Creating climate risk metrics for real estate markets

The building and construction sector produced 39 percent of energy and process-related carbon emissions globally in 2017¹  .It is also directly exposed to adverse climate events such as storms, flash floods, and extreme heat and cold, which are now expected to happen more frequently and with greater intensity.

Governments are already responding by placing design and performance requirements on buildings to lower emissions and improve their resilience against extreme weather. Nineteen cities, including London, Paris, and New York, have signed the Net Zero Buildings Declaration, committing them to introduce policies ensuring all buildings use energy ‘ultra- efficiently and are supplied by renewables by 2050. Paris aims to halve energy consumption in buildings by 2050, while New York will require owners of large buildings to reduce their carbon footprint by at least 40 percent by 2030, and 80 percent by 2050.

Green ratings and benchmarks in real estate markets have been slow to adapt to the rapidly changing regulatory environment. A recent INREV Climate Risk roundtable concluded that existing green building certifications and energy ratings fail to address climate risks adequately. Schemes such as LEED, BREEAM, HQE and DGNB certify buildings’ technical credentials and have led to moderate improvements in environmental performance over time – but their backward-looking nature means that they say little about a building’s potential to mitigate future climate risks, something which would also make them more relevant to long-term real estate investors. The energy-efficiency improvements demanded by certification schemes are not ambitious enough to adequately prepare the market for a regulatory environment driven by the goal of keeping global warming to ‘well below 2°C’, the goal endorsed by all parties to the Paris agreement and many global gateway cities.

Nineteen cities, including London, Paris and New York have signed the Net Zero Buildings Declaration 

Green building certifications therefore need updating so that they assess building resilience to carbon constraints and extreme weather events in a standardised way. This gap is hampering the efficient pricing of real estate. Currently, investors, companies or job-seekers cannot tell whether buildings are managed in line with a 2°C scenario, if they only have information derived from a green building certification scheme. The energy efficiency improvements required by green certification are unlikely to match the deep energy and carbon cuts needed to meet the Paris agreement targets. The Carbon Risk Real Estate Monitor (CRREM), an EU-funded project supported by INREV and backed by a consortium of academics and investors, found that emissions from commercial stock would need to fall by 78 percent over the next 30 years to align with a 2°C pathway.

But there are some positive signs. Those running green certification schemes have started to consider how they could be changed to reflect climate risk better. Meanwhile, new concepts such as a ‘net zero carbon’ building are providing a context for defining performance benchmarks and energy use pathways that are consistent with a 2°C target. In line with this, the World Green Building Council (WGBC) has defined it as a ‘highly energy efficient building that is fully powered from on-site and/or off-site renewable energy sources and offsets’. Separately, the French and Dutch GBCs have specified a target metric for office energy use consistent with net zero carbon of 50 kWh/m2 per year. The German Sustainable Building Council (DGNB) is considering adding targets for ‘carbon-neutral operations and construction’ in its certification methodology to align with government policy and the ambitions of the Paris agreement. The US GBC is now issuing a LEED Zero Energy certificate for buildings that only consume energy from renewable sources, either onsite or through offsets. And the CRREM project is developing decarbonisation pathways for different property markets and types that will allow real estate investors and managers to stress-test their assets against climate scenarios, including a scenario in which governments set carbon regulations in real estate markets that are sufficiently stringent to achieve the ambitious goals of the Paris agreement.

The Carbon Risk Real Estate Monitor (CRREM) found that emissions from commercial stock would need to fall by 78 percent over the next 30 years to align with a 2°C pathway

While laudable, these efforts will not be helpful to investors unless they lead to greater harmonisation. Capital markets work more efficiently if standards and metrics are similar across markets. In September, at an INREV joint-hosted conference in Brussels of non-listed market participants and the European Commission, a panel of investors and valuers united in calling for the EU’s sustainable finance action plan to help harmonise energy and carbon ratings for real estate across EU member states, and beyond. Currently, energy performance certificates for buildings in different EU member states are not based on the same methodology, and in some cases, are not even designed to rate energy performance. While there are often good reasons for the range of locally-defined certification schemes and energy ratings that currently exist, this invariably hinders their use among investors with international portfolios.

INREV is promoting such harmonisation through the work of its ESG committee and by communicating with members, engaging with other industry bodies and collaborating with ESG focused organisations such as Global Real Estate Sustainability Benchmark (GRESB). But the certification bodies themselves have an even more important role to play in developing the next generation of sustainability metrics and benchmarks in real estate markets. This will mean wide-ranging collaboration with each other and with their stakeholders.

This article was contributed by Derk Welling, member of the INREV ESG Committee

1 Source: WBGBC Gobal status report 2018, p11.