Transition-related Climate Risk and its Impact on Commercial Real Estate
Working toward net zero is not elective. Climate change will prove disruptive for property owners and occupiers.
April 19, 2022
Executive SummaryClimate risk is important for everyone. As professionals in an industry responsible for approximately 30%1 of the world’s greenhouse gas emissions, the commercial real estate industry is beginning to come together globally to address the challenges.
CBRE Econometric Advisors (CBRE EA) recently hosted its Client Forum on “Preparing for a Changing Investment Climate.” Two panels of experts shared insights on climate risk, net zero and physical and transition risks related to commercial real estate. In this Viewpoint CBRE EA will share some of our views on transition risk.
Transition risk is business-related risk that follows societal and economic shifts toward a low-carbon and more climate-friendly future. Examples include policy, regulation, technology, or reputation.
Stranding Asset Risk And The Journey To Net ZeroThere is a limit to the amount of carbon that can be emitted globally before 2050 to ensure that global temperature increases do not exceed 1.5 degrees Celsius (or 2.7 degrees Fahrenheit).
To measure carbon risk, real estate professionals have started using the Carbon Risk Real Estate Monitor (CRREM) tool, which originated in Europe and has become more widely adopted worldwide. The tool analyzes greenhouse gas intensity on a per-square-meter basis (convertible to per sq. ft.) annually. The green line in Figure 1 shows a decarbonization pathway that one would need to meet to be aligned with the Paris Agreement2. The pathway varies significantly among property types and countries.
Figure 1: A Theoretical Framework for Transition Risk & Stranded Assets
Sources: CRREM, AEW & CBRE Research 2022
The dotted line in Figure 1 shows a typical property’s current carbon emissions. With the expectation of future improvements, we include a climate and grid correct asset performance, represented by the black line. When the asset performance is above the decarbonization pathway, a property will theoretically be “stranded” and prone to a “brown discount,” or decline in value. In the above figure, by 2038 there will be an asset that no longer meets the carbon reduction intensity pathway and therefore becomes stranded.
Figure 2 shows the reduction in greenhouse gas and carbon intensity that needs to be achieved before 2050 to comply with the Paris Agreement, on which the CRREM tool is based (note: these are equally weighted averages across property types and countries). There are some significant differences among sectors and countries. For example, healthcare and high street are more carbon-intensive than multifamily or industrial warehouses. In France, where the energy grid is powered more heavily by nuclear energy, the required future carbon reduction is much less than in the Netherlands or the United States.
Figure 2: GHG Reduction Pathways by Sector & Country
Sources: CRREM, AEW & CBRE Research 2022
Quantifying Transition Risk
Luckily, technological advances will decrease the high costs over time. Figure 3 shows the intervals at which costs might decline over the next 30 years, and a plotted time curve of costs for energy reductions ranging from 15% to 95%. In the coming years, expect further refinement as more data becomes available with larger usage adoption.
Figure 3: Projected Annual Reduction Rate from the Average Total Project Costs Over Time per Reduction Target (%)
Sources: DEEP, BPIE, CRREM, AEW Research & Strategy
Both property owners and occupiers have power to influence carbon reductions, though property owners have more direct capabilities. Depending on the property’s age and layout, sometimes retrofitting a building is more expensive than tearing it down and starting over, but sometimes simple changes can make a substantial difference. Another consideration is that the process of tearing down an existing building itself releases carbon into the environment.
For reference, to achieve a carbon reduction of 75%, a property owner can expect to pay, on average, approximately $500 per sq. meter, or $46 per sq. ft. However, more environmentally conscious property owners – or those with larger budgets – may choose to retrofit, despite this being more expensive than tearing down a building in most cases.
Another opportunity is to incorporate green leases – a movement in which occupiers agree to share some of the energy use responsibilities and work with property owners to achieve energy reductions. This is a movement that occupiers can help drive. If occupiers are demanding more environmentally conscious spaces and efforts, complying is in property owners’ interests. According to CBRE’s most recent Occupier Sentiment Survey, more than 70% of respondents indicated that reducing greenhouse gas emissions is their top priority.
Who Is Leading The Change Around The World
The Securities and Exchange Commission (SEC) also proposed in March 2022 rule changes that would require registrants to include certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements. The required information about climate-related risks also would include disclosure of a registrant’s greenhouse gas emissions, which have become a commonly used metric to assess a registrant’s exposure to such risks.
Many large U.S. companies are using innovative technology to address climate risk. Between these resources and the relative new vintage of its overall building stock, which are more energy efficient, the U.S. is in a good position to make major progress in the next 30 years.
Canada has committed to achieving net zero by 2050 and has a leaderboard to track its efforts. Canada has been transparent about its efforts, but like others, is struggling with the governance of what net zero means.
A Business Opportunity
1 Sustainable Real Estate Investment – United Nations Environment – Finance Initiative (unepfi.org)
2 The Paris Agreement is a legally binding international treaty on climate change. It was adopted by 196 Parties at COP 21 in Paris, on 12 December 2015 and entered into force on 4 November 2016. Its goal is to limit global warming to well below 2, preferably to 1.5 degrees Celsius, compared to pre-industrial levels.