Fundamentals: Building Paris every week

The numbers are piling up in favour of retrofitting as the answer to slashing the property world’s huge carbon bill without driving costs through the roof. In our latest Fundamentals episode, real estate analyst Cian O’Sullivan discusses the latest state of tech and financial thinking on greening the sector’s planned huge expansion over the next two decades.

How big a project is it to reduce the carbon footprint of the real estate sector? 

It’s the biggest asset class on earth and it's getting bigger. About 40 per cent of global greenhouse gas emissions are attributed to the built environment. So, it's pretty clear that if we continue with a business-as-usual approach to the development and operation of real estate, we're going to exacerbate the climate crisis and make the financial risks that face the whole sector considerably worse. 

In Europe, 80 per cent of the buildings that will exist in 2050 have already been built, and 95 per cent of the buildings around us are still going to be in use in 2050. So really the challenge is to retrofit and refurbish the stock that we have to get to net zero by 2050.

The good news is that we largely have the technology we need to make that transition, unlike some sectors like agriculture or aviation, where the technology isn't quite there yet. 

We're not waiting for a tech breakthrough.

Exactly. I mean, there will be more to come, but largely I would say we have the tools we need to make the transition. We just need the capital to unlock it. 

So why fix up an old building rather than just knock it down and start again? 

I think the simplest answer to that question is that a lot of what we already have is fit for purpose. The building just needs some improvement to make it more operationally efficient: if we were to start from scratch, it would be a bit of a waste.

Almost one-third of real estate’s carbon emissions are from what we call embodied carbon. That’s the carbon that gets emitted from building materials in the construction and development phase of things like concrete, glass and steel. 

They’re really high carbon materials. 

Exactly. And there's not a lot you can do about it once you've got the building completed. So really, I think the challenge is to make the best use of what we've got. Those resources are valuable! And the built environment is still growing, so we will need them to afford the new spaces we need to accommodate the approximately 7 billion people that will live in urban areas by 2050. 

That’s a big jump

Really, we’re looking at adding a floor plate the size of Paris every single week.  

It’s about 75 per cent growth from what we have today. 

So, what sort of changes are we talking about when we're talking about retrofitting? 

The headline ones would be things like removing gas from buildings, converting to alternative sources of heat like heat pumps, and installing more onsite generation of power technology through solar panels. Insulation is the big one of course. 

But aren’t those costs prohibitive?

So, I admit it costs more money to build green buildings or to refurbish buildings into highly sustainable real estate, because if you want to put panels on the roof or use a heat pump, that technology is going to cost. But that's only one part of the equation. If you look at the future cash flows from that building once it's completed - so rent in the case of landlords like us - occupiers are willing to pay more for green buildings for a number of reasons. You’ve got a more insulated building, so it's cheaper to use.

But occupiers are also companies that are setting net zero carbon targets themselves, and given their offices or warehouses often are a large proportion of their overall carbon footprint, it makes sense for them to be in the greenest real estate they can. 

So, they may pay more in rent?

Right. Plus, if you look at the financing side of the equation, green lenders are willing to give cheaper rates on debt if there are certain sustainability criteria that that can be achieved along the way. It reduces the transition risks, so you're de-risking the asset and having a cheaper cost of debt has a positive impact on your end returns. 

Then finally, when it comes to selling on a building, we know that many investors now are willing to pay more for sustainable real estate. They recognise the value of having future proofed assets.

It just doesn't make sense to be buying a portfolio of brown buildings unless you've got a plan on how you're going to decarbonise them. 

And the regulatory environment is also changing

Yeah. I think, in our sphere of real estate, which is mostly commercial real estate, there are some great opportunities to make this transition profitably, but there are also certain pockets of the market where there is the risk that people are going to see stranded assets. I think public policy measures, both carrot and stick, will be required to help push along the transition of those more difficult-to-rectify assets. Minimum energy efficiency standards in the UK and Netherlands, which will prohibit landlords from leasing inefficient buildings by the end of this decade, or the recent support for heat pump technology in the Inflation Reduction Act in the US, are both good examples.