October 13, 2022
The Urban Land Institute (ULI) has warned of a ‘carbon bubble’ in the pricing of European real estate and urged the industry to work together to preserve values across the sector as it aims to meet the decarbonisation targets set in the Paris Agreement. To support a more collaborative approach, at the inaugural ULI C Change Summit, the institute has published its Transition Risk Assessment Consultation Guidelines as part of its C Change programme. These guidelines set out a standardised method for assessing the costs of decarbonising buildings and disclosing between owners, investors, potential buyers, and valuers the main transition risks and impact on values.
ULI believes that the cost of doing nothing, given the current lack of regulation driving change, is currently not factored into property valuations, which means current building values are too high, resulting in the carbon bubble. If transition risk costs are not factored in now by owners, then the industry could face a major crisis on achieving decarbonisation if the bubble bursts due to a change in regulation or an economic shock, causing values to fall quickly. And this may happen rather sooner than later, given the current energy crisis, which may significantly impact rent affordability by tenants.
ULI Europe CEO, Lisette van Doorn, says, “All buildings have transition risks and we know that some leading market players have started to consider the costs of decarbonisation and started to act on it. However, we need to bring the wider industry on board, and spread the knowledge to speed up the process and prevent the bubble from bursting. We need to get the whole industry moving faster by building a strong case for a collaborative approach to transform existing stock.”
ULI’s supporting analysis suggests that the current approach by owners means that decarbonisation activity is focused on higher-value assets, predominantly in higher-value locations, e.g. prime offices in CBDs and high-end residential, where the cost-to-value ratio of retrofitting is lower. Without collaboration and transparency on transition risks, there is the danger of a two-tier market with a strong concentration of retrofitting activity in locations and of assets with higher values, while lower-value assets and locations are at threat of decline.
“Our combined goal should be the long-term preservation of values across all our buildings, keeping all of our cities and neighbourhoods investible and liquid. If we don’t act on real estate valuations, our industry’s significant contribution to climate change will continue and we will exacerbate social inequality.”
“The consultation guidelines help remove transition risks as a point of competitive advantage for the market and instead close the knowledge gap to the benefit of all owners and managers. If everyone is better educated on these risks, we can better achieve the broader goals of decarbonisation.”
ULI’s vision is for standardised disclosure of transition risks to aid in asset price negotiations and reporting to investors to make the risk visible and stimulate adequate action. The proposed guidance identifies nine transition risks of material impact to real estate assets that can be financially modelled, standardised and communicated. Those risks include the cost of decarbonisation, internal resourcing, energy costs, the carbon price, and embodied carbon, as well as the impact of decarbonisation on depreciation, changes in rental income and exit value.
The consultation also includes three standard templates for disclosure and reporting – a manager disclosure sheet, a valuation service provider disclosure sheet and an investor reporting sheet.
With the industry sharing information on transition risks, it will be able to build up an evidence base to support valuers to understand the impact on building values, and demonstrate some of the benefits to net income that decarbonisation can offer.
The draft consultation guidelines were prepared with the support of the founding partners of the ULI C Change programme, Allianz Real Estate, Arup, Catella, Hines, Immobel, Redevco and Schroders Capital, together with technical support from ULI Europe’s membership including more than 50 one-to-one interviews and a series of consultation workshops with around 100 experts.
ULI will now begin a period of consultation over the coming months and will be engaging with the industry individually, across companies and in specialist groups. More details will be published on the ULI C Change webpage.