Real estate stewardship: how to decarbonise buildings

Real estate can achieve a variety of objectives for long-term diversified portfolios.

It can create growth, protect against inflation, provide a stable income, and, importantly, provide an inversely correlated asset class to traditional asset classes, such as equity and bonds.

However, in the context of net zero, buildings present significant challenges. The buildings sector, which includes energy used for constructing, heating, cooling and lighting homes and businesses, as well as the appliances and equipment installed in them, accounts for over one third of global energy consumption and emissions, according to the International Energy Agency.

To find out more about how large asset owners are working on decarbonising their real estate assets, Net Zero Investor spoke with the Canadian pension giant CPP Investments, the Norges Bank Investment Management (NBIM), which manages Norway’s Government Pension Fund, and APG, which manages Dutch pension fund ABP’s real estate portfolio.

Read more of Net Zero Investor's Stewardship Series here:

Part 1: Best practice in private credit and equity markets with IIGCC's Mahesh Roy

Part 2: Stewardship in short-dated bond markets with Aegon AM's Rory Sandilands

Part 3: Why private markets are well-suited to engagement, with BCI's Jennifer Coulson

Get the right data

Like all areas of the net-zero transition, data is a crucial starting point; but data is often lacking in the historically opaque asset-class of real estate.

“Data is a key challenge,” affirms Thomas Jackson, head of real estate, Europe, at CPP Investments.

A lot of real estate data gaps result from “not having appropriate access to information from tenants / customers,” he explains. To help plug the gap, CCP’s partners and portfolio companies are undertaking “a lot of tenant and customer engagement”.

CPP’s goal is to ensure “a good understanding of what the future state of their buildings looks like and what the cost is to get there.”

The fund’s Abatement Capacity Assessment Framework provide a plan to help its partners “collect data appropriately”.

CPP is also utilising carbon accounting software to track and monitor emissions and energy utilisation across its portfolio. This enables the fund “to build better trend analysis and identify both success stories and areas for improvement”.

Real estate accounts for 8% of CPP’s $640 billion portfolio.

“The energy usage data that we have collected makes it is very clear that our biggest lever for reaching our 2030 targets is increasing energy efficiency,” says Nina Galbiati, who lead’s NBIM’s sustainability efforts in real estate.

Understand the particularities of each sector and building

Asset owners must be sensitive to the different carbon profiles and decarbonisation possibilities of each building, which often vary according to geography, location, and sector.

In colder climates, heating and cooling systems may account for 50% or more of total emissions, while properties in global cities with limited roof space may have limited opportunities for on-site solar generation.

NBIM is currently studying the potential for “geothermal” energy for office and retail buildings in central locations, though not all sites are suitable for drilling.

“The good news is that the technology exists and it is implementable,” says Galbiati. “However, whether it’s retrofitting and refurbishing, installing insulation and on-site renewables, or setting up thermal looping systems, we’re also talking about significant Capex investments. There needs to be a compelling business case to make them.”

Find the business case

NBIM sees growing demand for green, energy efficient buildings, especially among global firms with their own net zero targets, as a compelling business case for decarbonising its $60 billion real-estate portfolio, half of which consists of direct, private investments.

In the ideal situation, the costly Capex of decarbonisation plans not only enhance the value of the asset but also allow the owners to charge a green premium on the rent.

Tenants themselves may be willing to pay more rent not only to satisfy their own net zero ambitions but also to reduce Opex costs associated with buildings with poor energy efficiency.

The introduction of carbon taxes, which is already happening in Europe but has yet to take off in the US, will only fuel this demand. Carbon taxes may penalise tenants for their scope 2 emissions, which covers energy use in buildings.

“We work with our partners to ensure that they are prepared to address decarbonisation and assess it through the lens of value creation,” says CPP’s Jackson. “We now have a number of case study examples of deploying value accretive sustainability strategies, such as the Trafford Centre.”

Owned by CPP, the Trafford Centre is a UK-based supermall for which the fund has identified a potential to reduce scope 1 and scope 2 emissions by over 50% by 2030 via energy efficiency measures.

