The covid-19 pandemic has given the real estate industry a lesson in real time about the importance of adapting swiftly to new realities. The next major disruptor is climate change. Given the imminent risks properties face – an estimated 35 percent of real assets worldwide are exposed to climate hazards, according to climate risk data firm Four Twenty Seven – are real estate players taking action?
According to a study from the Urban Land Institute, published in October 2020 and conducted with Chicago-based real estate investment manager Heitman, climate risk is beginning to affect property investors’ decisions – mostly when it comes to assets and, to a lesser extent, at market level. What is evident is that, in the last two years, the real estate industry has increased pledges to net-zero carbon emissions, with targets ranging from as early as 2030 to as late as 2050.
“We have seen a huge uptick in the importance of sustainability, and climate change in general, in terms of funding, underwriting, financing and project selection,” says Katherine Beisler, head of ESG consulting at real estate consultancy Hollis. “Most of our clients are really concerned about things like the ability to improve the energy efficiency of the buildings that they’re stepping into, but also about the costs and the risks associated with a new project.”
Property managers are closely watching changes to regulation and legislation, which are driving many decisions around properties’ energy use and reduction, to address climate change and de-risk portfolios. “The asset managers and investors that are more at the forefront want to do better than what the legislation requires. They are pushing to reach net-zero targets and looking to influence their tenants to be more energy efficient,” Beisler explains.
Italian insurance giant Generali is one of the institutional investors committed to decarbonizing its portfolios to net-zero emissions by 2050 to avoid a global temperature increase above the 1.5C Paris target. Its property asset management arm, Generali Real Estate, is using its building refurbishments to implement energy efficiency measures and, consequently, reduce CO2 emissions.
“We are strongly focused on having a more performing envelope in order to reduce overall energy consumption and carbon footprint, while also using technical equipment powered with green energy,” says Paolo Micucci, Generali Real Estate’s head of engineering and project management. After the refurbishment of ‘The Corner’ building in Milan, which was built in 1964, Generali has been able to save energy and costs by more than 60 percent, avoiding 539 tons of CO2 per year.
Invesco is another property manager that has carried out redevelopment projects in line with a detailed green program during the design and construction phases, with a focus on reducing a building’s negative environmental impact. The US-based manager did a redevelopment of a partly historic office building in the prime CBD of Milan, near Il Duomo.
“This included reusing 60 percent of the structural elements of the building, sourcing materials locally and recycling almost 100 percent of construction waste,” says Max Kufer, Invesco’s head of ESG for private markets.
Photovoltaic systems were also integrated into the roof canopy, while geothermal technology and 100 percent renewable energy was sourced to supply building energy uses, Kufer adds.
Stranded assets
As managers try to mitigate the environmental impact of their buildings, another concern is pushing them to make assets more energy efficient and less carbon intensive: the risk is that inefficient buildings become obsolete, leading to write-downs.
“A major driver for action is the obsolescence of buildings, as they face the risk of becoming stranded assets,” says Peter Hobbs, managing director at bfinance. “In the office market, for instance, there’s a real polarization between [climate] resilient buildings that perform very well – and which occupiers want to occupy – and the ones that don’t meet EPC [Energy Performance Certificate] requirements, or have very poor ESG credentials. The cost of improving those or turning them around is often just too much.”
Indeed, costs are significant. Consultancy firm Colliers estimates that, just in Europe, some €7 trillion may be needed to retrofit buildings to comply with emerging ESG requirements. Despite costs, some real estate managers like Generali Real Estate trust green buildings as an effective solution to reduce climate risk and keep the value of assets.
“We believe that, in the near future, the real point of making a building ESG-compliant is not only to add value, but to maintain it,” Micucci says. “With climate change becoming more and more relevant, if a building doesn’t go in the direction of ESG, the product will become obsolete. And, perhaps, we will get to a point where if the building is not aligned with ESG parameters it is actually losing value.”
Real estate managers, particularly in Europe, are paying more attention to sustainable buildings compliant with current – or upcoming – energy performance regulation when it comes to eligible acquisitions, Beisler notes.
