The real estate sector is often overlooked when people think of the green transition, said Zsolt Kohalmi, global head of real estate and co-CEO of Pictet Alternative Advisors, during a presentation on a “green wave” in real estate held at Pictet in Geneva on 20 September. Instead, much of the attention centres on the transportation sector, such as carbon emissions due to air travel, or industry.
But buildings are responsible for 40% of energy consumption and 36% of greenhouse gas emissions, according to the European Commission. The International Energy Agency has calculated that 39% of energy-related global CO2 emissions in 2022 came from buildings. Moreover, 90% of the building stock in the European Union was constructed before 1990, notes the European Commission, and in many cases, these buildings not very energy-efficient.
Need incentives for energy-efficiency renovations
“The average life of a building is 90 years,” said Kohalmi, and “in general, 40-44% of carbon emissions are produced during the first two years when the building is constructed.”
Renovation to make these buildings more climate-friendly would therefore result in lower carbon emissions than brand-new constructions. Fifteen tonnes of carbon are emitted for the refurbishment or renovation of a building, compared to 50 tonnes of carbon emissions for a newly constructed building. And emissions, once produced, stay in the atmosphere for hundreds of years, he added.
For Kohalmi, two things need to be done. “One, the measurement of emissions needs to be changed to include emissions produced during construction,” he said, not just annual emissions. And second, “As time goes on, we will see more incentives for refurbishment, instead of new construction,” added Kohalmi, pointing to the 90% of buildings in the EU constructed before 1990. “It will really be necessary to do a lot of refurbishment.”
“Paradigm shift” in real estate sector
But besides the environmental benefits, why bother with renovations that improve energy efficiency?
Between 2008 and 2022, interest rates were very low, resulting in multiples (cap rates) improving every year and cheap leverage increases. All of this benefited property owners, and in particular, core funds and mega funds, explained Kohalmi.
We’re now back to what I call ‘old-school real estate,’ or the situation pre-2008
“For me, we’re in a new paradigm in 2023,” he said. “This annual revalorisation ‘gift,’ thanks to lower interest rates and improving multiples, is no longer there.” And so, new ways of creating value in real estate must be found. “We’re now back to what I call ‘old-school real estate,’ or the situation pre-2008,” said Kohalmi. This means that owners have to improve their buildings, such as by adding another floor or changing something in the building to make it more attractive, to add value.
“This is a rather important shift in real estate. It’s a shift back to what we had seen before 2008, but that we had almost forgotten, in a world where interest rates were at 0%,” said Kohalmi.
Green buildings bring in higher rents
Beyond the need to find ways to add value to property, given the current economic environment, physical risks related to climate change, such as flooding or extreme heat, can also lead to devaluation in commercial real estate, noted Pictet’s presentation. So by making buildings more sustainable, you can hit two birds--an economic bird and an environmental bird--with a single stone, so to speak.
A green office building will, on average, have rents that are 23% higher, making it more lucrative for owners, continued Kohalmi, referring to a CBRE sustainability study on ESG certification. Many have also made “promises” to shareholders to diminish their greenhouse gas emissions, he added, thus pushing them to move towards green buildings.
Green buildings are also rented out more quickly, argued Kohalmi, but this is very difficult to measure. He offered as an example Pictet’s purchase and refurbishment of 100-year old Victorian buildings in Manchester into modern, climate-resilient offices. “It was purchased at 80% rented,” he said. “It’s now rented at 100%, even though the market has gone down. And why? Because we have decreased the building’s [energy] consumption, we have created a green building.” These offices today are powered by 100% renewable energy.
“Buy high, sell low”
At first glance, the strategy initially shown in Pictet’s presentation--“buy high, sell low”--might seem counterintuitive. Of course, one has to look a little deeper. The full strategy is actually to buy high carbon emission buildings, then sell low carbon emission buildings.
So--concretely--how does this work?
Not every building is refurbished in the same manner. But with every building, we become more efficient
“The most important, I always say, is the heat pump, because that is three to five times more efficient than gas,” explained Kohalmi. “But a heat pump comes with other aspects. To install a heat pump and for it function well in a building, you have to check what other measures need to be taken: do the windows need to be changed, is more insulation required, does floor heating need to be installed. And this changes all the time, depending on the building. There’s no standard, and that’s what’s difficult in renovation--not every building is refurbished in the same manner. But with every building, we become more efficient.”
Heat pumps, in addition, can be reversed to allow for cooling in the summers, added Kohalmi, increasing their usefulness. These can be expensive, but they pay for themselves within a few years (depending, of course, on the price of gas and electricity).
Proptech--or property technology--is another important way to make buildings more climate-resilient, said Kohalmi. Examples of proptech include sensors that can regulate the temperature of a building, he said, illustrating his point with the example of a building where 40% of its heating was used between 21:00 and 4:00, before being corrected. “Sensors are becoming more important,” he said.
Advantages of modular, Lego-like constructions
In response to a question about wooden buildings--such as Guillaume Poitrinal’s low-carbon WO2 office buildings in France or the Wooden building in Leudelange--Kohalmi thought these “will have their place.” Many people are looking into how to use wood in order to have the necessary “solidity,” but getting permits for wooden buildings is “not easy.” The authorities are not yet used to wooden constructions, said Kohalmi--they’re more used to evaluating concrete buildings.
In addition, wooden buildings are limited to five or six floors, he said. In order to build higher, a concrete “core” would be needed.
Instead, what Kohalmi is a “big fan” of is modular construction. It’s like building Model T’s, he said, referring to Ford’s famous mass-produced automobile, which used an assembly line to speed up production. In the construction sector, pieces are built in a hangar, which can then be put together on-site like giant “Legos.”
The advantages? There’s much less waste, less construction noise, it’s faster and--with the thousands of photos taken during the process--it’s easier to inspect and find any issues, said Kohalmi, adding that many projects that combine wood and modular construction are now in progress.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link.