Transition risks in real estate: What’s next?

Prof. Dr Sven Biernet

Prof. Dr Sven Bienert, MRICS REV, professor at the Competence Centre for sustainability in Real Estate at the IRE|BS Institute of the University of Regensburg. He is an author of specialist books on real estate economics and the recipient of numerous research awards while active as an expert and consultant.

Transition risk is increasingly viewed as a strategic concern. A majority (68%) of financial institutions surveyed by UNEP FI and CRREM expect climate risks to become substantially more important in the coming years when making strategic decisions regarding real estate holdings.
Transition risk evolves to be a major strategic concern
They cited key drivers such as tightening regulatory frameworks regarding energy efficiency and GHG emissions, the rising risk of economic obsolescence of properties, expected increases in carbon and energy prices as well as more related reporting requirements.
One of the biggest challenges in the reduction of GHG emissions results from the poor energy efficiency of existing buildings and still too low refurbishment rates in virtually all European countries. More than 80% of the property stock that will be used in 2050 is already built today; therefore, the sector needs to optimise standing investments in order to win the race to net-zero. The Carbon Risk Real Estate Monitor (CRREM) initiative’s main objective is to support and enable this necessary transition to a decarbonised built environment and also steer this process. CRREM provides real estate investors, managers and other stakeholders globally with a clear Paris-aligned direction to set and control ambitious 1.5°C aligned decarbonisation targets in order to stay in the downscaled ‘fair share’ of the GHG budget for real estate in the use phase (operational emissions).
EPRA and CRREM joined forces in April 2022 to support the listed real estate sector in formulating, setting, and implementing science-based targets to reduce operational carbon emissions of buildings towards a 1.5°C goal, hence reducing transition risks. Prof. Dr Sven Bienert, Founder and Managing Director of the Institute for Real Estate Economics (IIÖ) and Head of the CRREM initiative, said: “We are happy to work with one of the main industry organisations to support the market in achieving net-zero.”
It remains an open question as to which measures investors should consider to gradually bring their portfolios in line with the Paris Agreement trajectories. It is clear that refurbishment roadmaps and other strategic considerations must be made very quickly to limit transition risks and possibly build up a competitive advantage.
How to overcome transition risks
As an initial step, there should be not just a net-zero commitment but a clear and feasible roadmap to decarbonise the entire portfolio until 2050. Activities may include upscaling the green retrofit capacity and budgets, developing clear efficiency standards for new developments and acquisitions (taxonomy and CRREM pathway compliance), promoting data sharing across the value chain, more renewable energy production on-site and addressing behavioural changes, etc.
Certainly, energetic retrofits are necessary to achieve climate goals. Electrifying the assets and just waiting for the electric grid to decarbonise is not a strategic option for various reasons. Firstly, regulators will ensure a fair split between the energy and the real estate sectors’ contributions to decarbonisation. Furthermore, also energy prices soaring upwards will put more and more market pressure on inefficient buildings; it can be expected that tenants will, even more than today, decide upon the overall operating expenses and not just the net rent. Lastly, regulation will also in the future address energy efficiency and not just carbon intensity. So, just switching to electricity and not reducing energy consumption is not a solution.
For those continuing to hold high-risk properties, a higher rate of return may be required to compensate. It is likely that grey discounts for properties not meeting decarbonisation and efficiency requirements will increase. Nevertheless, also energetic retrofits require a lot of material and produce waste, both leading to embodied carbon. Therefore, the net reduction must not only ensure a positive financial trade-off related to the retrofit but also a positive ecological trade-off between the embodied carbon of the investment versus the operational savings achieved.
Board-level attention on the rise
A survey undertaken by CRREM reveals that already a majority (95%) of company boards have ESG topics as a board-level discussion. Further, responses indicate an increase in climate change risk assessment activities in the next two years (89% of respondents confirm this). Nevertheless, an increasing gap between net-zero commitments being made and operational changes and action implemented can be noticed. There is the danger that our industry is underestimating the challenges and changes required and that greenwashing is taking place.
Companies need to develop a holistic approach to structure and implement the ESG/sustainability agenda within the organisation. ‘Green Governance’ is needed to ensure ambitions and net-zero commitments will be implemented on all organisational levels and within all processes of the company’s value chain.
Upcoming publications
EPRA and CRREM will publish two white papers with the support of Hines (Privately owned global real estate investment, development and management firm) and UNEP FI (The United Nations Environment Programme Finance Initiative) on best-practice and frameworks for Green Governance enabling net-zero commitments as well as a paper on the pay-off from energetic retrofits from an ecological perspective. The articles are addressed to leaders, pioneers and professionals in the real estate industry. Also EPRA and CRREM will further collaborate to facilitate the use of CRREM resources for EPRA members.