Greenwashing, where firms make false or misleading claims about the environmental benefits of products, has been identified by The United Nations as a “significant obstacle to tackling climate change.” A European Union study in 2021 found that nearly half of the “green online claims” being made by companies were exaggerated, deceptive, or false.
The U.S. Environmental Protection Agency (EPA) ranks “electricity and heat production” as the number one contributor to global greenhouse gas emissions (34 percent), followed by industry (24 percent), agriculture (22 percent), transportation (15 percent), and buildings (6 percent).
When electricity is accounted for its use in buildings instead of the energy sector, emissions from the real estate sector are 16 percent, putting it ahead of transportation, in fourth place. Given its carbon emissions ranking, the real estate sector should pay greater attention to greenwashing, as well as to another emerging practice to avoid disclosure, greenhushing.
Greenhushing involves companies actively staying quiet about their climate strategies on the basis that if they don’t say anything they can’t face accusation should they fall short on targets. If you do not set a target, then you cannot miss it and you absolutely cannot be accused of greenwashing.
In the real estate sector greenhushing is not an option and setting targets is crucial with stakeholders facing major challenges with both the investment and new technology required if they are to successfully meet net zero targets.
Andy McDonald managing director of real estate finance, HSBC U.K. says, “Sustainability is an issue that effects every property owner, developer and tenant and time is clearly of the essence. As an industry, we simply cannot afford to ignore the need for action, and we must all play a part in securing a just and timely transition to Net Zero.”
Accessing the right data is crucial for the global real estate sector to address the investment challenges, and the scale of the challenge to get to net zero is huge. McKinsey estimates investment of $1.7 trillion every year between now and 2050 is required.
Renovating assets and making them fit for purpose in a carbon-neutral world is central to achieving that and there are major risks that real estate portfolios will become stranded assets. Retrofitting assets will be a critical success factor in achieving net zero.
A study by market leading ESG data intelligence firm Deepki with senior European commercial real estate asset managers in the UK, Germany, France, Spain and Italy controlling a combined assets under management of $240 billion, highlights how big an issue it is. Nine out of ten respondents say that at least 20 percent of their real estate portfolios are at risk of becoming stranded assets in the next three years due to poor energy performance.
Deepki’s ceo and co-founder, Vincent Bryant, says, “ESG criteria will increasingly influence property valuation. The industry is already seeing the impact of brown discounting, with access to capital becoming increasingly difficult where ESG performance falls short. Many are establishing strategies to address these issues, recognizing the need for urgency.”
Stranded Assets
Deepki’s study revealed that nearly half (47 percent) questioned say that 20 to 40 percent of the commercial real estate assets owned by their organization are currently stranded. Half of the survey respondents say that 20 to 40 percent of their real estate portfolios are at risk of becoming stranded assets in the next three years, and 42 percent say this is a risk for 40 percent to 70 percent of their portfolio.
While retrofitting is favored over other options, with two in three (67 percent) organizations planning to retrofit their current real estate to upgrade and improve their energy performance, 64 percent are considering selling, 40 percent are considering demolishing and rebuilding, and 40 percent are considering incorporating green leases.
Physical stranding is already a problem in the wake of the pandemic which resulted in more people working from home. Real estate advisers JLL report that the 250 million square feet of vacant office space in the top 35 European cities could provide 500,000 homes. Around 90 percent of global real estate investors anticipate repurposing U.S. offices into residential assets.
Claire Stephens, research director of the Smart Building unit at research and advisory firm Verdantix warns, “With North America traditionally behind other regions in building decarbonization and sustainability, new climate and sustainability disclosure regulations represent a major risk for the real estate sector. We could see insurers pulling the plug on facilities with insufficient climate resilience and investors shunning companies with poor sustainability performance across their real estate.”
Authorities are offering incentives to repurpose underused offices. In New York, where the office vacancy rate is 18 percent, there are tax breaks for residential conversions while in Paris developers can build 30 percent higher if they are converting offices to flats. The City of London says it will fast-track applications to turn offices into flats and across the U.K. some office building conversions do not require formal permissions.
Deepki’s study reflects those priorities and found the sectors facing the greatest risk of their buildings becoming stranded assets are retail, according to 29 percent of respondents, followed by the industrial sector (26 percent), offices (13 percent), healthcare (10 percent), and residential (9 percent).
Regulation, Technology, And Tokenization
Greenwashing is under attack with regulators setting out the path for delivering net zero. Greenhushing is clearly not an option with the alphabet sour of E.U. regulations focused on disclosures. Investors are advised to take this seriously or risk their reputation and credibility.
The E.U. has introduced six sustainability related directives and frameworks which include:
- the E.U. Taxonomy (for sustainable activities),
- Sustainable Finance Disclosure Regulation (SFDR),
- the Corporate Sustainability Reporting Directive (CSRD),
- Corporate Sustainability Due Diligence (CSDDD)
- the Alternative Investment Fund Managers Directive (AIFMD). and
- the Markets in Financial Instruments Directive II (MiFID II).
