How COP27 Impacts Real Estate: Pricing Real Estate Climate Risk

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How COP27 Impacts Real Estate: Pricing Real Estate Climate Risk

Guest post by Joe Miller, Member of USGBC Delegation to COP27 

One topic of urgent and primary focus at COP has been around how and who will finance the changes of climate change. 

The general mood around GFANZ (Glasgow Financial Alliance for Net-Zero), a group of the world’s largest financial institutions which pledged at COP26 in Glasgow to finance their own and their assets’ net zero transition, is not optimistic based upon current progress, despite the grand plans. 

Regarding real estate specifically, the latest Global Status Report released by UNEP this week found that built environment energy consumption has increased beyond pre-pandemic peak levels by 2%, calling for an urgent increase in energy efficiency in both new construction and existing buildings. Combining this with the estimated 300 million additional buildings required to meet demand by 2030 to avoid a severe housing shortage, the question at COP is how do we find the mechanisms to unlock capital for energy efficiency projects? 

REALISTICALLY PRICE TRANSITION RISK

At the moment, capital for the climate transition domestically and in emerging economies is often costlier due to perceived risks in policy uncertainty, technological developments, and less data on rate of returns. One of the primary levers being discussed to adjust this parity is realistically pricing transition risk into the market. Transition risks go beyond physical risk of climate change and include rising costs due to pricing-in of carbon emissions (through carbon taxes and pricing schemes), market effects, technological disruptions, legal liabilities, energy efficiency, and other regulations and reputational risks. When these risks are included in the market, the cost of not doing anything becomes enormous and cost of green capital decreases to appropriate market levels. 

To address this opportunity and risk, UNEP has developed CRREM (Carbon Risk Real Estate Monitor), a tool that allows building owners to assess the operational climate impact of their assets against the Paris Agreement goal for limiting to 1.5 degC. Referenced with the EU Taxonomy, any building that is not in line with 1.5 based on the tool can be labeled as a stranded asset—labeling the building of being at risk of early economic obsolescence due to not meeting energy efficiency or market standards. 

FREQUENTLY UPDATE VALUATION OF EXISTING BUILDINGS

Existing buildings are a specifically critical area to focus, as we need to retrofit roughly 3% per year, but are currently at a rate of less than 1%. Beyond not factoring in carbon and transition risks, existing building capital improvements that address energy efficiency are not updated at a regular enough interval to improve their credit score. Currently valuation often only happens when buildings are bought or sold, but improvements are made in between. If these are included more regularly, credit raters can more realistically value the building and improve opportunities for lending’s benefits. Initiatives, such as PCAF, are looking to aggregate the amalgamation of decarbonization data in real estate and develop tools that will assist in providing clear guidance for building valuation of energy efficient buildings. 

FACILITATE A JUST TRANSITION THROUGH POLICY

Addressing energy efficiency in low-income housing will also be crucial to protect underserved communities against rising energy costs, which pose a huge economic threat for those at the bottom of the economic ladder. Some provisions exist within the IRA for higher level tax credits for energy efficiency and renewable energy projects in low-income and brownfield sites. While these are not nearly enough, they are examples for how policy can play a role in a just transition. 

Other financial mechanisms include development banks and green banks which can de-risk investments by taking on the major liabilities and allow private capital to flow to sustainable projects in developing countries and low-income areas. 

ALIGN ON STANDARDS

Some additional takeaways from all discussions at COP are the need for alignment, clarity, and accountability of standards. There are too many definitional discrepancies of terminology, and lack of parity even between in-nation governing body standards let alone between countries. Central alignment of policy, building code, supervision, and certification at both the national and international levels will be a necessary next step. International meetings such as COP play this role to help progress a strategic direction and unification of stakeholders when functioning properly. 

Despite the consensus that we are well behind on the target path and on meeting past commitments, the solutions and talent to solve these challenges are readily available. It is motivating and inspiring to be surrounded by the international community and watch as the dialogue progresses each day. It is clear that everyone has the motivation, but our success will not be based on high-level discourse. Rather, it will come down to decisions to choose the sustainable options by the individual person, business, organization, state, and country.