The impending carbon bubble poses substantial risks to the real estate market, with asset stranding and devaluation emerging as pivotal concerns. Strategic retrofitting, green building practices, and robust investment strategies are crucial to navigate the transition risks and protect the financial health and sustainability of asset manager companies.
In a world progressively converging towards Net Zero emissions by 2050, the real estate sector, a pivotal player in global economies and a significant contributor to greenhouse gas emissions, is teetering on the brink of a potent carbon bubble, underpinned by obfuscation, transition risks, and imminent decarbonisation mandates1,3. This means that actors in the real estate market, notably investment and asset manager companies, might need to navigate through some tumultuous waters.
The Carbon Bubble
Unveiling Hidden Perils
The carbon bubble entails an overinflation of real estate market value, driven by the lack of acknowledgement and incorporation of climate risk and transition cost into asset valuations and investment strategy. As much as 80% of anticipated building stock for 2050 already exists, posing a serious challenge to achieve Net zero Emissions by 2050 and underscoring the pervasive risk of assets becoming stranded2,3.
What is a stranded asset?
Asset stranding occurs when assets (such as buildings or infrastructure) unexpectedly and prematurely lose value, often due to shifts in regulatory, environmental, or market conditions. In the context of real estate and a carbon bubble, assets may become stranded due to new environmental policies, advancements in green building technologies, or evolving investor and tenant expectations towards sustainability.
This depreciation or total loss in asset value can significantly impact the investment and financial health of asset manager companies and individual investors alike, necessitating strategic planning to mitigate potential risks and losses. The early obsolescence of stranded buildings not only costs companies and individuals money, but detracts from the true value of the building itself by reducing its lifecycle. All of the precious materials and embodied carbon emissions that have gone into the buildings go to waste, quite literally, if the building is demolished to make way for another. Thus, understanding and mitigating the risks of asset stranding, particularly in the realm of the real estate market, becomes imperative to sustainably navigate through evolving climate risk and decarbonisation pathways.
The real estate market has yet to fully understand either the costs of indispensable property retrofits or the financial consequences of delaying or foregoing action. Yet, this oversight is not exclusively deliberate neglect but is obfuscated by a scarcity of market standards, data collection systems, and benchmarks that enable valuers to comprehensively factor Environmental, Social, and Governance (ESG) risks into property valuations3.
Ilona Otoka of Cushman & Wakefield underlines this dilemma, explaining that whilst investment funds are increasingly utilising climate risk assessment tools, such as CRREM (Carbon Risk Real Estate Monitor), valuers remain hampered by insufficient market data to accurately incorporate ESG transition risks in real estate values. This scenario perpetuates a dangerous cycle, where property values remain artificially inflated, causing the carbon bubble and sending warnings of a "wave of stranded assets"3.
Investment Strategies and the Stranded Asset Phenomenon
Informed investment companies are gradually beginning to appreciate the merit of proactive climate risk management, particularly through employing tools to gauge which assets in their portfolios are most likely to be stranded in terms of environmental impact and loss of value over time3.
However, deadlines are looming, with global GRESB participants (including all regions and sectors) projecting the average year of stranding to be 2024 and the European benchmark region faring only slightly better, reporting a projected stranding date of 20265. These figures suggest that current action is insufficient to meet Net Zero commitments set out for 2050. Therefore, we need to substantially accelerate transition efforts and embed robust decarbonisation strategies into the investment (and building) life cycle.
Green Buildings and Retrofit Projects
Investment in green building and comprehensive retrofit initiatives of existing building stocks not only enhances their long-term viability but also mitigates the risk of obsolescence and stranding. Innovative green building design and green building materials are pivotal in navigating the pathway toward Net Zero buildings and ensuring compatibility with a low-carbon economy.
The urgency for retrofit projects is also fuelled by changing work patterns, increasing occupier requirements, economic flux, and rising legislative mandates around sustainability standards, particularly in the context of achieving 2030 and 2050 targets3.
Decisive Actions for Asset Manager Companies
Asset manager companies must take a proactive stance by leveraging insights from climate risk assessment and carbon assessment tools to formulate investment and retrofit strategies that acknowledge the palpable transition risk and potential real estate market correction.
Carbon Management Plans
Comprehensive Carbon Management Plans will be at the core of understanding and incorporating transition risks, with the challenge for investors being the identification of affected assets and determining how to respond. Life cycle assessments (LCAs) and whole life carbon assessments (WLCAs) used for calculating and reporting greenhouse gas emissions for buildings and construction projects will be critical for investors to be able to quantify, compare, improve and track the environmental performance of their real estate assets on their journeys to Net Zero portfolios.
Aligning investment property strategies with Net Zero commitments and incorporating comprehensive decarbonisation and climate risk frameworks is not merely a pragmatic endeavour but a ethical one, simultaneously securing long-term asset value, mitigating the perils of the impending carbon bubble, and ensuring that the valuable materials used and embodied carbon emissions spent on existing buildings do not go to waste.
Resources
3. Carbon bubble to be a serious threat to the property market (Property Forum)
5. 2022 GRESB results and CRREM pathways: a call to action (GRESB)
