How to get to net zero in real estate investment
How to get to net zero in real estate investment
The Paris Agreement was met with great acclaim when signed in 2015. It set a target of a net carbon-neutral world by 2050, with a 45% cut in emissions by 2030 needed to limit global warming to 1.5C. The reality is that little has changed in the intervening years.
Putting the transition into perspective
Real estate needs to achieve both net zero operational carbon by 2030 and net zero embodied carbon by 2050.
To effectively transition according to the above standards, in time, the real estate industry has to meet some significant hurdles. 40% of buildings and 75% per cent of infrastructure that are predicted to exist in 2050 have yet to be built. These new buildings will need to be net zero carbon across their lifecycle.
This includes embodied carbon – the emissions generated in creating building materials – which must be reduced by at least 40% by 2030, with leading projects achieving at least 50% reductions. By 2030, 100% of new buildings must be net-zero carbon in operation. But it means much more. 80% of today’s European building stock will still be here in 2050. As such, retrofitting every one of those assets to be energy efficient must either be complete or, at the very least, well underway by 2030 to be able to meet these targets.
Unity and practicality; how to get to net zero
2015’s COP21 saw over 190 countries agree on climate action, but the interpretation of the actual requirements supporting this agreement has been widespread. As result, the varying government guidelines and industry standards put in place are not yet fully aligned, and will not lead to a net zero outcome in time to keep the temperature rise below 1.5°C. More coordinated and focused action is needed, also including emerging markets, home to 85% of the world's population, with forecasts of steep economic and population growth, and starkly different developmental states.
Perhaps the biggest finding was that in our industry, the focus has been more on data gathering and theoretical energy labels rather than on in-use emission reductions. Of course, reduction cannot be achieved without first measuring, but being awarded full marks or green stars for reporting only, could lull our industry into a false sense of security.
Actual emissions, including also those of the tenants – in use – can only be reduced through action targeting the total building, its operations and waste. This approach relies heavily on cooperation between the end investor, manager and tenant.
What does this involve?
Operational carbon emission can be reduced via energy efficiency measures with metering, installing LED lighting, optimisation of building management systems (BMS), upgrades to heating and ventilation systems and measuring output in close collaboration between tenant, property manager, owner and investor.
Embodied carbon reduction requires carbon analysis of the whole value chain of a building delivery from design, building materials, construction methods and delivery, through to the commissioned operational building. Such an approach should reward value and carbon engineering for the lifecycle of a building.
To achieve this, mindsets must adjust permanently, to “renovate, not replace” and buildings must be designed for the real world; for “in use”, not “in theory”.
Carbon needs to become a key factor in appraisals, alongside financial analysis. Profit needs to be considered after environmental impact, and using a clear carbon price as a proxy at least, can address this. Although the industry generally agrees that buying offsets is not the best way to achieve net zero for real estate portfolios, the reasons why this method is generally dismissed are not valid in our view.
It is argued that it is not economically viable to buy offsets to reduce to zero as it would hurt financial returns. However, this is missing the point: the costs of carbon emissions are effectively already there. That is to say, the time-discounted cost of forecast climate change disruption for our industry is enormous. One cannot assume that wider society or even the industry itself will accept the sector to “free ride” on these future costs indefinitely.
These implicit emission costs should be taken into account in the underwriting of assets now. This can ensure the right investment decisions can be taken and assets are readied for long-term future sustainable financial performance.
A decent proxy for these implicit costs related to carbon emission embedded in real estate portfolios, can be the price at which voluntary carbon offsets are trading on the market. Our research has concluded that capitalising the implicit carbon costs (at offset pricing) is a very good proxy for the capex that is required to be invested to actually reduce the carbon emissions (landlord-controlled) by c.70%.
The environment will charge us one way or another
The industry needs to move away from "let's not get ahead of the grid”. We have an opportunity to self-regulate to the right outcome for all stakeholders, incentivise our asset managers beyond short-term profits and in favour of long-term relevance and performance.
- Silicon Valley Bank: what does its failure mean for markets and the economy?
- What are the implications of China’s reopening for the global economy?
- Why tackling gender inequality is key to delivering real financial inclusion
- The charts that show how the world has changed in the past 12 months
- Is Europe’s energy crisis over?
- The compelling case for dividend investing in Asia
The contents of this document may not be reproduced or distributed in any manner without prior permission.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect nor is it to be construed as any solicitation and offering to buy or sell any investment products. The views and opinions contained herein are those of the author(s), and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The material is not intended to provide, and should not be relied on for investment advice or recommendation. Any security(ies) mentioned above is for illustrative purpose only, not a recommendation to invest or divest. Opinions stated are valid as of the date of this document and are subject to change without notice. Information herein and information from third party are believed to be reliable, but Schroder Investment Management (Hong Kong) Limited does not warrant its completeness or accuracy.
Investment involves risks. Past performance and any forecasts are not necessarily a guide to future or likely performance. You should remember that the value of investments can go down as well as up and is not guaranteed. You may not get back the full amount invested. Derivatives carry a high degree of risk. Exchange rate changes may cause the value of the overseas investments to rise or fall. If investment returns are not denominated in HKD/USD, US/HK dollar-based investors are exposed to exchange rate fluctuations. Please refer to the relevant offering document including the risk factors for further details.
This material has not been reviewed by the SFC. Issued by Schroder Investment Management (Hong Kong) Limited.