Last week, PGGM Investments, a EUR190 billion Dutch pension fund, announced that over the next 5 years, it is seeking a 50% reduction in carbon emissions from its investments in real estate – both listed property companies and private equity real estate funds. This is the world upside down: typically corporates make announcements for energy reductions or carbon neutrality – recently Coca Cola pledged to reduce the carbon footprint of “drinks in hand” by 25% in 2020, and Google and Walmart have announced to target powering their operations for 100% by renewable energy. PGGM’s goals are laudable, but I’d like to provide some context:
Targets (and precedent)
The real estate sector is responsible for 81% of electricity consumption in North America and Europe, and figures are comparable for other developed markets that shifted from manufacturing to an economy focused on the service sector. While these numbers are high, and are leading to regulatory and investor scrutiny, the numbers do not necessarily mean that the built environment is hopelessly wasteful. After all, the energy and electricity are inputs for economic production – the energy is used to run buildings and appliances, in the same way that manufacturing facilities use energy to produce widgets. So, while we know that buildings use a lot of energy, we do not necessarily know how efficient or productive the sector is as a whole. Consequently, it is difficult to understand the levels of reduction that the sector can achieve while increasing economic output.
Let’s be clear, this should not be an excuse for inaction: I fundamentally believe that the real estate sector can dramatically improve its efficiency. The McKinsey curve may be overly optimistic about the profitability of many energy efficiency opportunities in the real estate sector (even though current interest rates brings the cost of capital very close to the social cost of capital used in the McKinsey calculations), but the fruit of energy efficiency is ripe and still hanging low, and opportunities for energy savings in buildings are abound.
Interestingly, the state of California recently passed legislation with a target to reduce the energy consumption of buildings, by 50%, over a period of 15 years (by 2030). In other words: slashing consumption is on the minds of both investors and regulators. But, PGGM’s goal of 50% reduction is no small feat, let alone in 5 years. For some perspective, the 2015 GRESB data provide interesting stats for energy reduction targets:
- 348 out of 707 property companies and funds have long-term energy reduction targets;
- The average reduction target is a 15% decrease in energy consumption over a period of 6 years;
- 10 companies and funds have reduction targets of 50%(or more), over an average period of 11 years;
- Short-term reduction targets (for one year) are in place for 282 companies and funds, with an average reduction target of 5 percent.
For carbon emissions:
- 288 out of 707 property companies and funds have long-term carbon reduction targets;
- The average reduction target is a 21% decrease in carbon emissions over a period of 7 years;
- 37 companies and funds have reduction targets of 50%(or more), over an average period of 13 years;
- Short-term reduction targets (for one year) are in place for 247 companies and funds, with an average reduction target of 7 percent.
And here are some illustrative examples of reduction achievements by property companies and funds (based on public statements on websites and on GRESB data):
- 35% portfolio-wide reduction in energy intensity and 46% reduction in emissions intensity, over the 2005-2015 period – The GPT Group (Australia)
- 30% portfolio-wide reduction in energy use, over the 2003-2013 period – Simon Property Group (U.S.)
- 65% reduction in landlord energy use, and 50% reduction in building energy use – Case study by British Land (one building, U.K.)
- 49% reduction in portfolio-wide energy use – Case study by Triodos Vastgoedfonds (Netherlands)
- 23% reduction in energy intensity and 56% reduction in carbon emissions intensity, both in the portfolio of managed shopping centers, over the 2006-2012 period – Unibail Rodamo (France)
- 60% reduction in carbon emissions of the portfolio, over the 2006-2015 period – Hermes Real Estate (U.K.)
Carbon emissions versus energy consumption
Reduction targets are often set for carbon emissions, not energy consumption. I prefer energy reduction targets to carbon reduction targets.
First, carbon emissions ultimately reflect the choices that a property company or fund makes regarding energy efficiency, energy procurement, renewable energy, and scope of reporting/coverage. For example, a property company or fund can simply procure “green” energy, with that reduce its carbon emissions and pass the (slightly higher) energy bill on to its tenants. There are quite some examples of property companies and funds that pursue procurement of green energy, ranking from the Local Government Super real estate fund that procures green energy only, to the Dutch funds managed by CBRE Global Investors, that procure green energy for landlord-managed areas. Of course, reduction through energy efficiency improvements or through the use of on-site renewables is much harder.
Second, carbon intensities are difficult to compare across jurisdictions, due to differences in the energy mix – carbon simply matters less in the hydro-rich Nordics or nuclear-powered France. So, the information content in company-specific carbon intensities is low.
Third, energy reductions have direct financial implications, whereas the relevance of carbon emissions can be important or irrelevant for property companies and funds. This depends on factors such as:
- Carbon pricing (even in the presence of a carbon trading scheme, financial implications are limited – for example, at a cost of USD32 per ton of carbon dioxide, this would translate into 32ct/sq.ft. for a firm like Walmart);
- Composition of the energy mix (mostly, percentage of the energy generation through fossil fuel sources);
- “Softer” factors like corporate CSR strategy and stakeholder pressure.
This is a complex trade-off frontier: energy cost and emissions are complementary issues. Energy costs have a complex price structure. Emissions are the environmental externality from energy consumption.
To measure the 50% carbon reduction targets imposed on property companies and fund managers, PGGM will rely on predicted measures of consumption for those buildings for which it currently does not have data. Measuring building energy consumption and carbon emissions used to be hard, and perhaps even expensive. However, times have changed, technologies have evolved, smart meters have been rolled out, utilities are becoming more open and able to share data, and simple data management systems can be procured at a (very) low cost. However, some property companies and funds still struggle with systematically collecting non-financial data – 28% of the 707 property and companies and funds reporting to GRESB in 2015 did not report any data. And of course, the scope of reporting is often limited to landlord-obtained energy data.
This leads to the question on how to get more data and more accurate data on the complete portfolio of investor’s real estate allocations. There are two ways: more pressure on property companies and funds to start collecting data, or relying on (gu)estimates. My strong view is that the first option is desirable. After all, building energy consumption estimates are inaccurate – the correlation between European building energy labels and real consumption is 0.65 at a maximum. The role of building occupants, building management, and an owner’s vision, determine how a building really performs. In order to make improvements reflected in savings on the meter over time, we need to measure real consumption, standardized by relevant metrics. Let’s not forget that an empty building performs best on a kWh/sq.ft. basis, and that increasing consumption in an industrial facility is not necessarily a reflection of economic inefficiency.
One more thing: now that we have the Volkswagen experience still fresh on our minds (memory is short, and in six months this will have been forgotten...), it is important to rethink how to properly enforce legislation requiring perhaps irrationally large reductions in emissions, and in the same vein, the realism of investors requiring such reductions. Wall Street famously finds ways around legislation, the automobile industry seems to be pretty capable at circumventing legislation, and so, perhaps, are many other industries, including the real estate sector.
Let’s set aggressive but realistic targets, pushing property companies and funds to invest in energy efficiency solutions that are now often disregarded “because the payback period is 5 years.” Let’s make those targets long-term enough so the market can do its work, innovating itself out of the energy and carbon challenge. Some may not agree, but I’m hoping that more investors will make clear to the real estate sector what they want, while monitoring and engaging along the way. GRESB is already providing the tools for such engagement, with many more solutions to come in 2016. I’m optimistic that the real estate sector can reduce its consumption and emissions by 50% over the next decade – buildings as the solution, that’s the mantra!