Optimise interventions

Given the cost and scale of renovation projects, asset owners need to make them as cost-effective as possible.

One route is to incorporate energy efficiency interventions into existing improvement and maintenance plans. In the context of the Trafford Centre, for CCP, this translated as adding changes to lighting systems and replacing and upgrading elevators.

Phased implementation plans that tailor to when tenants move in and out may also be an attractive option, depending on the building type.

NBIM, for example, is currently undergoing “deep energy retrofits” in one of its office buildings in downtown New York. It has tailored its “floor-by-floor” retrofit plan, which includes a complete change of mechanical engineering systems, according to when the tenants are scheduled to move out.

NBIM expects the retrofitting to be complete in 2032.

“It’s rare for us to take back a whole building in one go,” says Galbiati. “That means we have to be smart and adopt a phased approach over several years.”

It’s also important for asset owners to have an “holistic” view of their assets. While they may not be able to do all the retrofitting in one go, if they lack an overall plan, their interventions could miss something vital. Once refurbishments are complete, it’s hard to justify going back and doing them again.

Decarbonise energy sources

Thankfully, falling costs for solar and geothermal have made renewable energy sources an attractive option for decarbonising the building’s energy supply.

They may also provide an extra revenue stream, with the rate of return depending on “whether you are selling to the tenants or to the grid”, Galbiati explains.

Derk Welling, senior portfolio manager for responsible investments and real estate at APG, argues that switching utilities companies is not a viable component of a decarbonisation plan.

“If you sell that asset, the next owner may simply switch back to a dirtier utilities company, which means your net zero efforts will have counted for nothing,” he explains.

Navigate fragmented standards

Navigating regulatory fragmentation presents a massive challenge for real estate investors.

“Sometimes we come across buildings with seven different certificates,” Welling says. “There are actually more than 100 green certifications schemes out there.”

Moreover, different investors from different regions will have different data requests as they look to comply with domestic legislation.

EU-based APG has to ask for EU-taxonomy aligned data even for property managers in Australia, for example.

“We also co-invest with Australian pension funds in Europe, and the Australians have their own legislation,” Welling adds.

It would be helpful if regulators converged around a single disclosure sheet and standardised the metrics, he continues. Even something as simple as “carbon emissions per square metre” depends on whether the number has been calculated using location-based or market-based factors.

Galbiati stresses the importance of greater transparency as a tool not only to increase understanding of emissions profiles of buildings but also unlock the value of decarbonised assets. After all, markets can only price what they can see.

“The demand signals are not always there, and that’s because the plethora of proxies, benchmarks, certifications, etc. make the market a little opaque”, she says.

Put pressure on partners

APG does not directly manage its buildings but delegates its $50 billion real estate portfolio to external property partners.

This means setting clear expectations on the performance of those partners is APG’s most important net-zero lever for decarbonising buildings.

Welling stresses the importance of CRREM, or the Carbon Risk Real Estate Monitor, as a global standard that enables investors to measure the extent to which their real estate assets align with the Paris Agreement and use clear transition pathways for buildings.

“We have agreed with ABP to become 100% CRREM aligned by 2030 and/or have an improvement plan in place to meet those targets,” he adds. “We have also set the same expectations with our partners.”

NBIM’s real estate exposure is split about 50/50 between direct ownership of unlisted assets and listed funds. Galbiati stresses the importance of selecting listed real estate fund managers “whose goals and methods align with their own.”

A question mark on carbon credits

The use of carbon credits to tackle residual emissions in buildings is a thorny issue that divides asset owners.

“We don’t use offsets in our current net-zero strategy for buildings because we’d rather use that budget to invest in improving the buildings,” says Galbiati.

NBIM is making a lot of effort to reduce the emissions of its portfolio by 40% by 2030 (compared to 2019) and, at this point, carbon credits are “simply a distraction”, since a 40% reduction doesn’t actually require net-zero.

She also notes that the off-set market is “still immature” and controversy lingers around the ability for asset owners to distinguish between good quality and bad quality offsets.

“No doubt there will be residual emissions, but offsets are a last resort,” she adds. “First, we want to do as much as we can without them.”

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