As low-carbon building performance standards spread, and banks and companies move to decarbonize their portfolios, commercial asset managers are profiting by transforming carbon-intensive commercial buildings into greener assets.
In Europe’s weakened commercial real estate (CRE) market, the “niche” business of converting fossil-fuel-heated, inefficient “brown” buildings to clean, energy-efficient standards is gaining traction, reports Bloomberg. The CRE sector saw values decline roughly 14% from March, 2020 to June, 2024, according to MSCI Inc. But with environmental regulations tightening and commercial tenants increasingly focused on cutting their Scope 1 and 2 emissions, some CRE fund managers are snapping up discounted brown buildings, retrofitting them green, and earning higher rents and sale prices.
But brown-to-green investment comes with risk, Bloomberg writes. “Analysts monitoring the market warn of rising capital expenditures, as well as a lack of skilled labour that could fan wage growth and significantly drive up renovation costs.”
While concerns over hefty retrofitting costs are legitimate, building owners and managers should consider the risks of not greening their portfolios, CBRE Canada Chairman Paul Morassutti wrote in a September post. Demand from occupants and investors is growing, with many tenants unwilling to compromise on their net-zero commitments.
“The unreported reality is that there is a shortage of this type of space,” he said.
Retrofitted green buildings also come with economic advantages: lower operating costs enable higher rental rates, which together boost net operating income.
Over time, “we expect building performance standards to increasingly become the norm rather than the exception,” wrote Morassutti, citing New York’s Local Law 97 and Vancouver’s new-minted Annual Greenhouse Gas and Energy Limits bylaw as examples.
As well, the “availability of debt capital is certain to change” as banks are forced to reckon with the lack of green assets in their own lending portfolios.
“Some groups estimate that the combined carbon footprint of Canada’s eight biggest banks is over twice that of Canada as a whole,” Morassutti wrote. “Banks will not be able to advance their net-zero goals by lending to brown assets.”
In Europe, change is already in the wind. “Over half of European CRE managers are now sitting on stranded assets equivalent to at least 30% of their portfolios because they don’t meet new green standards,” writes Bloomberg, citing a recent study by Deepki, a sustainability data provider for real estate owners and investors.
The same study found that 87% of CRE managers surveyed “plan to increase the purchase of poor energy-performing buildings with a view to retrofitting them.”
Asset managers getting in on the ground floor are turning green into gold.
United Kingdom-based Schroders, which manages a £460 million (C$826 million) investment trust that’s “focused on improving the sustainability of about 40 UK commercial properties,” recently retrofitted a warehouse in Manchester into an operationally net-zero-carbon building, enabling it to charge up to 40% more in rents than older properties on the same estate.
Houston-based Hines is also getting in on the action, with 35 pension funds alongside other investors buying into its US$1.7-billion fund to flip commercial properties in Europe.
Hines expects to turn a profit of at least US$2.57 billion by the projected 2030 end-date for the fund, Paul White, senior fund manager for the Hines European Real Estate Partners series, told Bloomberg.
“We usually sell pretty quick,” White said. “We can flip a building in three-to-four years.”