“In the UK, for instance, we see that for any building with EPC below B – which will be the minimum according to the future legislation – a client would expect to not pay a top price, because they know that they’re going to have to do energy improvement upgrades in the next nine years to reach the level that it needs to be,” she says. “We also have a lot of clients that won’t buy a building unless it has a very good [sustainable] certification.”
Beisler explains that while property managers in Europe are mainly focusing on transition risk and making their buildings more energy-efficient to reduce carbon emissions, in the US property managers are more concerned about the impact of natural disasters on real estate due to climate change, probably due to the increased frequency of climate events compared with Europe.
“The first type of climate risk that real estate investors in the US think about is the physical risk – the risk to their asset because of flooding or other extreme weather events,” says Marta Schantz, senior vice-president of the ULI Greenprint Center for Building Performance. “At the same time, transition risk is becoming more and more important, especially as European investors invest in American funds.”
“If a building doesn’t go in the direction of ESG, the product will become obsolete”
Paolo Micucci
Generali Real Estate
Thus, an increasing number of US investors are incorporating ESG into their due diligence when acquiring and disposing of assets, thinking about assets’ long-term physical risk. Meanwhile, their concerns about how upcoming climate policy and stakeholder expectations will affect the asset are gradually gaining strength, Schantz notes.
Some managers have already taken steps to address acute resiliency at properties. For instance, Brookfield’s Pier 70, a mixed-use development in San Francisco, built sea-level rise projections into its design, elevating the entire site so that all buildings can withstand the potential rise, PERE understands. Another development from Brookfield, the Greenpoint Landing residential scheme in Brooklyn, is one of the first waterfront projects to deal with post-Hurricane Sandy regulations for developments in flood hazard zones.
“Environmental risks are something we consider closely both at our existing properties worldwide and as a factor when contemplating an investment,” says a spokesperson for Brookfield Real Estate.
Divestment decisions
Investors are starting to make decisions on whether to invest, or continue investing, in markets particularly vulnerable to the impacts of climate change, according the above-mentioned ULI report.
“Investors are thinking about their long-term risk in different markets, and while I have not seen any examples yet of a company that has completely divested in an area because of physical climate risk, I have seen examples of firms that have stopped making new investments in a region because of climate risk,” Schantz says.
Many investors, meanwhile, are still active in vulnerable markets to climate risk such as New York City, Boston or South Florida, as they have historically been profitable.
“If investors have some risks at some assets, they want to have lower risk at other assets,” Schantz says. “In this sense, many are looking more at the portfolio level as opposed to one single asset being deterred because of climate risk in a particular market. They are trying to be more strategic in that way.
“Most investors are not immediately divesting from a region because of climate risk, but many are taking steps to move away from higher-risk regions over time; or pausing any new investments in a region until they have more information to help them better assess and price these risks. Some investors are getting ready to pull out or are already pulling out of some areas because of climate risk – just not immediately, and not abruptly.”
Leading real estate investment managers are increasingly recognizing climate risk as a core issue that is beginning to affect their asset decisions in terms of acquisitions and day-to-day management. These investors have increased actions to build asset resilience and to make their buildings more energy efficient and less polluting. Climate-conscious decisions at the market level are incipient, though.
The consensus, according to the ULI report, is that market-scale climate risk assessment will play a role in future investment decisions, mirroring the recent advances in assessing physical risk at the asset level.
What do LPs want?
Institutional investors committing to real estate funds no longer see environmental considerations as ‘nice to have’ but as fundamental risk factors, argues Peter Hobbs, managing director at investment consultancy bfinance.
“All investors we work with are looking very much at how managers integrate these considerations in their investment decision-making,” he says.
Investors are particularly focused on what managers are doing when it comes to carbon reduction goals and energy efficiency, as well as how they’re measured and reported, Hobbs explains. They are also paying attention to the manager’s internal resources and how staff are trained to mitigate climate risk, he adds.
“Some investors say they won’t invest with a manager unless they are a UNPRI signatory. I also know of investors that have come to like a manager, but because of a weak GRESB score, have decided not to invest with them. This illustrates the ways in which ESG factors can influence investors making selection decisions.”
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