By Ilona Otoka, ESG services manager and licenced valuer, Cushman & Wakefield



Global real estate – one of the largest contributors to greenhouse gas emissions – should become net-zero in less than three decades. With as much as 80% of the predicted building stock for 2050 already in existence today[1], this best illustrates the scale of the challenge. Meanwhile, the commercial real estate market has not, as yet, officially acknowledged either the costs of necessary property upgrades or the costs of delaying or not taking any action. At the same time, due to a lack of market standards, benchmarks and a system of data collection, valuers can hardly factor ESG risks in property valuations. This impasse has significantly increased the risk of a carbon bubble.

Today, investment funds frequently rely on climate and decarbonisation risk tools such as CRREM (Carbon Risk Real Estate Monitor) in assessing which assets in their portfolios are likely to be stranded in terms of environmental impact and risk of losing value over time. At the same time, valuers still lack sufficient market data to properly factor ESG transition risks in real-estate values. This is likely to keep property values at higher levels, leading to a risk of a carbon bubble.

This view is shared by the Urban Land Institute Europe, which has warned the real-estate industry of a serious crisis unless it develops standards for factoring transition effects in pricing.

The concerns are that if real estate values do not factor in decarbonisation costs and benefits or other transition factors such as non-compliance with future ESG regulations or expectations and requirements, this may lead to a carbon bubble.

If we allow it to inflate and take too long to incorporate the risks of transition towards a low-carbon economy in real estate values, the carbon bubble is likely to result in sudden repricing.

A growing proportion of office stock is at risk of falling out of the market

According to Cushman & Wakefield’s report Obsolescence = Opportunity: The next evolution of office space in Europe, more than three quarters (76%) of office stock across Europe will be at risk of obsolescence by 2030 unless landlords actively invest in improving the quality of their space or look to find alternative uses for it. The combination of changing work patterns, growing occupier requirements, an uncertain economic backdrop as well as increasing legislative action around minimum sustainability standards are all key factors driving this risk to office assets.

While it is not too complicated to give an estimate of the costs of replacing a building’s systems or other upgrades, it is much more difficult to assess the risk of new taxes or charges for excess carbon emissions. Meanwhile, a wave of stranded assets is likely to arrive much sooner than we may think.

According to GRESB[2], an international organisation providing validated ESG performance benchmarks for real estate, the average stranding year for the European property sector is 2026. This is a clear signal that transition must significantly accelerate.

A ‘stranding year’ is a term introduced by the initiative Carbon Risk Real Estate Monitor (CRREM), which has developed a tool enabling property investors and landlords to identify and assess the risk of operational (in-use) carbon emissions against regulatory requirements. It shows, in practice, where a property is on the decarbonisation pathway consistent with the target of the Paris Agreement of limiting the average global warming to 1.5°C by reaching net zero by 2050.

A stranding year for an individual asset means the point in time at which it no longer meets current and future energy efficiency standards and market expectations, and will require additional investment in the near future or may be subject to new charges, such as those on carbon emissions.

Deflating the carbon bubble step by step

The lack of a market standard is the biggest challenge, which cannot be overcome overnight. Without reliable analyses and evidence, we are unable today to assess to what extent capex could improve a property’s energy efficiency and value. What we, as valuers, can already do is describe risks in real estate valuation and take account of specialist analyses such as climate risk analyses in order to calculate asset property values as best as we can. More and more of our clients are carrying our net-zero analyses and developing decarbonisation strategies for their real estate, which is a step in the right direction. A useful piece of information during the valuation process is, for example, the stranding year, that is an expected year in which a property will be above a decarbonisation pathway resulting from the targets set in the Paris Agreement and is likely to become less attractive due to the transition towards a low-carbon economy. This transition includes new environmental challenges, strict sustainability regulations or changing social norms and market relations, including tenant and investor requirements. Properties that are energy-inefficient or dependent on fossil fuels will be incompatible with a low-carbon economy and as such will be less sought-after and considered more risky. Taking account of this risk will help minimise its negative impact on property values.

Not every valuation method allows for taking account of this risk. The income approach and a discounted cash flow method make it easier. By contrast, the comparative approach or a simple capitalisation method can hardly take account of capital expenditure and transition or climate change risks.

Valuers act in compliance with legal regulations and professional standards, but when it comes to risk assessment, they rely primarily on market data. Change must take place fast and the market’s response must be clear. Standards and regulations must also regulate the issue of taking account of sustainability factors and transition toward a low-carbon economy – only then will valuers be able to fully reflect the transition risks in property values.

[1] Call for action: Seizing the decarbonization opportunity in construction, McKinsey

[2] Global Real Estate Sustainability Benchmark