Investors Need More Data, Better Methodology to Assess Carbon Risk

As the real estate industry focuses increasingly on the mantra of carbon efficiency, owners and occupiers are scrambling to find ways to reduce carbon footprints. The recent Decarbonisation and Resilience Conference, held by ULI at Hong Kong’s Fullerton Hotel, brought together experts across a range of disciplines to discuss the migration to net zero for both new and retrofitted buildings.

Probably the main catalyst for the shift toward greater carbon efficiency has come at the hands of real estate investors. Fund managers—especially in Europe—have been compelled by stakeholders to prioritize carbon efficiency when eyeing potential purchases, or even to veto deals if assets fail to satisfy minimum environmental thresholds.

The emergence of this carbon mandate has in turn resulted in the evolution of various industry frameworks that aim to assess buildings’ environmental credentials. In doing so, they look in particular at two areas: physical risk, which involves assessment of the risk of environmental events like storms or floods, and transition risk, which involves pricing buildings’ carbon emissions in terms of factors such as higher energy costs, stricter building codes, and heightened buyer expectations that make carbon-intensive buildings less appealing to investors, thereby eroding their value.

More Data

According to Jonathan Waite of APG Asset Management, a large pension provider based in the Netherlands, transition risk is currently the company’s major focus. Its goal is to gather energy and other data from all 100,000 of its real estate assets, calculate where each building stands in terms of its trajectory toward net zero, and ultimately apply a discount rate to the asset value based on the extent of excess emissions.

“It’s probably never been easier to get data on a building-by-building basis”, Waite said, “which is a big change from a couple of years ago. But the challenge as always is: how realistic is that figure? One challenge is that you might understand, say, the building’s exposure to a certain climate hazard, but how well it can deal with that, how resilient the local infrastructure is, or whether the government’s plan to respond is included, is another matter. So in some ways, data has been a game changer, but once you get into the detail you then start to need more data.”

The need for more information to create accurate models is underscored by the experiences of insurance companies, who for years have collected vast amounts of data for insurance underwriting purposes. According to AXA’s chief underwriting officer Chelsea Jiang: “using actual loss data to validate models [used] over the last three decades, I can tell you that the modeled losses were probably about three times more than the actual losses incurred. We realized as a result that we needed to look at resilience per building, resilience by district, and even in some places by street—looking at things in a more granular way to be more accurate in our pricing.”

In order to promote the development of consistent methodologies to assess how transitional climate risk affects property valuations, ULI’s C Change program has identified 14 risks associated with transitioning buildings to net zero. Used in conjunction with standardized datasets and analysis tools such as the Carbon Risk Real Estate Monitor (CRREM) pathways, C Change establishes a framework to create a consistent baseline for valuers to use.

The 14 risks identified by C Change include:

• Cost of decarbonizing an asset
• Cost of carbon—either an internal cost or an external policy price
• Energy cost—increases or declines resulting from decarbonization
• Depreciation of high-efficiency equipment installed for decarbonization purposes
• Opportunity cost of missed rental income while tenants vacate as buildings are upgraded
• Rental income change as a result of building upgrades
• Higher exit yields as a result of building upgrades

Embodied and Operational Carbon

Another decarbonization issue discussed at the conference focused on strategies being developed by owners and occupiers to mitigate different types of real estate carbon emissions: outputs either from embodied carbon (ie, those associated with materials and construction processes throughout a building’s lifecycle), or those from operational carbon (ie, emissions resulting from a building’s use).

The significance of the distinction between operational and embodied carbon was underlined by John Haffner, deputy director of sustainability at Hang Lung Properties in Hong Kong. Haffner pointed out that, until recently mitigation efforts were focused mainly on the operational side. Today, however, the emphasis is shifting, due in part to rising public awareness of the vast scale of emissions arising from embodied carbon, as well as the fact that owners have often already harvested the low-hanging fruit of easy upgrades on the operational side.

Demand for data relating to embodied carbon is therefore becoming an important tool for owners and occupiers, although delivering it is not always straightforward. According to Helen Amos, Asia Pacific sustainability consulting lead at JLL: “Data is the driver for delivering change, but that piece around embodied carbon is where we don’t have data yet, and that’s where we need to improve. In Hong Kong, embodied carbon is an average of around 1,000 kilograms (1.1 ton) of CO2 per square meter of built office space—that’s a huge amount when you translate into the whole site of the building.”

Various problems are preventing effective assessment of embodied carbon emissions. First, while available datasets are growing rapidly, the lack of consistency in measuring embodied carbon—both within individual buildings and across the supply chain—remains an issue. In Europe, uniformity of standards has been driven by regulation. A similar approach in Asia would help to both bring home the scale of the problem and allow prioritization of mitigation strategies, Amos said.

Apart from sourcing data, assuring integrity is another problem. This is especially difficult in Hong Kong because almost all inputs used in local construction projects have to be sourced from abroad, where data collection practices can vary significantly, both in methodology and quality.

Nonetheless, ensuring accurate data on embodied carbon is seen as a priority because it represents an effective way to force downstream sources to comply with more stringent carbon efficiency requirements. As Kevin O’Brien, CEO of Gammon Construction said: “People like me can make change happen because I can force it through procurement—if I’m not going to buy from you because you can’t supply me with the data, then you’re going to have to do something about it—if I start going directly to other manufacturers because that way I can be more certain of getting accurate data, then I’ll do just that.”

Construction and Design

Savings in embodied carbon can also be realized at the construction stage. Building design, for example, can be altered to favor a more minimalist approach. As Amos observed: “In Asia, we build so fast that we are often designing the structure of the building while we build the foundations, which means the foundations are designed to be far more robust than needed.” If specifications were calculated more exactly from the start, therefore, significant reductions in concrete use could be achieved.

Beyond that, construction companies are reducing their own operational carbon footprints. The most obvious change is to reduce onsite consumption of diesel fuel. The first 150-ton electric construction crane was imported into Hong Kong recently by Gammon. More are likely to follow as other construction companies follow suit.

In addition, onsite diesel generators have been adapted to become more energy efficient, while concrete performance can also be improved, either by purchasing low-carbon cement (although this can be difficult to source) or by mixing in CO2 as it is poured, thereby transforming building foundations into carbon sinks.

While the price of low-carbon alternates may seem high compared to those of traditional equivalents, the industry is becoming increasingly aware that the value proposition is more nuanced given that higher upfront costs for low-carbon materials are likely to be offset over the long term by “brown discounts” applied by investors to carbon-intensive buildings.

In terms of emissions caused by the building’s operational performance, efficiency is again being driven by external mandates. In particular, multinational companies (MNCs) looking to occupy commercial space often come to the table armed with checklists to assess buildings’ sustainability performance. In doing so, they are motivated partly by the realization that green credentials ensure better employee retention and recruitment and partly by the need to satisfy reporting requirements set out by corporate headquarters.

According to Helen Amos: “We’ve seen in the last year or so a number of MNCs come to us. Some are focused on green certification, but others are more granular: Is there a performance meter in place? Can I access my data? Is there a landlord/tenant partnership I can be part of? And this forces landlords to go to other tenants and say: ‘What are you going to do to meet my target?’ The emergence of the landlord/tenant partnership is very real—in Hong Kong, we’ve seen many of them.”