Now is the time to act: The grave risks of not urgently improving the sustainability of property portfolios

November 17, 2022
David Walsh

The need for the commercial property sector to enhance the sustainability of its operations is well-documented. However, we feel the conversation has been slow to emphasise the level of urgency required to curb the 28%¹ of global carbon emissions that can be traced to property operations. Failure to act with both haste and purpose will only worsen the situation, given that 80%² of buildings in 2050 have already been built. After a drop in consumption in 2020 due to COVID-19 disruptions, carbon emissions from building operations are once again back to levels that need to be halved by 2030 if we are to successfully contribute to a net zero world. Therefore, we strongly advocate for property owners and managers to heed the calls for concerted, prompt and decisive action to enhance the efficiency of their operations.

But going beyond the now ubiquitous ‘race to net zero’ rhetoric, what else is compelling the world’s property leaders to run their portfolios more sustainably? What should be driving this urgency to act for individual developers, property trusts and fund managers? Well, failure to quickly establish a sustainable operating model will impact financial performance, limit access to green finance, spike dependence on unreliable and increasingly costly carbon offsetting, and increase exposure to future regulatory demands. Importantly, the longer a company waits, the more pronounced these implications become as their cumulative growth snowballs into a ‘mountain of climate debt’.

Financial implications

Naturally, commercial properties that are inefficiently run attract lower sustainability credentials. The bottom line impact of this is increasingly significant as tenants and investors become more sustainability-minded, with ‘green premiums’ driving higher rents, yields and asset valuations. The debate over whether this is legitimate and quantifiable was put to the test in a comprehensive analysis of 42 studies on the ‘value of green’ conducted by Dalton and Fuerst. It showed that green certifications for commercial properties yielded an average rent premium of 5.4% and a sales premium of 11.5%³. This is supported by the world’s property investment community, with a JLL Report on ‘Decarbonising the Built Environment’ finding that 63%⁴ of leading investors strongly agree that green strategies drive higher rents, occupancy, occupant retention and overall higher value. In the case of Kyko Group, the use of CIM’s building analytics software improved the green credentials of Brisbane office site 193 North Quay, driving higher asset valuation and stronger tenant interest.

So, the value creation argument is strong, but stronger still is the value preservation argument. Establishing superior performance via ‘green premiums’ is one thing, but avoidance of ‘brown discounts’ is another compelling incentive to act with urgency in mind. Guy Grainger, JLL’s Global Head of Sustainability Services and ESG explains, “green premiums are temporary, brown discounts are forever.” By delaying activity that will facilitate a more sustainable portfolio, companies run the risk of losing value to competitors with each and every period that goes by. As ESG becomes an increasingly foundational part of commercial behaviour, the performance gap between green and brown buildings is likely to widen, meaning owners of suboptimally run buildings will need to work even harder to keep up.

Access to finance for property owners is also increasingly contingent upon their transition to sustainable activity, with most investors and banks favouring capital allocation to companies that pursue decarbonisation. At the COP27 climate conference in Sharm el-Sheikh, enhancing the market for ‘green bonds’ (bonds that are linked to projects deemed environmentally beneficial) was a hot topic for companies and country delegates. Reliance on green bonds has skyrocketed of late, with companies borrowing record sums last year totalling $859 billion, a 60% increase since 2020⁵. Bank of England Governor Mark Carney went so far as to say that “companies that don’t adapt will go bankrupt without question.”⁶ This shift has happened quickly and is predicted to keep picking up pace. So, property companies that fail to invest in technologies, tools and innovations that drive the operational efficiency of new and existing stock will get left behind and be punished financially.

Over-reliance on carbon offsetting

Many property companies are turning to carbon offset purchasing as a vehicle to compensate for their emissions. While this does have a role to play in a wider net zero strategy, the foundational focus should be on maximising operational efficiency so that fewer carbon offsets will need to be purchased now and into the future. Currently, the price of carbon offsets is ‘unsustainably low’ due to a surplus on the voluntary market. Research predicts carbon offset prices will grow exponentially in years to come, up from just US$2.50 per tonne of CO2 in 2020 to between $11 and $215 per tonne in 2030⁷. By immediately adopting strategies to minimise reliance upon these increasingly burdensome costs, companies will be in a far less precarious position.

