Winter Issue 2022 - 90

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KEVIN FAGAN
Capital Flows
5 takeaways from COP26 for real estate.
The 26th meeting of the Conference of the
Parties (COP26) in Glasgow last November
reinforced commercial real estate (CRE) as
a major mechanism to achieve the global
goal of net zero emissions by 2050. Pledges
of $130 trillion among financial institutions
to support the initiatives delivered serious
scale to the efforts.
The next decade will be a critical period
of change, with ongoing uncertainty amid
big evolution in technology, data, and laws.
Many CRE market players will shift their
strategies, affecting capital flows into and
out of the asset class. COP26 is European-
centric at present, but it offers hints of what
is next for the United States.
In a CRE-focused session, noted CRE
professionals from the United Kingdom and
European Union shared their perspectives
on achieving COP26 decarbonization goals
and demonstrated that they were further
along than the United States in many ways.
Although some of the Old World's playbook
will not directly transfer to the New World,
the challenges (and lessons) are similar.
The following key themes relevant to CRE
capital markets materialized:
1. Approaching critical mass: Net zero planning
in CRE is becoming more of the norm
than an exception. The United Kingdom's
Better Building Partnership (BBP) hosted
the COP26's CRE session. The BBP has
experienced growth to 44 member firms
(with 11,000 properties worth about £270
billion), all committed to achieving net
zero across their portfolios. Coincidently,
green bond issuance hit $1 trillion in 2021,
rising in lockstep with corporate adoption
of reporting standards like the Task Force
on Climate-Related Financial Disclosures
and the emissions laws like the aggressive
" Fit for 55 " regulations of the Energy Performance
of Buildings Directive (EPBD).
Impact: Eventually, access to capital will
likely require sustainability plans attached
to property portfolios to satisfy lenders and
investors. Nonsustainable buildings will
also face rising expenses and impaired
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marketability, and vice versa for highly sustainable
buildings. Many unknowns have
prevented the CRE valuation community
from fully pricing in climate or transition
risk, but efforts to quantify the cost of
" net-zero-carbon audits " have begun. As
buyer concern and regulation reach " critical
mass, " valuations and bids will adjust. For
example, in the United States, the imminent
cost of adhering to the Climate Law Mobilization
Act and Local Law 97 in New York
City will need to be considered seriously
by investors and lenders. Similar laws and
energy benchmarks are percolating across
other U.S. cities.
2. More (good) data needed: The most
common theme was the need for detailed
energy usage data. Having a strong, flexible
data infrastructure to be able to adapt
to unknowns over the next 10 to 40 years,
either from an energy usage or regulatory
standpoint, will be key. Having rich,
relevant data is the start of every net zero
framework, such as the World Economic
Forum's Action Plan for Net Zero Carbon
Buildings.
Impact: Proptech investment-already
skyrocketing in the United States-will likely
accelerate, focused on energy and building
management systems, the " internet
of things, " and smart sensors that guide
where improvement may be needed. Also,
certain data elements will be required for
investor and lender reports for climate disclosures
and risk assessments.
3. Targeted retrofits will flourish: To highlight
the importance of effective retrofitting,
it was estimated that " 80 percent
of buildings in 2050 exist today. " Current
retrofits focus on the roughly 65 percent of
energy consumption that stems from heating
and cooling, lighting, and appliances.
High-impact retrofits start with insulation
upgrades, on-site renewable energy, and
encouraging hybrid work to reduce usage.
Impact: Most new capital will flow to
funding retrofits. One organization estimated
the investment in green retrofitting
will approach $25 trillion globally. The
Urban Green Council estimates that retrofit
costs for New York City buildings, given
new emissions limits, will be in the order of
$1.50 to $18 per square foot ($16 to $194
per sq meter), given a wide range of needs.
C-PACE financing provides a tested model
that others may follow, though it presents
hurdles for some first-mortgage lenders. A
first for C-PACE in New York, $89 million of
financing was closed this past summer for
efficiency upgrades for 111 Wall St.
4. Consistent, transmissible reporting: The
ability to correctly and consistently
measure greenhouse gases (GHGs) stemming
from properties, along with a compatible
carbon trading system, will be crucial.
The G-20 nations were admonished to
help standardize carbon trading systems
worldwide, rather than the 60 or so systems
used at present. Common standards and
nomenclature are critical for both efficiency
and equity concerns. As stated on one
panel, " You cannot reduce what you can't
measure, and you cannot finance what you
don't know the cost of. "
Impact: Acquisition due diligence will
increasingly consider energy usage, retrofit,
and, in some cases, carbon trade costs.
Certain building types in certain locations
will fail to meet net zero standards, and
some system of high-integrity carbon offsetting
will be required, with cost transparency
for CRE capital markets. Firms that offer
high-quality retrofit assessments will be in
high demand.
5. Net zero takes a village: All participants
will be affected across the CRE value chain.
Therefore, all should carry risks (costs) and
rewards, and share information and responsibility.
Impact:
Who pays for these costs-
owners, tenants, the private sector, or the
government? European owners trying to
recoup their refurbishment costs directly
from tenants have faced leases with established
provisions for sharing needed repair
and capital expenditure (capex) costs-but
not for government-mandated or voluntarily
adopted sustainability improvements. U.S.
landlords will face similar challenges, but
often the benefits may be recouped at the
top line with stickier tenants and higher
rents. UL
KEVIN FAGAN is senior director and head of commercial
real estate analytics for Moody's Analytics.
Winter Issue 2022

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