Investors’ strategic shift to address climate risk .

The 2010-decade records eight of the ten hottest years since we started recording the globe’s temperature. 2020 is no exception as, according to the American organization NOAA, there is a 50 to 75% chance that it will become the hottest year ever and 99% chance that it reaches the top 5. Just a few weeks ago, the Siberian city of Verkhoyansk broke the temperature records in the Arctic Circle with a temperature above 38°C, causing the ice to melt and methane to spread (methane emissions being 20 times more harmful than those of CO₂ according to NASA). The same temperature was recorded in Las Vegas the same day. The physical impact of climate change is a tragic reality that affects all forms of life on earth as well as the global economy. Modelling implemented by scientists and insurers, predicting a temperature increase scenario up to 4°C demonstrate that the world would not be insurable. Blackrock estimates a 275% increase when it comes to risks of natural disasters by 2050 if CO₂ emissions are not reduced. To put things in its context, these events are similar to the three storms Harvey, Maria and Irma, which shook the United States within just two months in 2017 and costed the country $280 billion (equivalent to all annual revenues of the French Government). How is this transforming the world of finance and the real estate industry today?

It is not always obvious to the general public that most of the world’s assets that shape the economy are owned by institutional investors. These are insurers, pension funds, and private equity firms. Public services pension funds in Holland, California, France and New York State all have long-term visions and will always need to meet the basic needs of their citizens. The moment capital owners take measures to manage climate risks, asset managers must comply with their investment criteria and implement strategies that will focus on sustainability and climate risks’ reduction.

How does this revolutionize the way real estate portfolios are managed? How to adapt? What about financial assessments?

In late 2019, 24 of the world’s largest real estate investors signed the climate commitments of the Better Buildings Partnership (counting 35 members worth £240 billion in assets under management). These pledges include the delivery of a strategy aiming to achieve net zero carbon targets (NZC) drafted by each member and attainable by the end of 2020. Construction projects’ carbon footprint and the ‘energy hierarchy’ according to which it will be necessary to reduce, produce and counterbalance will be detailed in it. By 2022, each signatory will publish their climate change adaptation and mitigation strategies. These are the largest property owners in the UK and this initiative is unique in the world, demonstrating the leadership position UK investors are taking to tackle climate change.

Carbon neutrality is a reality that is gradually transforming our sector. In this context, under the leadership of Allianz and the United Nations, the Net Zero Asset Owner Alliance – which targets the carbon neutrality of almost $5,000 billion in assets – was created. Some aim to reach it by 2030, others 2040 or 2050 and meet Governments’ regulations. Today in real estate, this three-headed dynamic comes from partners holding capital, tenants, and State regulations. It no longer is an option for asset managers but a sine qua non condition.

Up until now, environmental and societal responsibility approaches had been implemented through an emotional dynamic. Today, dynamics have completely transitioned to the development strategies responding to anthropogenic global warming based on science. As John Kerry says, I think we all know the effects and consequences of climate change today, and the decision-makers who insist on going against the climate emergency should be held accountable. Faced with undeniable physical and scientific evidence and witnessing a strategic shift, the entire industry must now mobilize to change its approach. Today, we are much more called upon by investors to implement their ESG strategy through a well-defined methodology than a few years ago. The development and implementation of ESG strategies are now an integral part of asset managers’ fiduciary duties. This requires identifying material corporate risks which almost always include carbon reduction and social welfare.

At Longevity, we help asset managers set up short and long-term carbon neutrality action plans and provide them with tools to measure the social value of their investments or operations (not necessarily quantifiable in monetary terms as we use other types of performance indicators). Today, not having a CSR strategy is risky. It is the same as having a high-performing car without a navigation system. Some pension funds such as APG in Holland have set up an investment committee within which the CSR Manager has a veto right. Consequently, considering climate issues when engaging in fundraising activities represents fantastic opportunities. I would even say that you have to be crazy today not to consider the opportunity the new economy represents.

Until now, the RICS had remained relatively discreet when it came to including sustainability in property valuation processes. Just a year ago, valuation firms did not take into account the added value that comes with the reduction of CO₂ emissions and the implementation of future-proofing strategies. However, from January 31, 2020, the RICS introduced a fundamental change in valuations: experts are now obliged to take sustainability into account in the property valuation process. This means that non-certified assets or assets that cannot demonstrate an adequate performance and climate risk management could be subject to a drop in value, also called brown discount.

Equally, it is known that revenues linked to the generation of renewable energies are assessed using a capitalization rate between 5 and 7%. We also know the reduction of service charge budgets contributes to tenant retention and, as a result, to an increase in asset value. The opportunity is real. To retain and optimize the intrinsic value of assets, one should also implement a digital technical data management system to benchmark data using certification systems as an asset management tool, and to have a reliable extra financial performance reporting system.

Without granular knowledge, it is impossible to deliver systemic change. With this comes the implementation of carbon neutrality trajectory and physical risk management plans as well as the implementation of long-term objectives to integrate innovation into the lifecycle of each investment. Such approach must be implemented from the get-go during the acquisition process through sustainability due diligence reports (DDD). With a clear program in place, it is possible to have a positive impact on portfolios, which in turn ensures compliance with the European Taxonomy that has been agreed on in December 2019 by EU Member States.

More than ever, the real estate sector is going through a dynamic era of change, an era full of opportunities to contribute to the transition to a more responsible and inclusive economy by ensuring the property asset investments are responsible for the years to come.