The other danger for property companies relying too heavily on carbon offset schemes is a failure to engage bigger-picture systemic thinking. It could, for example, result in missed opportunities to leverage more reliable and proven mechanisms to improve sustainability performance such as digital innovations that drive everyday efficiencies and optimisations in the way buildings are run. The external cost of carbon offset purchasing may be enticingly low given the current lack of regulation, but this limits the internal incentive to invest in more ‘sustainable’ strategies. Not to mention the use of carbon offsetting as a key strategy to avoid the work involved in making buildings green may inevitably lead to accusations of greenwashing, which sophisticated investors do not take lightly.

Tightening regulatory pressures

Companies, particularly those in the property sector, can expect to experience increasing scrutiny from governments, industry bodies and regulatory agencies about their sustainability performance. While regulation, mandates and standardised disclosure of climate-related risks have been quite lax in the past, there is growing momentum amongst global authorities to tighten commercial industry requirements. As an example, the Australian Government, which has been historically non-committal on climate legislation, recently introduced the Climate Change Act 2022. While the Act itself does not impose obligations directly on companies, its commencement into law sets the scene for sector-based reforms to implement the economy-wide 2030 target and emissions budget, which will seriously impact businesses that are ill-prepared.

Similarly, earlier this year the US Securities and Exchange Commission proposed a rule to increase climate-related disclosure in the real estate sector. If successful, the rule would require publicly listed real estate companies, investment trusts and most large real estate owners to disclose material climate risks, greenhouse gas emissions, emissions reduction targets, and transition plans. The EU, United Kingdom, Japan, New Zealand,  and Hong Kong are all moving ahead with similar measures. This underscores the urgent need for companies to future-proof their portfolios by proactively executing strategies to accommodate future mandates. Failure to do so may lead to unnecessary exposure to penalties, tarnished relationships with governing bodies and forced shifting of resources. Building climate intelligence and capability as a matter of urgency will prepare the sector for inevitably stricter conditions.

Waiting too long to execute real change will only force a scrambled response to future regulation, magnifying the impact on productivity and competitiveness. Companies will need to ensure that they have credible plans to meet climate commitments, have appropriate data and tracking in place, sufficient resource allocation and a clear direction. The luxury of voluntary commitments or commitments that lack the mechanisms in place to execute will soon no longer be available. “Many companies have made public commitments with great intent, with the assumption that they will figure out the details later. For those companies, the ‘later’ is now” says Laura Corb, Senior Partner at McKinsey⁸.

Ultimately, the adoption of data, technology, digitised operations and a productive workflow are the fundamental building blocks for property owners and managers to maintain portfolios that are efficient and sustainable; the resulting cost savings from which can be subsequently invested in electrification and renewables. The key to unlocking the potential of these tools is simple; embrace them now, rather than delaying. Acting with urgency will circumvent the negative impacts associated with inefficient properties, namely poorer financial performance, limited access to green finance, the increasingly burdensome cost of carbon offsets and exposure to regulatory pressures.

 

Footnotes:

  1. Bringing embodied carbon upfront, World Green Building Council
  2. Call for action: Seizing the decarbonization opportunity in construction, McKinsey
  3. The conversation about green real estate is moving on as corporates prioritize sustainability, World Economic Forum
  4. Decarbonizing the Built Environment, JLL
  5. Explainer: Decoding COP27: the many shades of green bonds, World Economic Forum
  6. Firms ignoring climate crisis will go bankrupt, says Mark Carney, The Guardian
  7. Future demand, supply and prices for voluntary carbon credits - Keeping the balance, Trove Research and University College London (UCL)
  8. Understanding the SEC’s proposed climate risk disclosure rule, McKinsey
David Walsh
November 17, 2022
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