Decoding Stranded Assets - A choice for sustainable Real Estate investment

Written by Craig Needham
24 Jan 2024
Real Estate Decarbonisation

In a rapidly evolving landscape, Investment Managers and Asset Owners find themselves at a crossroads – when is an asset no longer an asset?

The decision-making process involves critical choices: invest in decarbonisation, run the risk of refinance challenges, or strategically divest to reduce overall carbon emissions.

Understanding Stranded Assets in the CRREM Framework

The Carbon Risk Real Estate Monitor (CRREM) stands as a beacon for the real estate industry, offering transparent and science-based decarbonisation pathways. Aligned with the Paris Climate Goals, these pathways not only limit the global temperature rise to 2°C, but also exhibit ambition towards the more stringent target of 1.5°C.

At the heart of CRREM lies the ability to provide industry stakeholders with a unique vantage point. It enables them to estimate carbon and stranding risks associated with premature obsolescence and potential write-downs. These risks are not abstract concepts, but are deeply entwined with changing market expectations and evolving legal regulations. CRREM encapsulates these challenges within the framework of 'transition risks.'

Understanding these pathways becomes paramount for Investment Managers and Asset Owners, when seeking to navigate the intricate landscape of sustainable real estate investment. By leveraging CRREM, they gain insights into the very essence of transition risks, equipping them to make informed decisions in the face of potential asset stranding.

The Dilemma - To invest or not?

In the realm of Climate Transition Risk, Investment Managers and Asset Owners find themselves at a key decision point, weighing up the major considerations associated with decarbonisation. For many in the industry, a stark reality is emerging as they grapple with the financial implications of this critical objective.

Decarbonisation, if done incorrectly, can be an hugely capital-intensive, with average estimates indicating a significant cost of £125 per square foot to decarbonise commercial real estate.

In recent industry discussions, the widespread acknowledgment of Climate Transition Risk has been emphasised. We’ve seen that 89% of Investment Managers and Asset Owners are actively factoring in asset transition risks within their decision-making processes, regarding investment, divestment, and disposal (C Change Summit – ULI Europe Group).

This clear focus on risk highlights the importance of the decision making process, with Managers are Owners facing the delicate balance of addressing Climate Transition Risk while navigating the financial intricacies of decarbonisation. The careful consideration of these factors becomes paramount in charting a course that not only aligns with sustainability goals, but also ensures prudent financial stewardship.

Navigating Refinancing Risks

In the CRREM framework, stranded assets are described as "properties that will not meet future energy efficiency standards and market expectations and might be increasingly exposed to the risk of early economic obsolescence." For those who aren’t yet convinced by the need to prioritise decarbonisation, this definition presents an interesting challenge.

Choosing not to invest in decarbonisation exposes assets to risks beyond mere environmental considerations. The attractiveness of the asset to potential tenants, often referred to as its "kerb appeal," becomes a pivotal factor. Should the asset fall short of achieving a minimum Energy Performance Certificate (EPC) rating of Grade B by 2030, it faces a substantial setback – the inability to secure leases.

A failure to meet energy efficiency standards not only diminishes the asset's market appeal, but also jeopardises its valuation. This scenario presents a myriad of challenges for refinancing. A reduced valuation could lead to insufficient equity, inflated debt costs to cover future risks, or, in the worst-case scenario, an inability to secure financing altogether.

In essence, the decision not to invest in decarbonisation not only risks the asset's environmental sustainability, but also poses tangible financial threats, making prudent risk management a crucial aspect of the decision-making process.

Strategic Divestment for Carbon Reduction

When striving for decarbonisation in Commercial Real Estate, success is often measured by the reduction in Energy and Carbon intensity across the gross internal area of the asset. Investment Managers and Asset Owners, recognising the imperative of sustainability, may find themselves at a crossroads when faced with assets that prove to be excessively carbon-intensive.

In such scenarios, where the cost of capital becomes a burdensome factor, strategic divestment or disposal of the asset becomes a viable option. The decision to divest is not merely a financial manoeuvre, but a strategic realignment of capital to ensure the most efficient use within the portfolio.

Divesting from a carbon-intensive asset allows for a strategic reshape, aligning the portfolio with sustainability goals and ensuring an optimal deployment of capital resources. This proactive approach not only mitigates the risks associated with stranded assets, but also positions Investment Managers and Asset Owners to thrive in an evolving real estate landscape that increasingly values environmental responsibility.

Navigating the Path to Sustainable Real Estate Investment

In the ever-changing world of real estate investment, the CRREM framework stands out as a powerful tool, offering a unique chance to identify and address potential risks. However, seizing this opportunity requires a critical consideration – the reliability of the data used in decision-making. As Investment Managers and Asset Owners leverage CRREM insights, the key lies in scrutinising the foundation, ensuring that every risk assessment is based on precise and dependable information.

The challenge goes beyond risk assessment to the crucial decision-making process around decarbonisation. Investment Managers and Asset Owners are faced with a dual mandate – understanding the capital cost associated with decarbonisation, and making informed choices on whether to invest or divest. Unravelling this challenge involves developing asset-specific, engineered pathways for decarbonisation.

These pathways are not just plans, but intricate guides that delve into the specifics of each asset in isolation. They are the key to deploying capital efficiently and effectively, steering real estate portfolios toward a sustainable and resilient future.

As the industry stands at the crossroads of risk and opportunity, the call to action is clear – invest in precision, align decisions with accurate data, and embark on a journey of decarbonisation that is both strategic and impactful.

For more on how we can support you on this journey, contact Craig Needham.

Craig Needham

Craig helps our clients to build their Net Zero journey and bring it to life.

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