European investors not yet pricing in climate risks, says AEW research

Current building certifications lack the focus investors will need to meet greenhouse gas emissions targets.

Investors are not yet pricing climate risks into asset acquisitions, according to new research issued by AEW.

The research, which assesses two sources of climate risk for real estate investors; immediate physical disasters and transition risk associated with climate change mitigation, says the transition risk associated with climate change mitigation might result in major issues for the property industry, despite recent media coverage focusing more on the issue of physical risks of disruption, damage and destruction of buildings as a result of storms, river flooding, rising sea levels, heat and droughts.

‘Recent headlines on storm induced flooding and Australian bush fires have placed increased attention on Environmental, Social and Governance issues from the media, investors, regulators and the public. Our analysis highlights the risk of properties becoming “stranded” by increasing insurance and adaptation costs in the short term,’ says Hans Vrensen, managing director, head of Research & Strategy. ‘But,’ he continues, ‘non-compliance with future energy targets and greenhouse gas (GHG) intensity pathways might be an even bigger game changer in the longer term, even if we expect delayed application and enforcement of these targets in local markets. Since investors are not currently fully considering these risk in acquisitions, it could have interesting pricing implications in the future.’

According to the research, which also examines the potential impact of non-compliance with stricter energy use and greenhouse gas emission rules set out by the United Nations and European Union’s Energy Performance of Buildings Directive, non-compliance might render many properties across all sectors as “stranded” well before the UN 2100 deadline. 

In fact, there is currently no clear correlation between the risk of climate hazards and the green certification of buildings. The current myriad of building certifications considers many varying factors with little weighting on energy use and/or GHG intensity. The expected shift in regulations toward GHG reductions could lead investors to shift their emphasis from finding green premiums for highly certified buildings towards quantifying climate related risk premiums and required returns for all buildings.

Physical risk of disruption, damage and destruction

Examining the physical risks from climate change, AEW analyzed climate risk scores provided by Munich Re, one of the world's leading Reinsurance companies. These climate scores are based on natural catastrophe models which are a combination of science and claims experience. This data allows for the quantification of the impact of storms, river flooding, rising sea levels, heat and droughts on a diversified sample portfolio of nearly 20,000 European buildings. The findings showed that properties in the Netherlands were potentially affected by rising sea levels. However the effects are mitigated by a countrywide system of flood defences. Areas close to rivers in the UK and France were among those facing increased risks in projected river flooding by 2050. Increased insurance and adaptation costs is likely to render many assets “stranded” or impossible to rent or sell, even in the short term.

Transitional risk could be bigger long term game changer than physical risks

Using data from the Carbon Risk Real Estate Monitor (CRREM), AEW found that buildings across multiple sectors in Europe are on the path to failing the future GHG intensity and energy use reduction requirements that would be necessary to meet the target of limiting global warming to well below 2°C by 2100 as committed in the Paris Agreement.

Without future action, these non-complying buildings risk transitioning into “stranded” assets well before 2100 leaving investors potentially unable to rent or sell them due to decreased market demand and/or tightened regulatory requirements. Both of these are reflecting efforts to future proof investments and portfolios.

Current GHG intensity varies widely between countries in Europe and across property types. Below average GHG intensity is seen in France - where 70% of the energy grid is sourced from nuclear power – as well as in the Nordic countries where renewable energy prevails. However, Poland and Czech Republic as well countries in the Baltics are above the average due to lower renewable energy sources, which translates into a much steeper GHG reduction pathway. Additionally, based on the intensity of their use hotels and offices have a much higher GHG footprint than residential and logistics across the European markets. Commercial properties will benefit from national government policies increasing the share of renewable sources in their energy production.

Thierry Laquitaine, head of Social Responsible Investment at AEW, concludes: ‘Our clients are increasingly asking for answers to how best to analyze and anticipate these issues. Climate risk is one of the most important risks that the industry will have to face, as the recent Davos forum stated. With a current lack of standardized tools and measurement, this research highlights some possible new ways going forward. We are actively collaborating with our investor clients, tenants, experts, regulators and government agencies to develop innovative new tools to manage climate change risks whether transitional or physical and seize related opportunities across our pan-European portfolio.’


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