(Bloomberg) — As if the commercial real estate market wasn't already in crisis enough, there's a new risk lurking in real estate portfolios.
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Real estate companies are facing a big hit to asset valuations as evolving European regulations force investors and bankers to reduce their exposure to carbon-intensive buildings. This problem raises the possibility that property owners' assets will be left in limbo as the value of their assets declines due to climate regulations.
“The industry is now very aware of stranded assets,” said Neil Menzies, director of sustainability at Dublin-based Hibernia Real Estate Group, part of Brookfield Asset Management. speaks. The risk of assets being left stranded “is even greater now that it has been enacted.”
Commercial real estate values have collapsed after rising interest rates and falling occupancy upended the financial logic of the sector's debt-dependent business model. The European Central Bank and the Federal Reserve have both said they are currently monitoring what lenders are doing to mitigate potential losses.
Against this backdrop, the industry is now facing a further valuation shock as it becomes clear how much retrofitting and investment will be required to bring most buildings across Europe to meet the European Union's new requirements for energy efficiency. Mr Menzies says that
Mr Menzies said the situation is so dire that the market expects “values for unsustainable buildings with very high energy usage will probably plummet over the next 12 months”.
The European Union estimates that around 85% of the region's buildings were built before 2000, of which 75% have “poor energy performance”, the EU said. The EU has set targets to reduce emissions in the building sector by 60% by 2030 and to fully decarbonize by 2050. According to the European Commission, buildings are the “single largest consumer of energy in Europe”, accounting for 42% of energy consumption.
Stranded assets:
The term, popularized by the Smith School's Stranded Assets Program about a decade ago, refers to assets that have suffered unexpected or premature write-downs, write-downs, or conversion to debt. UBS Group AG says that in the real estate context, this can include buildings that are energy inefficient and ultimately become impossible to rent or sell or uneconomic to own. It pointed out. Such properties may also become uninsurable due to increased physical climate risks, UBS said.
Other EU regulations, such as the Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive, also make it difficult for investors in the region to ignore the carbon footprint of real estate.
Warnings about climate risks in real estate portfolios are steadily increasing. Analysts at UBS Group AG said in October that the new regulations increase the likelihood that assets will become stuck, “potentially leaving owners with significant capital losses relative to their current book values.”
The Swiss bank said the problem could become a vicious cycle. UBS said: “Inefficient buildings are also likely to have an impact on investors' climate balance sheets, and high utility costs and poor sustainability ratings may make them less attractive to tenants.” There is.
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Although Europe is ahead of other jurisdictions in enforcing regulations, the risk of valuation shocks is global.
“North America has traditionally lagged other regions in decarbonizing and building sustainability, and new climate and sustainability disclosure regulations pose significant risks to the real estate sector,” research and advisory firm Claire Stevens, research director for smart buildings at Verdantics, said:
In a statement related to the December release of Verdantix's annual Smart Buildings Survey, he said, “Insurers are moving away from facilities that are insufficiently resilient to climate change, and investors are increasingly looking at sustainability performance. There is a possibility that companies with low performance will be avoided in real estate as a whole.” With increased awareness of these risks, companies are now stepping up efforts to convince investors of their greenness, “particularly in industries such as hotels and leisure,” he said.
Hibernia's Menzies said in an interview that investors are now using so-called carbon risk property monitors to try to accurately estimate when a property asset is considered stranded.
Investors and bankers using the CRREM tool “know exactly the date the building will be stranded,” Menzies said. They ask detailed questions about climate-related issues such as anticipated energy usage before offering credit.
“Financial providers are very sophisticated and have the talent in-house to model this,” he said.
CRE financing by country (in billions of euros, % of loans)
Bloomberg News: EU banks' €1.4 trillion CRE lending stress appears to be under control for now
Hibernia, which focuses on the Dublin office market, is renovating older buildings and developing new ones with the aim of making buildings net-zero carbon and climate resilient by 2030. Mr Menzies said. The company's 30 buildings were valued at about 1.3 billion euros ($1.4 billion) when they were acquired by Brookfield in 2022.
For companies that can develop credible sustainability plans, the response is “very strong interest and interest in green loans and other sustainability-related loans and refinancing projects,” he said.
Overall, Mr Menzies said the fall in valuations he expects next year will “hopefully” bring the market to a level that creates “opportunities for companies to come in and buy”. And by investing in renovations to bring the building up to new standards, it will be in a position to support valuations, he said.
Meanwhile, companies like Hibernia “need to show real-time performance and year-on-year improvement to get interest from investors and lenders,” Menzies said.
–With assistance from Gautam Naik.
(Adds comment on global ripple effects of climate risks in buildings starting from paragraph 11)
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