Climate-related stranded assets in real estate part 2: Is energy performance the best indicator?

Kevin Muldoon-Smith is Senior Lecturer and Paul Greenhalgh is Professor of Real Estate and Regeneration. Both are based at the Department for Architecture and Built Environment, Northumbria University. Martin Haran is Professor of Real Estate and Urban Studies at Ulster University. In the second of this four-part series, we spoke to the experts about risk, data availability, and the use of EPCs.

How do you determine if your portfolio is at risk?

Paul Greenhalgh: In the UK, we know that minimum energy performance standards are rising and expanding. The suggestion is that all non-domestic property is going to have to be B by 2030, so I don’t believe a portfolio exists where there is no risk of stranding.

Kevin Muldoon-Smith: It’s almost a given that most properties are at risk. The real question is: what is holding landlords and owners back from doing more about their exposure at the moment? Some in industry are hedging their bets. They are waiting to see what international and national governments do, and whether they are really going to enforce the rules. For example, in the UK with the Minimum Energy Efficiency Standards, research published by the Estates Gazette published in 2019 [1] found no action had been taken to enforce the rules across the country. While landlords and investors are waiting to see what happens, there’s a small vacuum.

The major banks - those issuing mortgages or financing real estate – are doing asset checks and taking on board energy performance certificates (EPCs) now as an indicator of the risk of assets they are lending towards. They are issuing debt at enhanced rates for those who have better performing properties.

PG: It also goes into the residential sector because a potential lever is via mortgages. You might argue that the biggest area of exposure is owner-occupied, because there is no lever, unless people feel it in their pockets through gas and energy bills.

KMS: The basis of current energy performance data is mostly derived from some form of energy performance certificate. You’ve also got to remember that EPCs, which are often used as a proxy for environmental performance, are not always measuring the carbon intensity of the building. There’s an issue there in the way we understand the performance of our buildings.  For example, EPCs for commercial stock use the Simplified Building Energy Modelling (SBEM) software to arrive at ratings. But really, we need a much more dynamic understanding of energy performance and exposure to different types of issues, including fossil fuel exposure.

So what are EPCs measuring, and what can they tell you about an asset?

KMS: The important thing to bear in mind is that when you’re talking about energy performance, you’re not talking about fossil fuel related stranding: they don’t run in parallel. The best data we have around the world is EPCs, but it’s quantifying a slightly different problem.

This is because EPCs are designed to provide an indication of how efficiently your building uses energy, which is an important contributor to reducing overall emissions.  What they do not necessarily measure is the reliance on fossil fuels in energy use.

KMS: Yes, you can have properties that are BREAAM excellent, and could be EPC rated between A and D, but they are still very fossil fuel reliant. For example, removing an air source heat pump and replacing it with a gas boiler can bring your EPC performance up because the underlying software tool recognises this as net benefit. But if you’re looking at climate-related stranded asset exposure – and want to reduce the carbon emissions associated with your asset, the performance rating should go down.

Some of my criticism of SBEM is unfair, as it was designed to be inherently simple and quick - in order for assessments to be conducted quickly. In doing so, it is reliant on the data available when the assessment takes place and when the data is not available, assumptions are made. SBEM has evolved during the lifetime of EPCs leading to considerable improvements. However, this reveals an additional problem: what happens to older EPCs when they are re-examined? EPCs in the UK need to be renewed every 10 years, and there can be significant volatility in the original assessments.

PG: There’s clearly an opportunity for RICS here, because a lot of its professionals are involved with doing EPC assessments. As a valuer, I know that it’s difficult to put a value on a property plus or minus five percent. You would have thought it would be easier to pin a certificate on a building, but the data would suggest its almost plus or minus a grade. The data needs to be more consistent, more rigorous and more comprehensive.

Martin Haran: One of the big challenges is having meaningful data around the levels of energy consumption, carbon consumption and the carbon intensity of building. This is where the CRREM [2] project can add value to the decarbonisation agenda. The CRREM risk assessment tool allows property owners or investors to plug in the data for their own property. Whether it’s an individual asset or a portfolio of assets, the tool facilitates the creation of a bespoke risk exposure framework that profiles when particular assets are likely to be exposed or susceptible to stranding.

The CRREM tool also enables companies to look at different intervention points in the timeline to conduct a green retrofit. From an operational point of view, if you initiate a green retrofit at year 15 or year 20, you want to understand what the clawback period is, what is being gained in terms of emissions reductions and how increased energy efficiency is impacting operational costs. Bringing that data together is key. The CRREM tool is free, and although the project has now officially ended, the tool can still be used as a starting point to enhance awareness and insight in the sector. Updates and ongoing maintenance of the datasets will be funded via the Laudes Foundation.

It sounds like there are still unknowns on the data side. What else is still unknown around this issue and why? How can we plug those knowledge gaps?

KMS: There’s two major unknowns: one is what governments are going to do, if they are going to put some teeth on the legislation. The other lies in the quality of the existing information out there. If you really want to get a hold of the problem, you need consistent data framework internationally.

MH: The big problem for us in working in this area is the fragmented nature of the real estate data value chain. GDPR was brought in to enhance privacy and the security of data, but it has also had some unintended consequences, making it difficult to connect or bring together all of the key data sets. Data is key to setting your baselines, to measuring impact and identifying operational uplift and benefits. Without robust data capture, it’s difficult to articulate and rationalise the decision around green retrofitting. A big deficiency in data also concerns behaviour. You can have the most energy or carbon efficient building, but actual energy usage can vary, depending on employee culture: how employees in that building consume energy.

[1] https://www.egi.co.uk/news/mees-one-year-on-no-enforcement-proceedings-in-first-12-months/

[2] https://www.crrem.eu/