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Build a business case for net zero real estate portfolios: 5 key considerations

By Oliver Light
16th June 2021

What’s the business case?

Before we get into it I should set the scene of why net zero, why now?

Given Real estate investors representing over £300 billion of AUM have signed up to net zero commitments; the demand from investors, tenants and of course, the UK government is increasing.

We’ve been helping real estate investors tackle this massive area, and the first thing they ask us is to help prepare a business case and gain buy-in for net-zero. If you start investing now, you can immediately benefit from energy savings and reduced maintenance and plant life cycle costs. In the medium term, this can improve your attractiveness of the building to premium tenants, which can reduce voids and attract higher rents. In the long-term, this can improve Net Operating Income, increase the building’s capital value, drive greater investor demand and IRR. Aviva Investors and other organisations also offer cheaper debt, including a margin reduction of up to ten basis points to CLS, subject to hitting green financing KPIs.

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Conversely, even if you do not invest now, you could end up spending more in CAPEX/ OPEX, as you resolve risks associated with building obsolescence, such as increasing legislation, rising energy costs, and offset costs. A failure to decarbonise will increase discount rates and exit yields at the point of sale.

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To define net-zero, we need to consider your whole life carbon which includes the use of materials and the process in construction, which allows us to calculate embodied carbon. As well as minimising ongoing energy expenditure by 70% to access a constrained supply of renewable energy in the years ahead.

So, here are the 5 key considerations to help you build the business case:

 

1. Understand why we need to do this now

The pace of change of climate-related regulations has accelerated and we’re not expecting the pace to slow anytime soon.

These risks are also very dynamic as the UK’s legislative framework for the transition to net zero is not yet in place. This means that the policies our buildings are working within are shifting very quickly. What an EPC is today will change. Part L is not net zero aligned. Even high performance on BREEAM ratings will not produce buildings which meet compliance requirements for net zero. In Australia they have already released an energy rating scheme called NABERS and linked improved capital value to a stronger rating and the UK is proposing their own framework.

Greater transparency  from incoming regulation such as the EU SFDR & TCFD will help investors identify the best performers in the market and drive a more significant brown penalty. Building owners are asked to disclose whether their building is a ‘nearly zero-energy building’? Or what is ‘the primary energy demand’?

This means that whilst we want to help build a business case, this is not an area property investors and developers will have choice over.

 

2. Tenant demand for net zero buildings

Occupiers now want to know how their space is performing and what the building owner’s net zero strategy is, resulting in a greater need for transparency, especially over energy use.

Meeting future tenant requirements will support longer leases, lower vacancy rates, and make the asset more attractive to premium tenants. According to JLL, offices with high sustainability credentials in Central London have been found to benefit from rental premiums of 6-11% ²

Building owners are real estate specialists; tenants are not. You will need to work together to help tenants with decarbonisation projects that future proof the asset. The real estate investor may wish to forward fund projects, which can support successful lease discussions and de-risk voids.

 

3. Data and governance structure for accountability

Implementing Net zero portfolios will require you to determine accountability from the corporate, to the portfolio, to the asset level. This accountability structure needs to be underpinned by data.

At the corporate level, we ensure clear direction around what needs to happen to achieve ESG targets. Data is fed up to the senior leadership team to help determine performance versus any target. Information is fed to investors to improve marketability and access to other opportunities such as green loans.

At the portfolio level, the fund and asset managers will work with the property managers to deliver a bespoke strategy to the fund type, such as differentiating between a retail fund or a long-income fund.

At the asset level, the best way to establish accountability of decarbonising the buildings is to provide data back to the tenants and the building management teams.

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We collect ESG data across 45,000 buildings in 60 countries using our data platform. All of this information should be fed back to the corporate level to measure success.

 

4. Performance management at portfolio as well as asset level

So why not offset your way out of this? There will be a finite amount of offsets available, even if you spend millions now, eventually the cost per annum of offsets will outweigh the cost to decarbonise, meaning all the money spent on offsets is wasted and potential energy saving opportunities missed. Our first tip when it comes to net-zero is to start developing a pathway now.

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For example we are developing a net-zero pathway for one of our clients with over £5 bn of assets under management and we’ve forecasted £15 million of energy avoided costs by 2030.

The programme will initially focus on quick wins through occupier engagement and our smart building programme. The smart building programme has saved another client, Aviva Investors, over £2 million avoided cost savings to date.

We will seek to track leasing events to help structure when we implement asset level improvements and track the impact of those improvements on rent and the assets marketability. To de-risk the acquisition and development process, investors include net-zero criteria from the outset to rule out investments that could be too cost-prohibitive to decarbonise.

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5. Refine your ambition

And finally, you will need to agree on an overall direction.

When refining your ambition, you will need to answer several questions – how quickly do you wish to achieve net-zero? How steep do you want your decarbonisation trajectory to be? How much do you wish to invest? How prepared are you to divest from certain assets types?

Not all organisations will want to be ambitious. Some will want to keep up with the market, so it’s about laying out your objectives from the start. With our clients we define whether they want to be ambitious, leading, or reactive. Typically our clients want an ambitious pathway, this gives more room for manoeuvre in the future.

 

So to recap.

Our biggest tip is to start your net-zero journey now by building your business case and looking at the whole life carbon of your portfolios. Even if you decide not to, we believe regulation and the rising costs of carbon will mean that you will not have a choice regardless. Starting now also means you can agree a long-term business plan that reduces stranded asset risk to your portfolio. To achieve this: Define your approach, develop a governance and data process, engage with your occupiers, and review your long-term CAPEX/ OPEX plan.

 

Watch our on-demand webinar with Property Week ‘Next steps to net zero carbon: How to transform your portfolios’ click here. 

Contact Us

If you would like to understand more about how we’re supporting our clients to set and achieve credible net zero goals then please email me.

Download | Net Zero: The Guide for Commercial Real Estate