Deloitte warns, “Investors and strategic buyers must now contend with the different speeds and direction of Governments and regulators, as they respond to macro ESG challenges by proposing and implementing new rules and regulations. In some cases, new rules present further causes of stranded asset risk, such as minimum Energy Performance Certificate (EPC) ratings for commercial property. However, just as investment is required to build resilience to physical stranding risk, so is it required to bring real estate up to minimum standards.”
Deepki’s study polled survey participants about the SFDR and E.U. Taxonomy which state that a building is only considered energy efficient when it has an EPC rating of C or above. Three-quarters questioned say that just 20 percent to 50 percent of their commercial real estate portfolio has an EPC of C or above.
Apart from reputation and credibility, transparency in ESG helps companies to raise capital in the financial markets at a better price. Investors are prioritizing sustainability when deciding where to put their money. A recent KPMG survey of global real estate investors found just 12 percent said sustainability was not as important as financial returns in their decision making.
Decarbonization strategies and sustainable finance will underpin the long-term value of real estate assets, so inevitably investors are pricing carbon related risks and opportunities over longer horizons while looking to decarbonize their portfolios and favoring lower-carbon businesses as institutional money flows into ESG funds.
“The global carbon credits market was estimated at $364 billion in 2022 and is projected to reach $479 billion in 2023”, says Bryony Widdup, partner, co-head sustainable finance and investment at Hogan Lovells, “it is a market with a use case designed for digitization and tokenization for the transparency of disclosures and asset pricing.”
In the E.U. emissions are falling fast, in areas where both the incentives and the technology have matured, reports the Economist, where sectors such as electricity generation which are covered by the EU’s biggest climate-change-fighting invention, its carbon pricing system, reduced emissions by 15.5 percent in 2023.
However, the reporting landscape is complex and dynamic and there are concerns about sustainability reporting and a demand for more granular information. Being transparent, and being seen to be transparent, are at the center of reporting.
Management consultancy Roland Berger warns that there are questions over ensuring a property portfolio’s ESG credentials is up-to-date and available to investors and says that is hindered by the asset class’s illiquidity, access to ESG data for due diligence, the large capital commitments required, and the long-term investment horizons.
There is a lot of the buzz in the market around the tokenization of real estate to “fractionalize” assets and create greater liquidity opportunities for owners and investors. The tokenization of real estate assets and market data arguably offers equal if not greater opportunities for making the reporting of asset performance such as environmental and financial performance targets much more effective, and with the (cost) economies of scale digital offers, over time.
There are big incentives, both financial and regulatory, to get on target while the industry is developing better tools and processes, like using tokenization and blockchain technologies as part of new Proptech solutions to accelerate the pace of change.
Bryant says “Our research highlights the growing role of PropTech when it comes to tackling the climate change challenge. European commercial real estate asset owners and managers know that they need to reduce carbon emissions and that data holds the key to this.”
BCG and ADX estimate that tokenization of real-world assets will grow to be a market worth at least $16 trillion by 2030. A recent EY Parthenon surveys of HNWI and institutional investors found that tokenized real estate was the asset class of second-most interest (50+ percent) following the tokenization of private equity (60+ percent).
The Market Needs Talent, Technology and Tokenization, Now
Deepki’s research shows the commercial real estate sector understands the need for investment. However, its study shows time, and a skills shortage are major barriers to success. Asset owners and institutional investors are developing strategies to address these problems, but success is dependent on the tools at their disposal – talent, technology and (data) tokenization.
The majority (85 percent) say that their business has plans to upskill or hire more people to help ensure the net zero challenge can be met. However, around two thirds (64 percent) say there is a shortage of people in the sector with retrofitting skills.
“According to the International Energy Agency (IEA) only 5 percent of new buildings construction was zero-carbon-ready in 2020. This means that there is much to be done, through both behavior and technology, coupled with market incentives, regulations and policies that are needed to reach 100 percent net zero by 2030.
“Although there are many challenges to decarbonizing real estate and buildings, for every problem there many solutions including digital data and tokenization solutions to help incentivize and monitor the journey to net zero,” says Deanna Reitman, Partner, Finance, Energy & Sustainable Commodities Practice at law firm Faegre Drinker.
The study highlights the need for technology with 88 percent of respondents say that Proptech solutions are important in measuring and managing carbon emissions. Around 84 percent of institutional asset owners and managers said that Proptech solutions are important tools when it comes to assessing and developing the investment plans for commercial properties that need to improve their ESG credentials.
Almost a fifth (18 percent) describe them as “extremely important”. More than three out of four (76 percent) expect their organization to increase investment in Proptech solutions over the next three years, underlining its role in helping the sector reduce its impact on climate change.
Adds Bryant, “The enormity of the task at hand is not to be underestimated, and companies should be spending no more than 20 percent of their time gathering data, so they can spend the rest of their time taking action and measuring impact. This requires innovative, scalable solutions. We anticipate huge additional spending on PropTech, such as SaaS solutions, IoT, and sensors.”
Commercial real estate asset owners and managers know that they need to reduce carbon emissions and that data and technology holds the key to achieving this. The enormity of the task at hand is not to be underestimated.
$1.7 trillion of investment every year between now and 2050 is a lot of money, but increasingly there are accessible and enabling digital solutions including Proptech and tokenization. As importantly, there is education and awareness, the best tools to help the talent solve the most complex problems business and society face.
