Stephen Hayes, Head of Properties Securities, First Sentier
Property facing its emissions reckoning
What ‘known unknowns’ might impact global property valuations in the future? An increasingly important issue will be measurement of carbon emissions. Real estate accounts for around a third of global emissions. And while the sector is moving towards net zero by 2050, both investors and regulators are demanding greater clarity on the total level of emissions across the sector. Full assessment however is being hampered by a lack of standardised measurement methodologies.
In general, the sector is lacking critical carbon disclosures. A partial reason for this lies with the World Business Council for Sustainable Development Greenhouse Gas Protocol Definitions. These are not translating well enough. Whilst some listed property companies do have fairly robust carbon reporting standards, many others do not, with the potential to negatively impact listed property company valuations.
Sector carbon emissions need to be measured both in terms of emissions generated from operations, but also ‘embodied carbon emissions’ – those associated with everything but the operating asset. These embodied emissions tend to be less transparent. There is no standardised methodology to measure embodied carbon emissions associated with modernisation programmes. The risk is that these might attract the attention for regulators, tempted to introduce more rigid guidelines.
In terms of emissions from operations, a large investment is being made with regards to more efficient plant and equipment. This matters as a lot of operating emissions are derived from heating and cooling systems, often reliant on power from fossil fuel power stations. But to capture the full picture, investors need to focus on how companies identify, measure and reduce their total carbon emissions. It is not just how they operate their property assets.
As way of illustration, the construction sector currently sends 13% of site materials straight to landfill. Is this being captured and reported?
Accurate measurement of total carbon emissions will drive the accurate valuation of listed property companies. To address the issue of the absence of an industry standard carbon assessment methodology, we have developed our own. ESG demands within the sector are only going to increase and our proprietary methodology allows us to integrate a full carbon emissions assessment into our investment process.
At the overall global sector level, there are some frameworks which exist, but as always, it is not their existence but their implementation that matters. More structural issues also affect the progression towards lowering emissions. The EU missed its 2020 operational energy efficiency targets, mainly due to the building stock within the EU not been renovated rapidly enough to realise environmental benefits.
Remember also that while new build property today achieves very high sustainability certifications, 70% of present buildings will still be here in 2050. To really move the dial, this legacy stock needs to be repurposed and refurbished. What needs to be done to achieve net zero by 2050? The International Energy Agency estimates direct building CO2 emissions need to be cut by 50% and indirect emissions reduced by a 60% reduction in power generation emissions. This means a 6% per annum reduction from 2020 to 2030.
Overall, we support greater ESG alignment – net zero efforts will actually improve long-term shareholder returns. It is for this reason we developed our in-house carbon assessment methodology. It allows us to measure modernisation, renewable energy procurement, carbon offset programmes and embodied carbon on-site renewable energy generation. This approach is likely to fully capture the costs and opportunities within the sector and allow more accurate valuations.
This view is increasingly apparent within the market. The World GBC recently reported grade-A buildings in central London with ‘very good’ or higher BREEAM ratings achieved 10% higher rents than those without. Vacancy rates were also only 7% for those with a ‘very good’ rating compared to the overall sector at 20%.
The value of property assets – no matter what or where they are – will certainly be impacted by the threat of obsolescence due to failure to meet occupational, investor and legislative sustainability standards. Buildings with higher efficiency ratings will attract higher rents, deliver lower running costs and have wider appeal to potential tenants. This will drive sector performance going forward.