EconomyMarket & Trends

Facing the Challenges of Decarbonizing during a Cyclical Downturn

By April 26, 2021No Comments

The real estate industry is tackling the twin challenges of a cyclical downturn juxtaposed with the long-term consequences from the disruption caused by COVID-19, and the environmental, social, and governance agenda becoming increasingly important.

A report by PwC and ULI highlights a clear global narrative of COVID-19 as an “accelerator of existing trends,” such as digitization and online shopping, while at the same time significantly reinforcing the real estate industry’s environmental, social, and governance (ESG) agenda. More companies than ever before are putting climate change and decarbonization strategies at the heart of the way they do business as they respond to the pressures of the pandemic.

Industry leaders surveyed for the annual Emerging Trends in Real Estate®:Global Outlook report are hopeful of a consumer-spending-led economic recovery feeding through into an uptick in activity in the second half of 2021. But much will depend on the rollout of vaccines and an easing of lockdown restrictions.

Unprecedented levels of fiscal and monetary stimulus threaten market volatility, and the emergence of stock market bubbles and renewed inflationary pressure in the United States and Europe are concerns for real estate leaders. Despite the risk of greater volatility, the loose monetary environment is keeping interest rates low for the time being and making the yield spread for real estate hugely compelling to investors compared with that offered by other asset classes.

Since the start of the second lockdown in fall 2020, lenders have adopted a far more cautious approach to real estate compared with that adopted by equity investors. While banks were generally

supportive of business at the outset—invariably at the behest of governments and central banks—lending criteria have become tougher. There is a widely held expectation that distressed debt will increase once government support packages end, although it is considered unlikely to match the levels of distress seen after the global financial crisis.

Given the pressure on occupier markets, the report speaks about “a bifurcation in pricing” between in-favor sectors like logistics that have provided stable income during the pandemic and those sectors that have been hardest hit, such as hospitality and parts of retail. Residential also is in favor, with investors seeing favorable supply/demand dynamics, which make housing a prudent defensive play for the foreseeable future, but the outlook for the office sector is more difficult to predict. The report suggests that the impact of the pandemic on offices might be lower than widely assumed, and employees are expected to eventually want to return to the office, albeit in more of a hybrid working model than in pre-COVID times. Also, in Asia, little long-lasting impact is expected given the corporate culture there and the relatively small living spaces in Asia’s major cities, which are expected to lead to a more consistent return to office working.

The overriding theme from interviews conducted is that the industry is looking beyond occupancies and returns, and it is starting to address its wider responsibilities. A growing focus on decarbonization in the real estate industry during the last 12 to 18 months has been driven primarily by providers of finance and the biggest tenants, but also by climate change becoming more tangible in the form of more frequent extreme weather events.

The main takeaways from the interviews point to a daunting amount of complexity in the development, ownership, and management of real estate, which makes coming up with

an effective strategy difficult even for the largest companies, let alone the execution. Currently there are no common definitions of what “net zero” means, whether it relates only to the carbon emissions related to the operation of the building or also to the “embodied carbon” emitted during the production and transport of materials and the construction of the building.

The profusion of certifications, standards, targets, and terminology creates the potential for “greenwashing,” giving the appearance of decarbonizing for reasons of brand and to attract capital, while actually focusing on only part of the story. To avoid greenwashing, alignment of goals and unprecedented collaboration among all stakeholders, including developers, construction companies, investors, tenants, and the public sector, is key: “Any certification or net-zero standard that does not put embodied carbon front and center of its thinking risks sending the real estate industry down the wrong path, stifling innovation in the areas where it is truly required, and diverting funding to initiatives that will not be that impactful in reducing carbon emissions,” the report says.

In the report, ULI Global CEO Ed Walter says: “However acute the economic impact of the pandemic, the real estate industry recognizes that the long-term impact of climate change will be greater. Few have fully gotten to grips with the challenge, but skills and innovations are spreading through the industry, and the Urban Land Institute is playing a key role in sharing of knowledge and best practices.”

The interviews reveal an industry that is alive to the fact that stimulus will need to be repaid, the importance of health and well-being is increasing, and ESG regulations will be tightened. But this comes at considerable cost, and lead times are significant for innovation to occur and changes to be implemented into supply lines. The vaccine alone will not take away the pain of impending reforms.

Craig Hughes, global real estate leader, PwC, said: “While many eyes are focused on the economic recovery, we should not underestimate the structural impact of this crisis, following the dislocation across many industries and society. It is about more than recession and rebound, as we won’t go back to how it was before. ESG factors are in laser focus, including an increased sense of urgency to decarbonize.

“There remains a daunting amount of complexity in the development, ownership, and operation of real estate, which makes coming up with an effective strategy vital. Owners, occupiers, and all other stakeholders in the real estate value chain will need to work together if the industry is to play its part in reversing climate change and adapting to a post-pandemic world.”

In a chapter focusing on decarbonization, the report advises a range of responses:

  • Assuming that around 80 percent of the buildings standing in 2050 have already been built, making them energy efficient rather than developing new buildings would have a huge impact on meeting net-zero carbon goals.
  • Complexity in ownership and management of real estate requires developers, owners, suppliers, advisers, customers, local and national governments, and international bodies to collaborate on common goals and strategies.
  • A change in valuation methodology to take account of retrofitting costs would force change and would include modification to industry best practice and could require changes from the regulatory bodies that govern how valuations and appraisals work in different countries.
  • Net zero is fast becoming the most important standard for buildings in terms of climate change and decarbonization.
  • Tenant behavior changes to include embodied carbon when assessing net-zero targets will significantly reduce the real estate industry’s incentive to develop new buildings.
  • Green leases can be used to incentivize tenants to switch to renewable energy sources and reduce their own energy consumption.

While about 28 percent of the world’s emissions come from building operations and about 11 percent from construction, according to the U.N. and U.S. Energy Information Administration, 74 percent of the carbon emitted during a building’s life cycle comes from its construction and demolition.

Given the proportion of carbon emissions coming from the built environment, regulation of real estate by city, regional, and national governments is expected to accelerate. The report cites New York City’s Local Law 97, Los Angeles’s Green New Deal, the U.K.’s energy efficiency standards, and Germany’s carbon tax on commercial buildings. In France, new legislation is proposed to make landlords and tenants equally responsible for the energy consumption of a building. In the Asia Pacific region, tougher regulation of real estate in China and Singapore is expected to follow a recent announcement of net-zero targets. Investors are increasingly conscious of the risk of “stranded assets” that cannot be brought into line with regulations and for which there will be no buyers or occupiers. This is already starting to show impact, with the general view that greener buildings are increasingly seen as more saleable.

ULI members can access the full 2021 Emerging Trends in Real Estate®:Global Outlookreport on Knowledge Finder.