Emissions trading for real estate  

Mark Wynne-Smith

Mark Wynne-Smith is JLL’s Global Head of Valuation Advisory, leading a team of 2000 people to appraise over USD 2 trillion of real estate across all sectors annually. He has worked extensively on portfolio and trophy asset sales globally and is a Fellow of the Royal Institution of Chartered Surveyors.

Since 2005, the EU’s Emissions Trading System (ETS), the world’s first major carbon market, has put a price on pollution[1].
The ETS is a ‘cap and trade’ system. A cap is set on greenhouse gases (measured in tonnes of CO2 equivalent or tCO2e), each lower than the last, driving the EU’s transition towards a low carbon economy. Market participants are given a free allocation of tCO2e that they are permitted to emit. They can then trade allowances, selling to over-emitters if they don’t require their full allocation or buying from auctions or other participants if they require more allowances to cover their emissions[2].
Already mandatory for the power, industrial and aviation sectors, the European Commission officially proposed on  July 14, 2021, that transport and buildings be included in a separate but adjacent system[3]. What would this mean for property owners and the value of their assets? EPRA and JLL set out to answer four key questions below.
1. What will the practical implication be for a property portfolio?
Participation in emissions trading would likely be handled by energy providers, with administration, transaction and direct costs of allowances being passed on to landlords and, ultimately, tenants in their heating bills.
This price shift would affect large landowners all the way down to private homeowners. The highest costs will fall to the owners and predominantly tenants of buildings with low energy efficiency using fossil fuel-based heating systems such as oil and gas.
Meanwhile, opportunities will arise for landlords producing on-site renewable energy. This prospect has not escaped one of the leading listed companies in Europe, who told JLL: “The real estate business can increasingly become its own energy supplier.” This is precisely what many real estate companies plan to do. Low carbon and renewable energy systems – such as photovoltaic panels, air or ground source heat pumps, and solar thermal water technologies – are likely to come to the fore. This could give landlords the opportunity to sell allowances themselves for profit.
2. Will it work?
The introduction of ETS should lead to more accurate measurement of actual CO2 emissions of real estate and drive low carbon and energy-efficient innovation. However, some argue that the price of allowances in the existing ETS is too low to achieve this[4].
Others are critical of the costs of retrofits or allowances being transferred to tenants, who may not be the key contributor to emissions, and penalising low-income households who are least able to afford upfront costs of energy efficiency improvements[5].
Some EPRA members surveyed raised the affordability of new measures as a potential issue: “It is good and right that politicians set clear climate targets. However, these goals must also be achievable.”
A delicate balance is required to impose a cost that encourages behaviour change without penalising those with limited control or resources.
3. What impacts have the carbon schemes had outside of the EU?
Given the high level of uncertainty of the implications of ETS on the real estate industry, we have conducted a global investigation into whether there are similar mature initiatives from policymakers. The EU seems to be at the forefront, with just a couple of initiatives affecting buildings globally.
In Canada, two provinces have cap and trade schemes, and the rest employ a carbon tax, which is now federally mandated[6][7]. The federal carbon tax is currently CAD 40/tCO2e and is expected to rise by 425% by 2030, reaching a price of CAD 170/ tCO2e.[8] A 2019 report found that rising carbon prices in Canada are likely to benefit the construction industry, with a wave of new investment and jobs[9]. Studies have also shown a decline in natural gas-related emissions in buildings in Canada as a result of these carbon schemes[10]. This suggests carbon schemes will stimulate investment in building improvements, as well as reduce emissions.
Switzerland has a carbon tax, currently set at CHF 96/ tCO2e. A third of revenues from the tax are allocated to funding energy efficiency retrofits for buildings and a governmental tech fund for innovation[11]. This is a major potential benefit for the ETS as well; funds raised could be used to invest in efficiency improvement programs for buildings.
4. How will this affect value?
Earlier this year, JLL produced a valuation methodology paper entitled ‘Valuing Net Zero & ESG’. It sets out how sustainability trends such as investor and occupier sustainability targets, lending criteria, and increasing legislation might affect property values in the future.
As legislation such as the ETS increasingly raises the costs of occupying less energy-efficient buildings using fossil fuel-based energy, tenants will demand more from landlords. In the short term, landlords could therefore benefit from enhanced returns for providing energy-efficient stock to tenants, with renewable energy systems benefiting their occupancy rates and rents. In the longer term, particularly as carbon costs rise, occupiers and, therefore, investors are likely to down-value outdated insulation, heating and cooling systems that no longer make economic sense.
In my opinion, the impact of the ETS in isolation will, however, only represent a small turn of the dial in what is a much larger market shift towards energy efficiency and renewable energy. Indeed, heating is only a part of the carbon emissions created by the construction and operation of buildings, and heating bills are not the only driver for tenants and landlords to occupy and own more sustainable stock. Nevertheless, an ETS for buildings is a step towards an economy where the true price of carbon is reflected, and this will contribute to the move towards sustainability impacting real estate values.
This complex topic is likely to evolve as more clarity on the scheme is provided by the European Commission, and particularly over time as carbon prices rise. For me, rising carbon prices appear to pose the key threat. Forward-looking management of real estate should include scenario analyses to futureproof investments and derive the right strategies aligned with sustainability goals. To explore this further, JLL, in partnership with EPRA, are set to publish an extended white paper on the topic of ETS and carbon tax for buildings in Q4 2021, analysing valuation scenarios to illustrate the potential impact.

[1] European Commission, “EU Emissions Trading System (EU ETS)” available at https://ec.europa.eu/clima/policies/ets_en
[2] European Commission, “EU ETS Handbook” 2015
[3] European Commission, “Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL amending Directive 2003/87/EC establishing a system for greenhouse gas emission allowance trading within the Union, Decision (EU) 2015/1814 concerning the establishment and operation of a market stability reserve for the Union greenhouse gas emission trading scheme and Regulation (EU) 2015/757” available at https://ec.europa.eu/info/sites/default/files/revision-eu-ets_with-annex_en_0.pdf
[4] Kemfert, C., et al, „CO2-Steuer oder Ausweitung des Emissionshandels: Wie sich die Klimaziele besser erreichen lassen“, 21. August 2019
[5] Cambridge Econometrics, “Decarbonising European transport and heating fuels - Is the EU ETS the right tool?” June 2020
[6] ACEEE, “Carbon Pricing Expands in Canada, Making Slower Progress in the United States” 2. March 2021
[7] BBC, “Canada's Supreme Court rules in favour of national carbon tax” 25. March 2021
[8] Chalifour, N. & Robitaille, D., “What the Supreme Court ruling on national carbon pricing means for the fight against climate change”, 28.March 2021
[10] Nadel, Gaede & Haley, “State and provincial efforts to put a price on greenhouse gas emissions, with implications for energy efficiency” (ACEEE & Efficiency Canada) March 2021
[11] Energiewirtschaftliches Institut an der Universität zu Köln, „CO2-Bepreisung im Gebäudesektor und notwendige Zusatzinstrumente“, September 2019