The Climate Financial Revolution


Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.

A quiet, financial revolution is going on around us that will have far-reaching effects on the real estate industry and beyond.  It is already causing large changes in investment and management methods, as well as a wholesale review of corporate philosophy and policy throughout entire organizations.  When we look back, we will see that it has forced a substantial reconsideration of real estate investment valuations, modeling, and benchmarking.   

The cause for this revolution is not COVID-19.  It is Financial Disclosure of Climate Risk. 

Climate risk has real consequences for the way companies are run and how assets are valued.  Despite implementing mitigation measures to curb greenhouse gas emissions, the climate is still changing via rising temperatures, sea-level rise, and an increase in frequency and intensity of natural disasters – all of which can impact real estate investment decisions.

An informed and savvy public is also adding pressure, with investors increasingly requesting disclosure of climate-related financial risks that arise as a result of the transition to a low-carbon economy. 

This has real-world impacts on the valuation of assets and capital raising, and it would be prudent for investment priorities to adapt accordingly.

How can investment managers act now?

So, how to get started?  A fundamental first step is identifying the gaps to improve readiness for climate risk reporting.  The Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) recommendations provide a clear methodology for how to approach the identification, assessment, and management of climate-related risk and opportunities, outlining disclosures to better align investment priorities with climate change resilience.  In addition, TCFD reporting is already a requirement for signatories to certain public commitments, such as PRI and the Better Building Partnership’s Climate Change Commitment, providing industry momentum for aligning with the framework.

In short, the recommendations of the TCFD provide means to guide the identification of gaps for proper management and reporting of climate risks and opportunities, in the same way, that other material financial risks are treated within a company.  To implement these recommendations effectively, it is necessary to examine the full range of climate-related risks across the real estate lifecycle – at strategic, acquisition, operational, and disposal points – as well as for major renovations and developments.  This will require climate considerations to be integrated into governance and risk assessment processes and will require ‘buy-in’ from important stakeholders, including members of the investment, risk management, and research teams.

When are you going to start paying off your (carbon) mortgage?   

Net-zero carbon commitments, driven by regulatory requirements and investor pressure, are but one climate risk that will impact investment strategies.  A commitment to net-zero targets may underpin changes to internal processes, which in turn are necessary for meaningful climate risk disclosure to investors. 

For example, a real estate portfolio with net-zero aspirations must necessarily consider the risks of assets being ‘stranded’ due to their inability to meet decarbonization targets.  Similarly, new investments will need to be assessed against net-zero targets before being added to a portfolio.  Failure to meet future regulatory efficiency standards or market expectations may result in stranded assets leading to a less marketable portfolio, reduced tenancy, and lower relative values – requiring costly energy efficiency improvement measures.

The transition to a low-carbon economy will fundamentally change how real estate assets are bought, operated, refurbished, and sold. 

Put simply, much like a mortgage or debt repayment, a portfolio with a net-zero carbon ambition has a fixed end date of 2050 or earlier, in order to align with the goals of the Paris Agreement to limit the global temperature increase to well below 2°C, with ambition towards 1.5°C.  This results in a corresponding number of capital expenditure payments in energy efficiency interventions required to reach a ‘zero carbon payment’ scenario – a series of carbon annuity payments, so to speak. 

Continuing this analogy, choosing to delay energy efficiency or renewable energy capital investments at assets today will simply require larger investments in later years; assets with high outstanding carbon payments in their annuity books will still need to ‘pay off’ their carbon debt within the remaining years.  

This is clearly a large paradigm shift in thinking from business-as-usual.  It may take a few years to reach a point where climate-related considerations are aligned with internal processes and where metrics and targets demonstrate how risk is managed for investors.

And as this area is so cross-cutting for businesses, it is vitally important to ensure that all relevant stakeholders are involved in and support the conversation.  The shift in behavior and processes required will ultimately be achieved through a team effort across all stakeholder groups.  Though climate change brings risks that businesses need to mitigate, it also provides opportunities to innovate and generate new revenue streams and a unique opportunity for holistic integration of climate resilience strategy across the whole corporate spectrum.

This article was written by Ryan Sit, Managing Consultant, and Philippa Gill, Director at EVORA.

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