Climate change costs not factored in risks ‘climate bubble’

Working towards making existing assets greener carries risks – particularly the impact on values while the transformation is underway, says the Urban Land Institute. Paul Strohm reports.

The Urban Land Institute is warning of a ‘carbon bubble’ in European real estate pricing. The institute has urged industry members to work together to preserve values across the sector while efforts to decarbonise buildings in line with the Paris Agreement are underway.

The ULI says that while almost everybody in the industry acknowledges the need to decarbonise the built environment in Europe, the cost of doing nothing, given the lack of regulation driving change, is not factored into property valuations. Current building values are therefore too high, resulting in the ‘carbon bubble’, it said.

If transition risk costs are not factored in by owners now, the industry could face a major crisis. The bubble could burst due to a change in regulation or an economic shock, causing values to fall quickly. ULI said this could happen sooner rather
than later due to the energy crisis, which may significantly affect tenants’ ability to afford rents.

“All buildings have transition risks and we know that some leading market players have started to consider the costs of decarbonisation and started to act on it,” said Lisette van Doorn, chief executive of ULI Europe. “However, we need to bring the wider industry on board, and spread the knowledge to speed up the process and prevent the bubble from bursting.

“We need to get the whole industry moving faster by building a strong case for a collaborative approach to transform existing stock.”

Higher-value assets

Decarbonisation activity at the moment focuses on higher-value assets. These are mainly in higher-value locations, such as prime offices in central business districts and high-end residential, where the cost-to-value ratio of retrofitting is lower.

Without collaboration and transparency on transition risks, there is a danger that a two-tier market will emerge: a strong concentration of retrofitting activity in locations and of assets with higher values; and lower-value assets and locations under threat of decline.

“Our combined goal should be the long-term preservation of values across all our buildings, keeping all of our cities and neighbourhoods investable and liquid,” said van Doorn. “If we don’t act on real estate valuations, our industry’s significant contribution to climate change will continue and we will exacerbate social inequality.”

By sharing information on transition risks, the industry will be able to build up an evidence base to support valuers to understand the impact on building values, and demonstrate some of the benefits to net income that decarbonisation can offer.

Transition Risk Assessment Consultation Guidelines

The institute has published Transition Risk Assessment: Guidelines for Consultation to support this collaborative approach it is recommending. They are part of its C Change programme and were launched at the inaugural ULI C Change Summit.

The guidelines set out a standardised method for assessing the costs of decarbonising buildings and disclosing – between owners, investors, potential buyers and valuers – the main transition risks and impact on values. A common methodology on transition risks can provide valuers with evidence to price transition risk as part of property valuations and assist the development of business cases for decarbonisation across all assets.

The standard disclosure method aims to deflate the carbon bubble in real estate values and prompt action.

“The consultation guidelines help remove transition risks as a point of competitive advantage for the market and instead close the knowledge gap to the benefit of all owners and managers. If everyone is better educated on these risks, we can better achieve the broader goals of decarbonisation,” said van Doorn.

ULI’s vision is for standardised disclosure of transition risks to aid in asset price negotiations and reporting to investors to make the risk visible and stimulate adequate action.

The guidance proposals identify nine transition risks of material impact to real estate assets that can be financially modelled, standardised and communicated. These risks include the cost of decarbonisation, internal resourcing, energy costs, the carbon price, and embodied carbon, as well as the impact of decarbonisation on depreciation, changes in rental income and exit value.

The consultation also includes three standard templates for disclosure and reporting – a manager disclosure sheet, a valuation service provider disclosure sheet, and an investor reporting sheet.

The C Change vision to mobilise the industry

With the industry sharing information on transition risks, it will be able to build an evidence base to support valuers in understanding the impact on building values, and demonstrate some of the benefits to net income that decarbonisation can offer.

The draft consultation guidelines were prepared with the support of the founding partners of the ULI C Change programme. They are Allianz Real Estate, Arup, Catella, Hines, Immobel, Redevco and Schroders Capital. ULI has started a period of consultation.

C Change is a ULI-led programme to mobilise the European real estate industry to decarbonise. It is a movement that empowers everyone to work together for a sustainable future and aims to connect the brightest minds from across the value chain.

The idea is to overcome barriers, share expertise and champion innovation to accelerate solutions that will transform the real estate industry and protect the planet.