Asset managers underestimate property ESG transition costs

Investors and analysts have warned that asset managers are ignoring the high costs of reducing buildings’ emissions.
Asset managers underestimate property ESG transition costs

A leading property investor has warned that many fund managers are ignoring future costs of reducing building emissions, resulting in artificially inflated valuations, as property analysts at a leading investment bank suggest such costs in some countries could reach 4% of a portfolio’s total value.  

Toby Selman, who is in charge of property investment strategy at the New Zealand Superannuation Fund (NZ Super), a sovereign wealth fund with NZ$60 billion ($40.5 billion) in assets under management, told AsianInvestor that asset managers often failed to consider the costs associated with moving the asset to a future carbon free economy when valuing an asset.

NZ Super uses value-at-risk – a measure that quantifies possible losses associated with the asset over a given time period – in order to quantify this so-called transition risk, but says that managers often fail to apply this or equivalent measures.

“They’ll say the value is 'x', but we’ll then ask have you incorporated the value-at-risk both direct and indirect? This measure of physical value at risk very much gets to the heart of the matter,” he said.

In a May research note for Jefferies, property analysts Mike Prew and Andrew Gill warned of poor disclosure and the danger of underestimated costs across Europe, especially in the UK.

“Retrofitting buildings is exposed to hidden and unbudgeted capex inflation and is now influencing lease and debt pricing. “Reit (real estate investment trust) disclosure is lagging,” noted the report, which is titled 'eMission Impossible? The cost of going green is getting more uncertain'.

“[Costs of decarbonising buildings can range from 1.2% to 1.7% per year of value over their useful lives, with hotels then offices worst affected and across Europe the Nordic markets [best] insulated.”

In light of current net-zero targets, it estimates average renovation costs, as a proportion of a building's value, required to extend commercial buildings’ economic life by 10 to 15 years in Europe, was 11.5% in industrial. Retail was 14.4%; offices 17%; residential 17.5% and hotels was 22.3%.


Selman also singled out the UK, namely London’s office sector, where many buildings must comply with nationwide government minimum energy efficiency standards by April next year.

“The building might look great, but then overnight [with the introduction of the new requirements] there is this risk,” he said, adding that the cost in some cases of transitioning a building in this way might be two years’ worth of rent.

The UK government estimates that 10% of rented commercial property, covering a total area of 20 million square feet, do not currently meet the new standards. For a subsequent set of standards, due to be enforced by 2030, this increases to 85%.

According to Jefferies, the costs to bring portfolios up to 2030 standards for British Land and Land Securities, two of the UK’s leading Reits, equates to 4% of those portfolios’ total NAV, although the developers’ estimates put the costs between 1% and 2%.


Selman associated the failure of many fund managers to consider these transition costs with a wider short-termism when it came to environmental, social and governance (ESG) that, he said, was at odds with many investors’ long-term stewardship goals.

“A fund manager might say ‘we’re only holding the assets for five years’ – I’ve heard that a few times. No, that’s wrong: you still have stewardship responsibilities,” he said, contrasting “a lot of glossy brochures,” with a lack of action in many cases.

If the goal is to achieve carbon neutrality from a building in 25 years, Selman said a five-year holding period should end with the building one fifth closer to the final goal. “We expect and demand that the building has improved and is on track to meet its carbon neutral goal,” he said.

Selman pointed to a paucity of measurement methodologies to keep abreast of transition risk from advisors. “Everyone knows building with poor carbon performance will be worth less than low carbon, but this hasn’t yet fed through to valuation methodologies, which incorporate mainly historical data,” he said. He pointed to the valuation methodology employed by the Royal Institute for Chartered Surveyors (RICS), a leading global building valuer.

Besides using physical value at risk for NZ Super’s own analysis Selman said it actively promoted use of standards such as GRESB by its managers.

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