Financing net zero neighbourhoods in the UK: An integrated approach

How can we finance the retrofit of over 29 million homes in the UK? In a recent webinar, a panel of experts discussed 3Ci’s ‘Net Zero Neighbourhoods’ initiative and the advantages to place-based investment.

According to UKGBC, as many as 29 million homes will need retrofitting before 2050 to meet the UK targets set under the Climate Change Act 2008. Yet amid a cost-of-living crisis, the financial capability and willingness of households to pay for this retrofit is limited and there are insufficient public funds to cover the entire costs of retrofit.

In this webinar, a panel of property and investment experts discussed the Net Zero Neighbourhoods initiative of the Cities Commission for Climate Investment (3Ci). By integrating a variety of net zero projects – including the retrofit of different housing types and tenures – into a combined attractive investment proposition, the initiative aims to substantially reduce the need for public subsidy, while allowing savings from the cost of the schemes to be passed to householders.

Cross financing underpins 3Ci’s Net Zero Neighbourhoods model

Steve Turner is director of 3Ci. He says, ‘one of the first pieces of work we did was to identify the cost for decarbonising the UK’s 12 largest cities, including London. We identified a figure of £208bn. That figure is way beyond the public purse to fund. [To realise] the net zero transition, [we] will have to develop models that allow private investment to sit alongside public grants.’

There are several types of assets in a neighbourhood including housing, commercial, green and blue infrastructure and transport infrastructure. Adopting a place-based approach is vital to overcoming the barriers to investment in assets, such as residential, that typically lack scale and a stable, low risk source of returns. Steve explains the role that cross-financing can play in a neighbourhood approach decarbonisation, ‘by that I mean taking the revenues generated from renewables and using that to fund the retrofit of more challenging assets like residential’.

Cheap investment capital requires low risk, stable returns

When it comes to financing decarbonisation and retrofit, access to capital is not the problem says Melanie Leech, chief executive of the British Property Federation. ‘The problem is harnessing that capital in ways that allow investors to meet their fiduciary duties and manage risk’.

Charlotte Clark is director of Regulation for the Association of British Insurers. She explains, ‘there are trillions of pounds in the UK’s pension system. What we look for in investments are very long term; over 30, 40 or 50 years … We look for steady returns. We like stability and certainty [because] we pay our pensions in a stable, secure kind of way. We’re trying to match our investments to those sorts of liabilities’.

The challenge with retrofitting involves how to generate a stable income stream to pay back the investment. Charlotte continues ‘do you try to put a charge on the neighbourhood? Do you put a charge on people’s energy bills, because you know their bills will be lower?’

By making the payback mechanism as certain as possible, you can make the capital as cheap as possible, Charlotte says. She continues, ‘that’s why it is so important to work in partnership. Government can take certain risks on its balance sheet that the private sector pension firms would find very difficult because [either] the regulations won’t allow them to, [or] because the return they would need on their investment would make the project less economical’.

Following the development of a detailed business case with HM Treasury, 3Ci have been working closely with a range of major financial institutions, organisations and local authorities to develop a financial model that generates low risk, stable returns on investments in net zero neighbourhoods. There are 40 neighbourhood schemes in the project’s pipeline.

A place-based approach provides the scale necessary for investors

While dealing with individual properties is a huge risk for an investor, the net zero neighbourhoods model is based on a proxy area of around 1,000 homes, explains Steve. Melanie agrees, saying it is the scale proposition that will allow place-based investment models to harness private capital.

Melanie explains why successful approaches must also be tailored to local circumstances. While the end point is the same– getting to net zero – the starting point will be completely different. A neighbourhood located in the North East may have access to wind power from the coast, whereas the solutions for city centre neighbourhoods will be different. The profile of homeownership, industry and demographic profile of the population will all be different.

A net zero neighbourhood model that uses blended finance must align public and private investment in such a way as to produce returns on investment, but also generate outcomes that are important to local people. Steve explains, some properties that are being lived in are not fit for purpose. Retrofitting those homes to be more energy efficient can improve the health and economic situation of residents, releasing some of the pressure on local health and social care as well.

‘One of the things that I think 3Ci have done really well [is] getting together a lot of different actors’, says Charlotte. She explains that sitting in meetings with local government, people with technology expertise, property professionals or investment experts reveals that when there is something you think is hard, someone else thinks it is easy.

Local governments must lead net zero neighbourhood initiatives

‘We all live in neighbourhoods … and we recognise what makes them .. more attractive for people to want to live there and for businesses to locate’, says Steve. The challenge lies in the fragmented operation and management of local assets, some of which is in private ownership and some is in public ownership.

He continues, ‘this is a governance challenge; making partnerships work so that everyone is working towards the same primary objective. Local government … is best placed to curate the programme of work to create net zero neighbourhoods because they are  democratically accountable bodies and answerable to the communities that live in those neighbourhoods.’

Melanie agrees. ‘What local authorities can bring to these models is the security for investors in having a partner with a clear vision and leadership. The private sector provides the investment and the local authority … delivers the services.’

Public sector capacity building underpins successful local partnerships

Steve explains that one challenge to making net zero neighbourhoods successful is the availability of the skills and capacity to develop place-based investment models. Some parts of the UK, such as Greater Manchester and the West Midlands, have fantastic capabilities to bring together public and private sector partnerships, whereas others don’t.

He continues, ‘in the present day, these skills tend to reside in private sector rather than local government, and accessing those skills is not cheap’. Charlotte agrees, explaining ‘if the UK plan is for [local authorities] to work with private sector investors, there has to be funding [that] allows them to build up that resource and those capabilities.’