prime, flexible logistics space, doubling the footprint of the existing asset. The project will achieve 100 percent heating and cooling self-sufficiency through solar PV and geothermal systems – this clean energy can be sold on to the tenants and is forecast to save 580 tons of carbon per year,” says Dean.

Nuveen has also performed successful ‘brown to green’ office conversions. “One of our existing holdings, an office building at 18-30 Clerkenwell Road in London, has recently been refurbished to BREEAM Excellent standard, improving its EPC rating from E to A. After the conversion, we have achieved a more than 50 percent reduction in operational carbon emissions, and secured a 10-year lease with architectural practice Hawkins Brown, a tenant that contributes 75 percent of the asset’s total income,” Dean adds.